By closing the gold window, President Nixon sowed the wind; hundreds of millions of hard-working Americans would then be forced to reap the resulting inflationary whirlwind. While Nixon bears the ultimate responsibility for severing the dollar's last tenuous link with gold, it is only fair to mention that August 15, 1971 was merely the final stop on a road paved with appalling economic idiocy. The enormous fiscal deficits produced by President Johnson's enormous expansion of the federal government, along with the huge costs of the Vietnam War, had been putting pressure on the country's gold reserve for years. The exact nature of this "pressure" and additional context into that fateful night in August 1971 follows next.
Unlike all other countries, the US could essentially create, out of thin air, the money it not only needed to borrow, but the money it needed to purchase oil, sugar, steel and all other commodities. This was the result of the "exorbitant privilege" the dollar had of being the world's international reserve currency. As the world's international reserve currency, the dollar was money the world over, and all commodities were priced in dollars. If West Germany wanted to purchase oil from Saudi Arabia, it didn't purchase the oil with marks or dinars - the currencies of the two countries involved in the transaction. Instead, the Germans would purchase the Saudi's oil with dollars. The system of international trade was totally reliant on the dollar maintaining value. It was gold's role to help ensure the dollar maintained value. As described by Wilhelm Ropke in Part I, gold was designed to put a "brake" on the creation of money.
However, as the US deficits continued to explode, the numerous creditors of the US became increasingly concerned. They could sense the huge increase in dollars in circulation needed to fund the deficits, but they realized the US gold reserve had not increased by nearly the same amount. Increasingly, these creditors started to ask to exchange their accumulated dollars for gold at the fixed exchange rate of $35 per ounce of gold. For much of the late 1960s and into the 1970s, gold poured out of the US. It was only after this had been going on for many years that Nixon "temporarily" closed the gold window.
As mentioned above, Nixon closing the gold window was merely the end of a road paved with appalling economic idiocy. Given this, it is then hardly surprising that Nixon's move - which was an act of great national shame - was cheered on so loudly by the economic establishment. Not only would the economic establishment cheer on eliminating the one "brake" on the creation of money, it would completely misunderstand the significance of this decision. It was on this complete misunderstanding of money that "modern" economics would then take the study of economics in entirely new, different and - completely erroneous - directions. All this will be seen by studying the ideas and faulty conclusions of just one college professor - Paul Samuelson.
Paul Samuelson was the author of the most widely used economics textbook, and was the first American to win the Nobel prize in economics. In the aftermath of Nixon closing the gold window, Samuelson was convinced gold would sink into complete irrelevance, and be treated no differently than any other commodity like zinc, lead or coffee. Insight into Samuelson's almost complete ignorance of the way economies actually work, and the nature of money, can be gleaned by his outlook for the price of gold after Nixon closed the gold window.
In the 1973 edition of this textbook Samuelson described the prospect of a "mid-east sheikh" making a bundle if the price of gold increased to $68, but losing a fortune if gold fell to $38.50. In just a few years, gold would leave prices like $68 in the dust and soar to over $800! Samuelson also claimed, "From the standpoint of economics - jobs, income, interest rates, inflation, lifetime savings - gold has not the slightest importance." (1) As Samuelson's comprehensive misunderstanding of the future movements of the gold price shows, Samuelson was completely ignorant of the enormous significance to removing the discipline of gold from the monetary system. It was the resulting lack of monetary discipline - which could only exist without the presence of gold in the monetary system - that created the inflationary firestorm which decimated savings and forever altered the economic make-up of the United States. Paul Samuelson was blind to all this!
In sharp contrast to the economic establishment's blindness to the significance to Nixon closing the gold window, the world outside economics departments took notice. From January 1973 to December 1974 a crushing bear market ravaged Wall Street. Stock prices as measured by the Dow Jones Index fell over 45%! At the time, it was the worst stock market crash outside of the Great Depression. A huge driver of the stock market crash was the raging inflation and enormous economic uncertainty created by Nixon closing the gold window.
In January 1974, the American economy received another shock directly related to Nixon closing the gold window - an enormous increase in the price of oil. In December 1973 several OPEC countries raised the dollar price of oil from $4.31 to $10.11 per barrel, with the price increase to go into effect in January. While this was an enormous price increase in dollar terms, from the standpoint of the oil exporting countries it only returned prices to their historical range before Nixon closed the gold window. (2) Before Nixon closed the gold window, one ounce of gold was priced at $35, and the price of oil was around $3.50 per barrel. Stated differently, ten barrels of oil could be exchanged for one ounce of gold. Even after the enormous price increase of January 1974, oil was still priced at the same 10-barrels per ounce of gold that existed in 1971. (At the start of 1974 gold traded for approximately $106 per ounce. At this dollar price of gold and an oil price of $10.11 per barrel, oil sold for about 10.5 barrels per ounce of gold.) In other words, measured in in ounces of gold the price of oil had hardly moved! What had changed wasn't the price of oil, it was the value of the dollar.
After the gold window closed, the gold price soared because the dollar's value plunged. Not only did it take far more dollars to buy gold, it took far more dollars to purchase wheat, copper and all other commodities. The oil exporting countries realized this. They recognized they were exchanging a limited natural resource, oil, for a paper currency, now backed by nothing, that could be created without limit. In the words of a Kuwaiti oil minister, "What is the point of producing more oil and selling it for an unguaranteed paper currency?" (3) Perhaps America's most stalwart mid-east ally, the Shah of Iran, best summed up the problem from the vantage point of the oil exporting countries, "You've (the West) increase the price of wheat you sell us by 300% and the same for sugar and cement. You've sent petrochemical prices rocketing. You buy our crude oil and sell it back to us, refined as petrochemicals, at a hundred times the price you've paid us. You make us pay more, scandalously more, for everything, and it's only fair that, from now on, you should pay more for oil." (4)
The 1974 oil price "shock" provides further evidence that Paul Samuelson - and all the other modern economists like him - don't know the first thing about economics! Samuelson completely missed the enormous practical significance of Nixon closing the gold window and the critical role gold played in trade. With the dollar no longer anchored by gold, its value plummeted. Unlike nearly all PhD economists, the oil exporting countries immediately recognized the dollar's plunging value. As with most crushing inflations throughout history, the US government - along with its lackeys in the media and Ivy League economics departments - seized on a foreign bogeyman, Arabs in this case, as the cause of a purely domestic inflation.
Before Paul Samuelson and all the other modern economists that staggered after him released all their malevolent influence on the United States, it was well understood that nothing wreaked more havoc on an economy than inflation. Perhaps the most succinct description of this was provided by Charles Holt Carrol in the 19th century. He called inflation "the surest way to fertilize the rich man's field with the sweat of the poor man's brow." The veracity of Holt Carroll's insight would be confirmed by the enormous concentration of wealth that followed immediately in the wake of Nixon's fateful decision of August 1971. Less than two years after the gold window closed - and the Fed became completely free to embark on an unprecedented campaign of increasing the money supply - income disparity began its inexorable march higher. In 1973, the share of national income earned by the richest 1% of Americans bottomed at 7.7%. (5) It would increase unabated for the next 47-years and counting. Perhaps Prof. Samuelson and all other modern economists underestimated the significance of what Nixon did after all?
19 AUG 2018
1. Ferdinand Lips, Gold Wars - the Battle Against Sound Money as Seen From a Swiss Perspective, The Foundation for the Advancement of Monetary Education (FAME), New York, 2001, p. 88-90
(2) David Hammes and Douglas Wills, "The End of Bretton Woods and the Oil Price Shock of the 1970s," The Independent Review, v. ix, n. 4, Spring 1995, p. 507
(3) Hammes and Wills, p. 507
(4) William Smith, "Price Quadruples for Iran Crude Oil," New York Times, December 12, 1973 https://www.nytimes.com/1973/12/12/archives/price-quadruples-for-iran-crude-oil-dismayed-purchasers-fear-a-new.html
(5) "Richest 1% Earn Biggest Share Since Roaring 1920s," published September 11, 2011 https://www.cnbc.com/id/101025377