End game

February 12, 2023 0 By Michel Santi


The gold standard was a system where the currency of a country was linked to gold and which could materialize either by defining a certain quantity of metal in exchange for the American dollar, or indirectly through currencies having a fixed parity against the greenback. As early as 1944 with Bretton Woods, only central banks had the right to convert their gold at the irremovable cost of $35 an ounce, plus possession by American private individuals of this precious metal was prohibited by President Roosevelt. For the record, it was not until 1974 under Gerald Ford that private Americans were able to legally acquire gold, and it was Nixon who  abolished in August 1971 the automatic convertibility of the dollar into gold, decision qualified at the time as a “temporary suspension”.


This fundamental historical date marked the definitive end of the gold standard, and the opening of another era, since the US debt was therefore to increase by an average of 8% per year, from 1,600 billion dollars in 1971 to around 31,000 billion today. The GDP of this nation was obviously also to increase substantially, from 1,100 to 25,000 billion, showing however a progression (5.8%) less than the debt. Economic activity – regardless of the country in question – is always dependent on the ability of its actors (companies and households) to contract debt. A basic and contemporary example happens to be the rate of 30-year US government bonds which has jumped in less than 2 years from 2.7 to 7%, while real estate sales have sunk in the USA by nearly 40%.


Without access to credit, or in the presence of a much more expensive financing cost, a significant proportion of consumers are thus excluded from economic life. Fanatics of the gold standard – or of some return of gold in the definition of money – periodically advance arguments that it will limit indebtedness while allowing some flexibility, because upward adjustments or the decrease in the quantity of gold supporting a given currency could be decided accordingly to the situation. Except that such a type of flexible standard would not differ in any way from our current system of floating exchange rates and would induce imbalances, speculation, crises and financial readjustments… so many upheavals which in the end would turn out to be even worse than the current system born in 1971.


The latter, it is true, is beginning to seriously show its limits, for elementary arithmetic reasons which indicate that the creation of debt – today – goes hand in hand and even exceeds the creation of money. Institutes have also calculated that an additional US dollar of debt produces barely 0.3 points of additional GDP. Our economies have – it is a fact – more and more difficulties to generate GDP without debt, a phenomenon greatly aggravated by the burden of this same debt which is still increasing altogether with rising interest rates. At the global level, it is around 11% of the world’s GDP which is thus trimmed by debt interests alone annually, and with a calculated average rate of 3%, in other words much more in reality with the interest rates closer to the double!


The fact remains that history has amply demonstrated that all standard systems were doomed to failure. The most glaring being that of the Great Depression which was indisputably aggravated and lengthened by the gold standard prevailing at the time within the industrialized Western nations. This correlation to gold acted as a straitjacket forcing monetary authorities to maintain high interest rates supposed to keep the convertibility rate of gold against the dollar, while the context of crisis demanded an immediate reduction in rates to revive the activity.


According to this logic imposed by the gold standard, the Federal Reserve of 2007 and 2008 would have been forced…to raise its interest rates instead of reducing them aggressively as it did in the aftermath of the subprime crisis! Is it necessary to make simulations on the devastating consequences for the American and global economy of such a rise in rates in the midst of the implosion of the real estate market or on the eve of the bankruptcy of Lehman Brothers?


The European crisis of the 2010s is also a textbook case demonstrating unequivocally that a regional bloc exacerbates its vulnerabilities when it renounces to exercise any control over its own currency. The 17 members of the European Union certainly did not link their respective currencies to gold, but they indexed it to the euro which had then acted, de facto, as a standard. Having functioned well for 10 years punctuated by decent growth and minor financial accidents, the “euro standard” was to reveal its structural weaknesses thanks to the Greek budgetary setbacks, the implosion of the Irish and Spanish speculative bubbles, or the flawed Italian economic policy. It was impossible for these weakened nations to carry out a so-called “expansionist” policy in order to revive their economy, either by devaluing their currency (which was pegged to the euro), or by reducing their interest rate (beyond their control because the sole responsibility of the European Central Bank). It was obvious that one and same standard (by definition totally inflexible) which brought together countries – like Greece and Germany – with such different – even contradictory – economic cycles and characteristics, was condemned either to collapse or to suffocate one block for the benefit of another.


In short, systems using a standard are not viable. Far from perfect, probably out of breath, we must therefore rethink our system, but certainly not in the light of barbarus relics.

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