How is the gold standard protected from inflation?

45 years without the gold standard

Richard Nixon buried the gold standard on August 15, 1971. A comeback is out of the question because the euro has reorganized the relationship between gold and money.

Vienna. It was a forward escape that Richard Nixon began in 1971. For years (especially in Europe) distrust of Washington and the dollar had grown. French President Charles de Gaulle even sent a naval ship to New York to pick up gold. A clever move: France was one of the last countries that was still allowed to exchange dollar reserves for gold.

It ended on August 15, 1971. In a televised address, US President Nixon ended the current monetary regime in one sentence: "I have instructed Treasury Secretary John Connally to temporarily suspend the convertibility of the dollar to gold." The Bretton Woods system, named after a New Hampshire resort, was history and with him the idea of ​​the gold standard. For the first time in history, all major world currencies were exempt from gold backing. But even if the 1971 decision went down in history as the “Nixon Shock”, the gold standard was dying long before that.

No alternative to the dollar

The post-war order was just a copy of the system that dominated the 19th century. The real grave digger of this classic gold standard, in which anyone could exchange paper money for gold at a fixed rate at any time, was not Richard Nixon, but the First World War.

From 1944 to 1971, only the dollar was tied to gold. And only foreign governments and central banks could exchange their currencies for metal. The Americans themselves were even prohibited from owning gold privately. Bretton Woods had nothing to do with the “golden age of stability”, as Stefan Zweig described Europe in the years before the First World War.

Nonetheless, Nixon's decision had massive consequences. Inflation skyrocketed in the following years, with the US dollar depreciating massively against hard currencies such as the D-mark. The price of oil - and not least gold - rose to unprecedented heights. Towards the end of the 1970s, the US dollar, the world's leading currency, was in a massive crisis. Contrary to the expectations of many politicians and economists of the time, the dollar was not only able to maintain its position, but even expand it in the coming decades.

The gold cover was replaced by an unofficial oil cover in the 1970s. This so-called petrodollar is an invention of the then US Secretary of State Henry Kissinger and is based on a deal between Saudi Arabia and the USA. Because OPEC trades its oil in dollars (and the revenue is in turn in US government bonds), King Dollar was able to continue to govern until today. The central banks and governments of the world accept this system because - at least until the euro was founded - there were no alternatives to the dollar. The Deutsche Mark and Francs were too small, the ruble and yuan too communist.

Despite the resounding success of the uncovered dollar, there are still voices calling for the reintroduction of a gold standard. Also because the petrodollar system seems to be slowly crumbling. Russia and China are agitating against it, Iran is already trading in euros. The gold standard issue comes up like amen in prayer in every US election campaign. Donald Trump has shown no aversion to this, even though he admits that "a return to gold will be very difficult". But the truth is: a comeback of the gold standard is not only difficult, but impossible. And the reason for this is, of all things, the euro.

Because unlike the dollar, which - legally - is backed by gold to this day (at the ridiculous sum of 42.22 dollars per ounce), the euro has always been a pure paper currency that also had to assert itself as such. However, with a little open secret: the euro zone holds more than 10,000 tons of gold reserves than any other currency area. And: These gold reserves are adjusted in the balance four times a year to the free market value of the metal.

Peaceful coexistence

This has interesting consequences: Firstly, unlike the dollar, the euro benefits from a rising gold price because that strengthens the central bank's balance sheet. Second, the European central banks don't have to surrender gold if confidence in the euro sinks. Anyone who wants gold can exchange euros for gold at the market price at any time - on the market. Thirdly, no other country can switch back to classic gold cover.

Such a theoretical new gold cover presupposes a politically controlled fixed price for an ounce of gold. Even if that price is set very high, like $ 10,000 an ounce, the system may not work for long. Because the US Federal Reserve would guarantee the exchangeability of $ 10,000 for an ounce of gold. But as soon as the free market price for gold rises above 10,000 dollars, the paper money would flow rapidly back into the USA, while gold flows out, which can be exchanged for money (e.g. euros) on the free market (e.g. in Europe) at a higher price. The USA would have to close the "gold window" again within a very short time and the new gold standard would have collapsed.

The euro central bankers do not peddle this little secret of the euro architecture - but de facto the euro has created a new currency system through its very existence, in which gold and paper money coexist in a kind of peaceful coexistence. In the meantime, other central banks, such as the Russian, but also the Chinese, have started to value their gold reserves at market value. With the introduction of the euro, the central banks also throttled their gold sales and have since become net gold buyers again. At the same time, the physical gold markets in Europe and Asia were massively liberalized, and access to physical gold has never been easier.

Because it is not based on a fixed price, this system is more flexible than a gold standard. And in an absolute monetary policy emergency, the central bank itself can sell or buy gold to combat inflation or deflation.

AT A GLANCE

US President Richard Nixon shocked on August 15, 1971 with the news that the dollar would immediately be lifted from gold backing. The end of the gold standard led to inflation and a dollar crisis, but the US currency held its position. A return to the gold standard is no longer possible today. The euro anticipated that.

("Die Presse", print edition, August 13, 2016)