Economic Outlook: History of the Dollar

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Illustration by Fotolia/Anatoly Maslennikov
The history of the dollar until recently was intimately tied to gold.

Congressman Ron Paul places much of the blame for the world’s current economic woes on “the deliberate destruction of the dollar,” and he (along with coauthor Lewis Lehrman) has traced that destruction, in great detail, in the book The Case for Gold.

We think this publication provides an interesting view of the economic disasters that are affecting us all today. It also reaffirms the wisdom of Daniel Webster, who said many years ago, “Of all the contrivances for cheating the laboring classes of mankind, none has been found more effectual than that which deludes them with paper money.”

Based on Paul and Lehrman’s book, here is a brief history of the dollar — the rise and fall of our American currency.

The High Cost of War

To finance our Revolutionary War, the Continental Congress issued paper money in great quantities. As a result, the currency fell, over a period of about 4 1/2 years, from a value of one paper dollar per one gold dollar to about 1,000 to one, giving rise to the phrase, “not worth a continental.”

In 1792, to correct this situation, a bimetallic dollar standard with the dollar defined as a weight of 371.25 grains of pure silver and/or a weight of 24.75 grains of pure gold was established, and a somewhat imperfect gold standard remained in effect throughout the nineteenth century with the following notable exceptions.

During the War of 1812, the federal government in flagrant violation of property rights permitted banks to stop all gold and silver redemption of notes and deposits, and yet force their own debtors to repay their loans as usual!

The Civil War had an even more damaging impact on the American monetary system. It led to federal expenditures that skyrocketed from $66 million in 1861 to $1.30 billion four years later. The pressure on gold and silver, brought about by an increased public demand for “coin money,” resulted in a general suspension of bank specie payments at the end of December 1861. This was followed swiftly by the Treasury’s suspension of specie payments on its own notes.

The U.S. government quickly took advantage of the situation. In the Legal Tender Act of February 1862, Congress authorized the printing of “United States Notes” (soon to be known as “greenbacks”) and made them legal tender for all debts, public and private. Over the course of the entire war, the money supply rose from $745.4 million to $1.773 billion, an increase of 137.9%, or an average of 27% per annum. The United States ended the war with a depreciated, inconvertible greenback currency and a public debt that had risen from $64.7 million in 1860 to $2.32 billion in 1866.

After the war, the question of the constitutionality of the legal tender laws came before the courts. It reached the U.S. Supreme Court in 1867, and in February 1870 that august body held that the irredeemable greenbacks were, indeed, unconstitutional.

This ruling upset the Grant administration as well as the railroads, whose heavy, longterm debt would if the court’s decision held have to be repaid not in paper, but in much more valuable gold. However, there were two vacancies on the court, so Grant appointed two Republican railroad lawyers. The new court quickly reconsidered the question and in May 1871 reversed the previous decision. From then on, paper money has been held to be consonant with the U.S. Constitution. However, in 1879 the country did finally resume the gold standard, and during the following decade the willingness of more foreigners to hold dollars caused gold to flow into the U.S. As a result, American exports increased, wages and production rose, and prices fell.

In the meantime, European nations were shifting from silver to gold standards, decreasing the demand for silver. At the same time, Nevada silver mines were in full production. This caused silver to become officially overvalued, and some politicians wanted to increase the nation’s money supply by backing our currency with that plentiful metal. To help accomplish this, they pushed through the Silver Purchase Act of 1890.

Uneasiness about the shift from gold to silver caused foreigners to lose confidence in the U.S. dollar, created a drop in capital imports, and put contractionist pressure on the American economy. Gold exports intensified in 1892, and in April 1893 the stock market collapsed. A month later, distrust of the fractional-reserve banks led to massive bank runs and bank failures throughout the country. This panic ended with the repeal of the Silver Purchase Act in November of that same year.

The Federal Reserve Is Born

In March 1900 the U.S. was placed officially on a monometallic gold standard. All paper was redeemable in gold with silver as a subsidiary metal. Though discoveries in South Africa and Alaska doubled the world’s gold stock from 1890 to 1914, the bulk of the increase in the supply of money during this period came from bank deposits pyramiding on top of an increase in gold. After 1900 this caused several mini-panics, arrested by infusions of Treasury money, but the Panic of 1907 frightened banks into calling for a new central banking system. The result was passage of the Federal Reserve Act of 1913.

From then until 1933, the United States was formally under a gold standard, but actually governed by an institution designed to inflate uniformly and bail out banks in trouble. Only the Federal Reserve could print currency, and all national banks were required to join this system and transfer their gold to the Federal Reserve. It, in turn, could print money by a three-to-one ratio on top of gold, and all member banks could multiply their deposits on top of the Federal Reserve deposits.

Not only that, but reserve requirements for the nation’s banks were deliberately cut in half, inviting the rapid doubling of the money supply. Indeed, total bank deposits, which were $14.0 billion in 1914, reached $29.4 billion by 1920 — an enormous increase of 110%, or 18.3% per year.

To deal with the global inflation of unprecedented volume that burgeoned both during and immediately after World War I, the Genoa Conference of 1922 was called. There emerged from it not a gold standard, but a more slippery “gold-exchange standard.”

The U.S. alone stayed on the old gold-coin standard, where anyone could present notes totaling $20.67 to the Treasury and receive an ounce of gold in return. But the Genoa Accord made the dollar and the British pound as good as gold, even though the English currency was not sound. In fact, Britain began redeeming pounds not just in gold, but in Federal Reserve notes. England now printed its currency with American support, with the U.S. agreeing to inflate enough to keep Britain’s reserves of dollars and gold from flowing to America. Nevertheless, many other nations began to use British pounds as backing for their currencies.

Also, around 1922 the Federal Reserve caused a substantial six-year bank credit inflation by buying securities on the open market and printing money to pay for them. This money bank reserves was pyramided several-fold by means of the fractional reserve banking system. In fact, between mid-1922 and April 1928, bank credit expanded by over twice as much as it did during the financing of World War I. As with all inflation, this caused speculative excess. In this case, new money poured into the stock market and real estate. The speculative fever was cooled in 1928 by the government, which finally became afraid of the overheated economy and tightened the money supply. This step, in turn, led to the Great Depression.

The stock market crashed in late 1929, but it wasn’t until 1931 that international bank collapses caused the abandonment of gold. The first nation to go was Austria. Its formation of a customs union with Germany in March 1931 was feared by France, which saw it as a step to political union. The French central bank insisted upon immediate repayment of short-term debts from Austria and Germany. Austrian banks clearly could not meet their liabilities, and in late May went bankrupt, taking Austria off the gold standard. In July, Germany did the same.

As the runs on British gold increased throughout that summer, Britain refused to defend the pound by raising interest rates. Instead, as gold flowed out, the Bank of England, printed new money to replenish the banks’ reserves. Then on September 20, 1931, two days after England assured the Netherlands Bank (which had all of its capital in British sterling) that it would not go off the gold standard, that’s exactly what that nation did. And since Britain had, for centuries, been the leading financial power, the world was stunned. Despite the spreading crisis and though the solvency of some U.S. banks was uncertain few Americans doubted their government’s promise to redeem notes for gold. In fact, the platforms of both parties in 1932 included vows that the gold standard would be maintained. In late December of that year, however, rumors grew that President-elect Roosevelt was going to take the nation off gold, and large-scale American hoarding of that metal started for the first time. Runs were made on banks by depositors anxious to get cash and on the Federal Reserve by cashholders eager for gold.

Roosevelt became President on March 4, 1933 with almost every bank in America closed. He kept them shut down until March 13, when the public, calmed by F.D.R.’s promises, poured both cash and gold back into them. But on March 9, Congress had given Roosevelt the power to do just about whatever he pleased regarding money and banking, and on April 5 he made it illegal to own or hold any form of monetary gold — coins, bullion, or certificates. (Industrial users were not affected.) So a banking crisis, brought on by past inflation, was—ironically—made the excuse to abandon the gold standard.

The remaining gold-standard nations — France, Belgium, Switzerland, Holland, and Italy — called the London Conference of June 1933 to persuade Great Britain and the U.S. that “gold should be reestablished as the international measure of exchange value,” and that the ultimate objective of non-gold countries should be to restore the gold standard. Roosevelt rejected the proposal. He said, “The United States seeks the kind of dollar which a generation hence will have the same purchasing and debt-paying power as the dollar value we hope to maintain in the near future.” Seven months later, the dollar was devalued by 40.9%, and we of “a generation hence” know what has happened to the purchasing power of our currency since then. All the countries remaining in the gold bloc stopped redeeming their paper for gold, and international economic peace was shattered by economic nationalism, competitive devaluation, high tariffs, and exchange controls. Moreover, this poisoned atmosphere played its part in causing World War II.

The Bretton WoodsAgreement

With the coming of war, nations achieved far-reaching controls over internal and foreign money exchange. And war’s end found government officials wishing they could retainthose controls, which allowed them to inflate and run budget deficits as they pleased, while still having access to easy credit, stable foreign exchange rates, and an absence of international “flight capital.” This was the idea behind the international monetary conference in mid-1944 at Bretton Woods, New Hampshire, which set up a monetary order that would break down a short quarter of a century later. The system was supposed to restore the currency stability formerly provided by the gold standard, but in reality was based on international trust that the United States would not print more dollars than it had in gold reserves. While the dollar would be convertible to gold at $35 an ounce, it would be so only to foreigners, and after 1962 only to foreign governments. All other currencies were defined in terms of the dollar, which itself was defined as 1/35 of an ounce of gold —and America was given the power to have the dollar treated as if it were gold. The rules also called for stable currency values. No currency was allowed to either rise or fall more than 1%. The Swiss franc, for example, was then fixed at 22.9¢. It could go no lower than 22.7¢ and no higher than 23.1¢. If the franc threatened to break these limits, the Swiss central bank was obliged to enter the exchange market and either buy or sell francs to hold its currency within the narrow margin.

Dollars, however, flooded the world through the 1950’s, and few seemed to worry about the gold reserves that might leave the U.S. Treasury. But in the early 1960’s, the market gold price threatened to go higher than the official $35 an ounce. With the U.S. in the lead, banks agreed to sell gold whenever this happened. They were successful as long as world inflation fears abated. However, by the late 1960’s, the world assessed the effects of a massive dollar inflation to pay for both the Great Society programs and the Vietnam War. The dollar had clearly become overvalued, and gold’s price undervalued.

Britain was the first major nation to violate the fixed-exchange regime by devaluing the pound in November 1967. This caused a large flight into gold, the first of the postwar era. Billions of dollars were spent by central banks in the next four months, trying to force down the market price of gold. Finally, in March 1968, governments gave up their efforts to control the market.

From March 1968 to August 1971, the political world pretended that the dollar was still convertible, partly because of the moderate lessening of American inflation during the recession of 1969/1970. But after that brief respite, our printing presses went back into high gear, and by early 1971 astute financial observers began to sense the imminent collapse of the dollar. The outflow of funds from New York to European money markets accelerated, forcing most European currencies hard against their upper ceilings.

Because Germany, in particular, had maintained a low inflation rate, dollars poured into that country, which was forced to buy them in mounting volume — more than $1 billion on May 3 and 4, 1971 and a further $1 billion during the first 40 minutes of trading on May 5. At that point the German central bank let the value of the mark float. Neighboring countries, afraid of seeing now-homeless dollars careen across their own borders, were quick to join Germany.

On August 6 more than $1 billion in gold and other reserve assets were drained from the U.S. Treasury, and over that next week almost $4 billion fled the country. During the week ending Friday, August 13, the U.S. Treasury borrowed almost $3 billion in foreign currency to try—unsuccessfully—to halt the dollar’s decline by buying back dollars with that on-loan currency. On August 15, 1971 President Nixon effectively declared international bankruptcy, announcing that no more gold would be given for dollars. There were then absolutely no checks on the ability of the United States to inflate.

Massive runs continued on the dollar, belying Nixon’s claim that a dollar separated from gold would “never again be subject to international speculation.” Finally, on January 24, 1973 the Swiss government stopped supporting the dollar. Other governments quickly followed. One month later, the entire fixed rate order collapsed.

When Paper Is King

What we’ve had since that breakdown is a constant withering away of the value of all currencies in terms of gold. The floating-rate system has given complete control of the value of each currency to the respective governments, so it should come as no surprise that the past decade has seen a marked jump in the world’s average annual rate of inflation and that the threat of world trade wars is greater now than at any time since the last regime of floating exchange rates: the Depression-ridden 1930’s. Nor is it an accident that our country’s highest, most accelerated rate of inflation has occurred since 1971, when the U.S. went over completely to flat (nonredeemable) money. Since then, gold prices have increased twentyfold, the consumer price index has gone up 128%, and the annual trade deficit 1,146%.

The climax of this policy came in October 1979, when—as a result of international pressure, weakness of the dollar, gold at $600 an ounce, and silver at $25 an ounce—the Federal Reserve started concentrating more on decreasing the money supply (which has been growing three times faster than the real economy) than on holding down interest rates.

Now, because there’s no long-term trust in money, the world is precariously dependent on short-term debt with high interest rates. The unprecedented cost of borrowing money has made it unlikely that a group of 22 nations, which together owe American banks more than $52 billion, will be able to pay their debts. This is forcing taxpayers of rich lands to subsidize loans to poor countries, so that they in turn can repay commercial banks. For a decade these banks have made reckless loans, because they believed until recently that they could make higher than ordinary interest income by financing risky investments — which, if they went bad, would be repaid either by tax money sent to replenish the treasuries of bankrupt governments or (indirectly) through more inflation.

Then, in 1980, the Federal Reserve System obtained legal authority to monetize such debts by buying foreign bonds guaranteed by the countries’ governments. More than $2 billion in Federal Reserve notes was issued upon such collateral in 1982, including some backed by Italian lira bonds.

Jim Davidson, founder and chairman of the National Taxpayers Union, wrote in a recent issue of Reason: “The mechanism is in place for a worldwide inflation of unprecedented proportions…. If the choice is narrowed to one of two alternatives — printing money at whatever rate necessary to preserve the entire world’s debt structure or falling into a deflationary collapse — the government will print money.”

And it’s already happening. In order to lower interest rates (temporarily, at least), the Federal Reserve has, since the closing months of ’82, gone back to the policy of increasing the money supply. Bank reserves plus currency held by the public (a sum that economists refer to as M1) grew by less than $3 billion between January and July of 1982. But from August through November, they increased by nearly $24 billion and by $600 million in the second week of December alone, bringing our M1 to over $475 billion. Such increases, however, can only postpone the all but inevitable monetary collapse waiting in our future, unless—as Jim Davidson has suggested—”we use the present crisis as an opening for real reform.”