In this special five part series, we’re exploring the reasons gold remains the only shield against boom and bust cycles. In part four, we look at how currency devaluation played a part in Rome’s downfall. We’ll also explore why our most recent gold standard, Bretton Woods, ultimately failed.
Currency Devaluation in Ancient Rome
Throughout much of their history, the Romans used both gold (aureus) and silver (denarius) to settle transactions. The denarius was the predominant form of payment day to day.
It was on the back of this system of gold and silver that Rome grew into the power that it became. But it was susceptible to the trappings all great powers encounter at one point or another.
At the height of its empire, Rome embarked on a series of spending sprees that threatened its economic stability.
On the one hand, they were burdened by an expensive welfare system. At the same time, there were expensive wars to finance. On top of which, politicians were always splurging money to curry influence and buy votes. Sound familiar? Not a lot has changed in thousands of years.
Ultimately, the Romans hit a wall following centuries of growth. They had two options available to them.
One was to let the gold standard do its job as a restraint on spending. The other was to do what most governments end up doing…devaluating their currency.
When gold first entered the Roman monetary system, the aureus was 8 grams of pure gold. Over several centuries, the purity of gold declined — first to 6.5 grams, then to 4.5 grams.
The same was true of the silver denarius. In fact, the denarius’ devaluation was even worse than gold’s.
Remember, gold’s portability makes it impractical for everyday use. But that wasn’t the case with silver. Silver was used in most day to day transactions.
As with gold, the weight of silver coins declined sharply over time. While the denarius started out as a 4.5 gram silver coin containing 90% silver, it dropped to as low as 5% within three centuries. Copper became a key ingredient in the new silver denarius.
The Romans were resourceful, and a little sly. They wanted to give the impression that the weight of the denarius had remained largely the same. The only way they could continue to expand supply — and the value of the denarius — was by producing it with copper.
Within two centuries of its introduction, the denarius had only 70% silver in it. By 350 AD, it had an exchange rate of 9 million to one gold aureus.
As you can see, the effects of inflation spiralled out of control even with the use of metals. They didn’t need paper currencies or computers to achieve this. But the outcome remained the same. Trying to create more currency, when there’s nothing to support its expansion, always leads to inflation.
It’s not surprising at all that the downfall of Rome coincided with the devaluation of their money supply. While this was a drawn out demise spanning centuries, the effects of inflation crept up over time. Eventually, the whole ruse blew up. As the debasement grew worse, Rome escalated into an economic basket case.
The only difference between the denarius and modern day currencies is that monetary collapse happens much quicker today. We’re talking decades — not centuries.
It’s important to remember that Romans who held gold weathered the hyperinflation better than those without gold. That’s a lesson we can all learn from.
The debasement of the denarius is just one example among hundreds throughout history. There’s little point in listing every credit expansion because it always leads down the same path — currency collapse and economic ruin.
The last time we had anything resembling a true gold standard was in the 1970s.
As with Rome, we find that history, while it may not repeat itself, certainly does rhyme.
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Does Bretton Woods prove that gold standards don’t work?
The Bretton Woods system was a short lived international system outlining the terms for commercial and financial relations between states.
This American-led global order pegged the US dollar to gold at US$35 an ounce. But instead of pegging other currencies to gold as well, something interesting happened. International currencies became pegged to the US dollar itself.
Why? With major currencies tied to the US dollar — which itself was tied to gold — it was hoped that this would stamp out competitive devaluations. But the initial optimism gave way to hard truths.
By the early 1970s, the Bretton Woods system had collapsed. As Markets and Money‘s Greg Canavan explains:
‘The Bretton Woods system died because it couldn’t sustain the US dollar to gold exchange rate. There was too much inflation in the system. 30 years later Bretton Woods was dead, and the 1970s was a time of inflation and great currency turmoil.’
The Bretton Woods system died once President Nixon effectively took the US off the gold standard.
Back then, the US dollar was literally ‘as good as gold’. International states were confident that the US wouldn’t manipulate the exchange rate between the dollar and gold.
But by the 1970s, the ‘gold standard’ became too restrictive for the United States. They had a raft of expenditures that were taking their toll on the economy. New social programs, the Vietnam War, and rising oil prices all contributed to the pressures weighing down the US economy.
Yet, as societies have shown throughout history, the temptation for credit expansion was too strong to ignore. It wasn’t long before the US money supply grew out of control. Treasury bills and cash were being printed at an increasingly rapid rate.
Seeing this imbalance between dollar reserves and gold, European nations, led by France, demanded to exchange their dollars for gold.
They had every good reason to be suspicious of the US. There was no way the US could keep borrowing at the rate they were and still guarantee delivery of gold to other states.
At this point, the amount of currency in the global system dwarfed US gold reserves. When France began talking about recovering their gold, the US got spooked. If the US caved to French demands, it could have unleashed a wave of gold transfers that would have flooded the US economy with dollars, ramping up inflation.
The US responded by floating the dollar against other currencies, foregoing the gold standard. With the fix effectively removed, the US set about printing as much currency as it needed.
The dollar moves from a gold peg…to an oil peg
Up until that point, the US strategy had been to exploit the advantages of issuing a global reserve currency. And they could do it without jeopardising the US dollar hegemony.
The US couldn’t tolerate the dollar devaluing against gold. Higher gold prices would only damage the credibility of paper currencies. And it would have compromised the dollar’s reserve currency status.
As a result, the US dollar became overvalued compared to gold. With other nations wanting to exchange dollar reserves with gold, Nixon acted.
In 1973, he officially took the dollar off the gold standard. But Nixon had another idea, much like his Roman counterparts.
To prevent the US economy from drowning in debt, he pegged the US dollar to oil with the help of the Saudis. This was the birth of the so called ‘petrodollar’. In a twist of genius, the US dollar, fixed to oil, retained its status as the global reserve currency.
Now, considering the role oil plays in world markets, it was a smart decision. Demand for oil has risen from 1.7% of world trade to 12% in 2011. The demand for US dollars has grown in equal measure. After all, you need US dollars to trade oil.
We can’t underestimate the impact of the petrodollar. It gives the US free reign to fund programs through credit expansion. And it’s all backed by oil.
So what does all this have to do with gold?
I bring this up for the purpose of showing that gold itself is never the problem. Instead, it’s the people behind gold fixes that make standards ineffective.
The problem makers are the governments, the central bankers, and the manipulators who refuse to let gold act as a restraint on credit expansion and inflation.
Bretton Woods wasn’t a real gold standard. And it didn’t die because it couldn’t sustain the US dollar to gold exchange rate. It died because the US changed the rules of the game once gold started to do what it’s supposed to — keep currencies in check.
And that’s why Greg is right about currency pegs. As he explains:
‘I don’t think returning to a gold standard, with currencies fixed to a specific weight of gold, will solve anything. It will just sow the seeds of the next crisis.
‘So if you try to fix values in the market place or economy, nature will slowly chip away at it until it breaks. And when it does break, all the associated pressures that have built up will release at the same time, causing turmoil.’
A gold standard may not be the answer to boom and bust cycles. Why? Because the people designing the system will never allow it to be. A system the ruling elite can’t manipulate to their will, in their eyes, is not one worth having.
But if we ever had a true gold standard, boom and bust cycles would be a footnote in history. Yet, pegging currencies to gold is the only answer to preventing the next economic crisis. At least in the aftermath of the next eventual crisis. Even if it only gives us a couple of decades of stability, it’s preferable to any system that facilitates credit expansions and debt accumulation.
Yet, the likelihood of this is small. As long as the central bankers control the game, gold standards will remain a distant likelihood.
Of course, you can sidestep this. You can minimise the effects of the next crisis on your family.
The effects of a currency crash could wipe trillions from those storing wealth in stocks, property or cash. But gold always retains its value. It’s the only depression proof asset available to investors.
Currencies may not fix their value to gold. But there’s nothing stopping any individual fixing their wealth to gold.
Junior Analyst, Markets and Money