Unit 9 Lecture Notes

The failure to return to the gold standard after World War I had doomed the world to experience the growth of government control of the economy, monetary nationalism, and growing isolationism; as a result, a growing sense of militant nationalism developed that had previously been alien to most of the civilized world, and would eventually culminate in World War II. The US emerged as the prime military and economic world power from the war, and so it took the lead in shaping the contours of the global monetary system.

The rest of this section of the paper is an excerpt from The Bitcoin Standard, starting page 56, on the contours of the postwar global monetary system which is relevant background for the rest of this paper.

It is well-known that history is written by the victors, but in the era of government money, victors get to decide on the monetary systems, too. The United States summoned representatives of its allies to Bretton Woods in New Hampshire to discuss formulating a new global trading system. History has not been very kind to the architects of this system. Britain's representative was none other than John Maynard Keynes, whose economic teachings were to be wrecked on the shores of reality in the decades following the war, while America's representative, Harry Dexter White, would later be uncovered as a Communist who was in contact with the Soviet regime for many years. 11 In the battle for centrally planned global monetary orders, White was to emerge victorious with a plan that even made Keynes's look not entirely unhinged. The United States was to be the center of the global monetary system, with its dollars being used as a global reserve currency by other central banks, whose currencies would be convertible to dollars at fixed exchange rates, while the dollar itself would be convertible to gold at a fixed exchange rate. To facilitate this system, the United States would take gold from other countries' central banks.

Whereas the American people were still prohibited from owning gold, the U.S. government promised to redeem dollars in gold to other countries' central banks at a fixed rate, opening what was known as the gold exchange window. In theory, the global monetary system was still based on gold, and if the U.S. government had maintained convertibility to gold by not inflating the dollar supply beyond their gold reserves while other countries had not inflated their money supply beyond their dollar reserves, the monetary system would have effectively been close to the gold standard of the pre-World War I era. They did not, of course, and in practice, the exchange rates were anything but fixed and provisions were made for allowing governments to alter these rates to address a "fundamental disequilibrium".

In order to manage this global system of hopefully fixed exchange rates, and address any potential fundamental disequilibrium, the Bretton Woods conference established the International Monetary Fund, which acted as a global coordination body between central banks with the express aim of achieving stability of exchange rates and financial flows. In essence, Bretton Woods attempted to achieve through central planning what the international gold standard of the nineteenth century had achieved spontaneously. Under the classical gold standard the monetary unit was gold while capital and goods flowed freely between countries, spontaneously adjusting flows without any need for central control or direction, and never resulting in balance of payment crises: whatever amount of money or goods moved across borders did so at the discretion of its owners and no macroeconomic problems could emerge.

In the Bretton Woods system, however, governments were dominated by Keynesian economists who viewed activist fiscal and monetary policy as a natural and important part of government policy. The constant monetary and fiscal management would naturally lead to the fluctuation of the value of national currencies, resulting in imbalances in trade and capital flows. When a country's currency is devalued, its products become cheaper to foreigners, leading to more goods leaving the country, while holders of the currency seek to purchase foreign currencies to protect themselves from devaluation. As devaluation is usually accompanied by artificially low interest rates, capital seeks exit from the country to go where it can be better rewarded, exacerbating the devaluation of the currency. On the other hand, countries which maintained their currency better than others would thus witness an influx of capital whenever their neighbors devalued, leading to their currency appreciating further. Devaluation would sow the seeds of more devaluation, whereas currency appreciation would lead to more appreciation, creating a problematic dynamic for the two governments. No such problems could exist with the gold standard, where the value of the currency in both countries was constant, because it was gold, and movements of goods and capital would not affect the value of the currency.

The automatic adjustment mechanisms of the gold standard had always provided a constant measuring rod against which all economic activity was measured, but the floating currencies gave the world economy imbalances. The International Monetary Fund's role was to perform an impossible balancing act between all the world's governments to attempt to find some form of stability or "equilibrium" in this mess, keeping exchange rates within some arbitrary range of predetermined values while trade and capital flows were moving and altering them. But without a stable unit of account for the global economy, this was a task as hopeless as attempting to build a house with an elastic measuring tape whose own length varied every time it was used.

Along with the establishment of the World Bank and IMF in Bretton Woods, the United States and its allies wanted to establish another international financial institution to specialize in arranging trade policy. The initial attempt to establish an International Trade Organization failed after the U.S. Congress refused to ratify the treaty, but a replacement was sought in the General Agreement on Trade and Tariffs, commencing in 1948. GATT was meant to help the IMF in the impossible task of balancing budgets and trade to ensure financial stability - in other words, centrally planning global trade and fiscal and monetary policy to remain in balance, as if such a thing were possible.

An important, but often overlooked, aspect of the Bretton Woods system was that most of the member countries had moved large amounts of their gold reserves to the United States and received dollars in exchange, at a rate of $35 per ounce. The rationale was that the U.S. dollar would be the global currency for trade and central banks would trade through it and settle their accounts in it, obviating the need for the physical movement of gold. In essence, this system was akin to the entire world economy being run as one country on a gold standard, with the U.S. Federal Reserve acting as the world's central bank and all the world's central banks as regional banks, the main difference being that the monetary discipline of the gold standard was almost entirely lost in this world where there were no effective controls on all central banks in expanding the money supply, because no citizens could redeem their government money for gold. Only governments could redeem their dollars in gold from the United States, but that was to prove far more complicated than expected. Today, each ounce of gold for which foreign central banks received $35 is worth in excess of $1,200. Monetary expansionism became the new global norm, and the tenuous link that the system had to gold proved powerless to stop the debauching of global currencies and the constant balance of payment crises affecting most countries. The United States, however, was put in a remarkable position, similar to, though massively exceeding in scope, the Roman Empire's pillaging and inflating the money supply used by most of the Old World. With its currency distributed all over the world, and central banks having to hold it as a reserve to trade with one another, the U.S. government could accrue significant seniorage from expanding the supply of dollars, and also had no reason to worry about running a balance of payment deficit. French economist Jacques Reuff coined the phrase "deficit without tears" to describe the new economic reality that the United States inhabited, where it could purchase whatever it wanted from the world and finance it through debt monetized by inflating the currency that the entire world used.

The tenuous link of gold exchangeability was an annoying detail for the U.S. government's inflation ism, and it manifested in two symptoms: first, the global gold market was always seeking to reflect the reality of inflationism through a higher gold price. This was addressed through the establishment of the London Gold Pool, which sought to drop the price of gold by offloading some of the gold reserves that governments held onto the market. This worked only temporarily, but in 1968, the U.S. dollar had to start getting revalued compared to gold to acknowledge the years of inflation it had suffered. The second problem was that some countries started trying to repatriate their gold reserves from the United States as they started to recognize the diminishing purchasing power of their paper money. French president Charles de Gaulle even sent a French military carrier to New York to get his nation's gold back, but when the Germans attempted to repatriate their gold, the United States had decided it had had enough. Gold reserves were running low, and on August 15, 1971, President Richard Nixon announced the end of dollar convertibility to gold, thus letting the gold price float in the market freely. In effect, the United States had defaulted on its commitment to redeem its dollars in gold. The fixed exchange rates between the world's currencies, which the IMF was tasked with maintaining, had now been let loose to be determined by the movement of goods and capital across borders and in ever-more-sophisticated foreign exchange markets.

Freed from the final constraints of the pretense of gold redemption, the U.S. government expanded its monetary policy in unprecedented scale, causing a large drop in the purchasing power of the dollar, and a rise in prices across the board. Everyone and everything was blamed for the rise in prices by the U.S. government and its economists, except for the one actual source of the price rises, the increase in the supply of the U.S. dollar. Most other currencies fared even worse, as they were the victim of inflation of the U.S. dollars backing them, as well as the inflation by the central banks issuing them.

This move by President Nixon completed the process begun with World War I, transforming the world economy from a global gold standard to a standard based on several government-issued currencies. For a world that was growing increasingly globalized along with advancements in transportation and telecommunications, freely fluctuating exchange rates constituted what Hoppe termed "a system of partial barter". Buying things from people who lived on the other side of imaginary lines in the sand now required utilizing more than one medium of exchange and reignited the age-old problem of lack of coincidence of wants. The seller does not want the currency held by the buyer, and so the buyer must purchase another currency first, and in turn conversion costs. As advances in transportation and telecommunications continue to increase global economic integration, the cost of these inefficiencies just keeps getting bigger. The market for foreign exchange, at $5 trillion of daily volume, exists purely as a result of this inefficiency of the absence of a single global homogeneous international currency.