The Prospects for Sound Money

by Tim Kelly

A silver lining of the global economic crisis is that millions of people have been awakened to the importance of sound money to a modern economy. The housing bubble and subsequent bust, excessive leveraging, reckless speculation, and the sovereign-debt crisis afflicting Europe and the United States would all have been averted had money been commodity-based (e.g., gold and silver) and therefore not subject to periodic devaluation by political authorities.

Since President Richard Nixon severed the U.S. dollar’s official link to gold on August 15, 1971, the global economy has functioned under a fiat monetary system. Because the United States was then the last major country in the world with a currency redeemable in gold, this represented a complete separation of the world’s currencies from the precious metal. For the first time in history, global monetary affairs were determined by governments and their central banks, enjoying total discretionary power in the issuance of paper currency.

Nixon’s decision was a de facto repudiation of U.S. debt, because the refusal to redeem in gold resulted in the devaluation of all dollar-denominated assets and currency. Basically, politicians in Washington were now able to print their way out of debt. The default also enabled the U.S. government, working in tandem with the Federal Reserve, to manipulate the U.S. money supply in pursuit of its own political objectives, a power greatly magnified by the greenback’s privileged status as the world’s dominant reserve currency.

With the United States inflating to pay for its expanding welfare-warfare state, and with the U.S. dollar having replaced gold as the international standard, foreign central banks inflated along with the Federal Reserve. This global monetary expansion predictably ushered in an era of economic instability punctuated by periods of sharp price inflation and high unemployment (stagflation), international banking crises, manic business cycles, increasing debt burdens, and morally hazardous bailouts of “too-big-to-fail” financial institutions. Indeed, inflation is the primary obstacle to recovery today, as Fed-induced low interest rates continue to distort economic activity and inhibit the painful but necessary liquidation of widespread malinvestment.

My criticism of the post-1971 fiat-dollar standard should not be taken as an endorsement of the Bretton Woods system, the infirmities of which were made evident by its collapse a mere 27 years after its creation. That system may look virtuous by today’s standards because it imposed some restraints on money creation, but in the end it proved to be an inadequate bulwark against inflation. Like the gold-bullion standard of the interwar period, the gold-exchange standard of the postwar era had the fatal flaw of ultimately relying on the judgment and good faith of politicians and central bankers.

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