In this series, we rarely get far into the 20th Century
because it's hard to have historical perspective on events that are that close to our own time.
But today, we're gonna have to roar in to the latter half of the 20th Century
to show you just recently this idea came to be.
This idea that seems so normal, that we all take for granted, as if it were always the case.
The idea that money is worth something
because we all agree it is.
Last time, we talked about the growth of central banks as a patch system to fix the numerous problems
that occur when you introduce paper money as the basis for an economy.
But for many people, one more step was required to really inspire confidence in this idea of
taking milled tree bark in return for their labor, and that was the Gold Standard.
The Gold Standard is basically the idea that
your paper money is backed in gold,
that at any time you could take your paper bill somewhere
and redeem them for a specified amount of gold.
Now I hear a lot of you say:
"Why would you ever do that? Doesn't putting a currency on the gold standard just mean that
we're back to the problem we were trying to solve in the first place?
By tying money to gold aren't we once again limiting the money supply?"
The short answer to that is:
And we're going to see just how that plays out.
The longer answer is:
"Ehh... sort of."
This is a pretty complicated economic question. Too complex to really get into here but
the concthe concise version is that
having paper money backed in gold rather than using gold directly
allows far more options when you need to expand the money supply.
And it has the advantage of letting you play fast and loose with the system when you need to.
But still, why would you do this rather than have your currency float free?
Well, that's where history comes in.
You see, the Gold Standard solves two major problems.
The first is inflation.
As you can probably guess,
it wasn't long after people started printing paper money that they figured that they could just
print a lot of paper money.
Way more paper money than they could ever redeem.
Way more than even our fractional reserve banking system thinks is sane.
As soon as people did that you started to get inflation,
and it could still happen even with the central currency controlled by the government.
Because when countries needed to say pay for an army, they would sometimes just print more bills to do it.
More bills means that each bill is worth less.
Which was a problem,
not only for those poor citizens whose life savings were now in paper bills,
but also for other countries who'd been accepting those paper bills in exchange for their goods.
Which brings us to the second major issue that the Gold Standard addresses:
exchange rates.
Right as paper money was becoming the standard in Europe,
international trade was really starting to pick up.
The Industrial Revolution was getting into full swing
and raw materials and finished goods had to be shipped and traded at a pace never before seen.
Simultaneously, mercantilism (that isolationist monetary policy that we discussed in an earlier episode)
is coming to an end,
causing trade to rocket to even greater heights.
But what happens when your ship full of cargo docks in some foreign port,
and you try to hand the local merchant your funny green paper money to buy their goods,
while they try to hand you their funny pink paper money to buy what you've got on your ship?
Well you both just sit there scratching your heads for a while.
Back in the day, you would have just weighed whatever coins they were trying to give you,
and accept them for their weight in gold.
But now they're handing you this piece of paper that you don't recognize and you have no idea how to value.
I mean, can you even trade this specific piece of paper for anything when you get back home?
But if both currencies are on the Gold Standard, problem solved.
Just as an example, let's say that
at any time
you could turn in 20 US dollars to get one ounce of gold.
1oz of gold is what your $20 are worth.
Now let's say you sail to England where (for the sake of keeping things simple)
the UK has set their gold standard so that an ounce of gold is worth two British pounds.
This makes everything nice and simple. Since you're both operating on the Gold Standard,
that means 1 British pound is the equivalent in value to 10 US dollars.
Done and done. Simple. So how does this all fall apart?
Well first we have to talk about how it all began.
If you saw our episodes on the first Opium War,
remember how we talked about the fact that all of Britain's silver was flowing into China to buy tea?
Well, to solve all the problems I just talked about,
the British were looking for some commodity to back the Bank of England notes with.
But with all their silver gone, the British chose gold.
And soon basically everybody followed suit.
But this system had its own breaking points.
Absolute adherence to the gold standard had to be suspended several times during the 1800s,
due to the massive expenses incurred by international war.
But in England, as in most other countries, there was always a return to the gold standard in peace time,
with countries working to build their gold reserves back up, and limiting the printing of further notes.
Other minor shocks llike the California Gold Rush other introductions of massive new sources of gold
would cause the system to lurch.
But, overall, use of the Gold Standard held up pretty well throughout the 19th century.
Then came World War One.
The Seminal Catastrophe.
The shatterer of so many notions from our past.
And like so many other things the Gold Standard crumpled under the impossible needs of the War.
Nation after nation abandoned gold to print more money
to pay for the arms, munitions and men that were being expended daily on the field.
And as more and more money was printed and spent to feed the insatiable hunger of this war,
trade became erratic.
Trade from the United States grew far beyond what the gold reserves of Europe could bear.
Inflation ran rampant. And after the war,
many countries couldn't drag themselves back to the Gold Standard.
Some nations like Germany,
who are spiraling into hyperinflation under the crushing debt of war reparations,
tried to stabilize their currency by backing it in land rather than gold.
Others like England appealed to people's patriotism and renched themselves back onto the Gold Standard
by asking people not to redeem their money for gold, just out of love of country.
But even this fell apart as the Great Depression hit.
Those few countries that had the wherewithal to stay on the Gold Standard like the United States
were now hamstrung by how the inflexibility of gold prevented them from reacting to the crisis.
And yet many people and many nations thought of this as a temporary hiccup.
"Sure the War and the Depression had made a mess of things,
but soon the good times would be back,
things would get sorted out and everybody would get back on the Gold Standard.
I mean, they had to, right?
Without the Gold Standard, how is money worth anything?"
But those good times didn't have a chance to come back because then came the big one.
World War Two.
World War Two was perhaps the most expensive war in history.
Economically, it was totally unsustainable, with the US racking up enormous trade surpluses
and every other country involved sinking into massive debt.
But the world had learned from World War One.
And as World War Two round down,
many of the major powers met to work out the first real international monetary agreement.
The famous Bretton Woods System.
You see, following the first World War,
Britain had owed the US a huge pile of money,
which they couldn't pay back unless
France paid them a huge pile of money it owed them.
But much of the war had occurred on French soil,
and the French couldn't afford to pay back the British unless they basically
made the defeated Germans pay for everything.
This of course had all been a disaster that caused huge financial and political instability.
So this time around, things would be different.
Reparations would be minimized.
Repayment of reparations would be on gentler terms.
And that whole problem of wildly unstable currency caused
by countries like Germany no longer being able to adhere to the Gold Standard after World War One?
This time the currency instability problem would be solved.
And how would it be solved?
Well at this point in history the US basically had everybody's gold,
because everybody had bought a ton of stuff from the US for the two biggest wars in history.
So the US actually WAS still on the Gold Standard.
So the solution was simple.
Peg everybody else's currency to the US dollar.
That's right, the system essentially boiled down to:
the US dollar is redeemable in gold,
and all other currencies are redeemable in US dollars.
And so every country had to keep some Dollars on hand to redeem their currency,
which is how the US dollar became the reserve currency for basically the entire world.
As other nations' economies recovered,
the Dollar became overvalued.
This came to a head in 1965.
Charles de Gaulle, who had always been a little bit miffy about America's position in the world,
decided that he was going to act on that redeemability.
So he sent the French Navy to cash in and pick up his bullion,
literally bringing boatloads of gold back to France.
Soon other nations followed suit.
By 1971,
with the Dollar still overvalued
and the Cold War and
wars like Korea and Vietnam
draining US resources
and sending US gold overseas,
Richard Nixon finally took the step that many argued had to come,
and took the US dollar off the Gold Standard.
Just... take that in for a moment.
1971.
Less than 50 years ago.
But here's where it gets good.
When Nixon pulled the US off the Gold Standard,
the shock was felt around the world but
it didn't stop many countries from still pegging their currency to the US dollar.
So now you had currencies around the world redeemable for US dollars
and the US dollar pegged to nothing.
Soon many other countries decided just to let their currencies float,
to let them be valued at what the market would bear.
And so, just like that, almost by accident, after 6,000 years,
we finally accepted money as an idea rather than a thing.
Or as John Law would say:
"we accepted money as the medium by which things are exchanged,
not the value for which they are."
Thanks for watching. We'll see you next time.
... and when we find ourselves
in the place
just right
twill be in the valley
of love and delight