The Trauma of Bretton Woods

The Trauma of Bretton Woods
July 7, 2011

(This item originally appeared in on July 7, 2011.)

Nobody really decided to end the world gold standard in 1971. They would have liked to keep it. By all appearances, it was working fine. The previous two decades had been a time of prosperity and abundance, not only for the U.S., but countries worldwide including the emerging markets.

There was never any grand international conference in which it was decided to transition to a floating currency system. There were no treaties, agendas or plans. When President Richard Nixon announced the closing of the “gold window,” on Aug. 15, 1971, it was supposed to be a temporary measure.

A decade of inflationary disaster followed. The 1980s were a time of recovery for most of the developed world, but for Latin America, it was another decade lost to hyperinflation. The 1990s saw further currency disasters, with hyperinflation again throughout Eastern Europe and Central Asia, a currency implosion in Mexico in 1995, and another round of currency collapse throughout Asia in 1998. In the last decade, currencies have been again declining in value throughout the globe.

The past 40 years have been a time of endless chaos. Vast swathes of the globe were engaged in crisis, collapse, and hyperinflation — not all at the same time, but nobody has escaped unscathed.

The collapse of the Bretton Woods gold standard was a great trauma. A centerpiece of Western Civilization crumbled before their eyes. It seemed as if nothing could be done to stop it.

The result of this trauma, it seems to me, has been that many are hesitant to attempt to try another world gold standard system. They are afraid that it too would blow up in their face.

Let’s say that you don’t know how to drive a car. However, you inherit a car from your predecessors and are expected to drive it. A horrible crash results. Naturally, you would be hesitant to try to drive a car again.

In the 1960s, people had forgotten how to operate the world gold standard system. They had inherited it from their predecessors, but they literally didn’t know how it was supposed to work. They didn’t know what it was for. They were never taught how to use it. A horrible accident resulted.

The Bretton Woods gold standard system collapsed because the U.S. was attempting a Keynesian “easy money” policy, resulting inevitability in a sagging dollar value. This is completely contrary to the automatic, currency board-like adjustment mechanism of a proper gold standard system. But nobody had told them that. They didn’t know that you can’t put the two together.

First, you have to know what a gold standard system is for. Its purpose is to create a currency of stable value. Nobody has ever found a better way. Ultimately, people discovered that you didn’t need to find a better way, because, although it would be a stretch to say that gold is perfectly unchanging in value, nevertheless it was close enough to this ideal that no great problems resulted.

Second, you have to know how to drive the car. A gold standard is an automatic value peg, functionally similar to other automatic value pegs like a modern currency board. The mechanism is adjustment of supply. When the value is too high, supply is increased. When the value is too low, supply is reduced.

Although there have been many varieties of gold standard systems over the years, they all have this aspect somewhere within them.

When you see that a gold standard system is based on an automatic supply adjustment function, then it becomes obvious that you can’t have a Keynesian interest-rate target or other “easy money” policies.

The leaders of the late 1960s and early 1970s crashed the car. But it wasn’t the car’s fault. They were simpletons who had not been properly taught, and who couldn’t figure it out for themselves. It’s time to face this historical disaster, to understand the mistakes of that time, and how they could be avoided in the future.

Hyperinflation again stalks the land. There is no more time for bumbling around and making excuses. Learn what a gold standard is for, and how it works.

This applies to the gold standard advocates as well. You can’t drive the car with vague platitudes. Somebody has to know how to play the game, in all of its practical details, and in every likely scenario.

Today, China, Russia and Germany have the spirit of greatness about them. Their leaders have not yet, I would say, fully assimilated the purpose and technical operating mechanisms of a successful gold standard system. However, they are trying, and eventually they will succeed. At that point, having worked out the details in their mind, they will have the confidence to put their plans into action.