The Great Monetary Devolution Away from the Gold Standard

Thankfully we’ve avoided the Christmas bug flying around the office this week. Being struck down with flu-like symptoms in the middle of summer is not much fun. We saw Dan Denning crawl back into the office this morning…he’s shut his door and is working in a ‘quarantined’ environment. Murray Dawes just stumbled in too, looking like he’s just had a night out with the inhabitants of the ‘Gatwick’ here on Fitzroy Street.

We suspect any resilience we have had to the bug is Mother Nature’s doing. She’s preparing us for a new addition to the family, due a few days after Christmas. But if Jeebers is listening to our better half’s prayers, our ‘bundle of joy’ will come right now. ‘I want it out!’ is a common refrain coming from the lounge room.

But Jesus is preparing for his own birthday bash, so he probably doesn’t have much time to help out. ‘It will come when it’s good and ready,’ we say with good intention and complete ignorance. It’s a comment received with an icy stare.

It makes us realise how clueless and simple we blokes really are. Would we be able to go nine months without a beer, growing another human inside of us? No way…which is why nature didn’t set it up like that. In fact, nature didn’t really hand out much in the way of nurturing genes to the males. In most cases, the male ups and leaves after his work is done…

Males ensure reproduction, females ensure evolution. We’re generalising obviously, but when we look at the carnage going on in financial markets around the world, we can’t help but think more women should’ve been involved in the design phase of the international monetary system.

Because as far as we can tell, it’s devolving.

Let’s quickly run through the history of it over the past 100 years or so…

From the late 1800s we had a classical gold standard. This worked well for a time but its mild deflationary tendency was incompatible with a growing democratic movement and the rise of the state.

As the age of capitalism morphed into the age of imperialism, the interests of great powers bumped up against each other and led to war. War and a gold standard cannot exist together. To execute a war, you need to unleash the inflation tax on society to help pay for it.

So the Great War in 1914 saw the end of the Classical Gold Standard. Following the war, the blokes in charge tried to get something similar happening and held a conference in Genoa in 1922 to do so. They came up with the ‘Gold-Exchange Standard’, a precursor to the US dollar standard we are on today.

This monetary system allowed central banks to keep part of their reserves in currencies (like the pound) that were tied to gold. While it sounded good at the time, it led to a huge global credit inflation and ended in disaster in 1929.

Following the depression, no one really knew what was going on. Britain got off the ‘Gold Exchange Standard’ quick smart. As manager of the world’s reserve currency at the time, it had the most to lose by staying on gold. That’s because it had printed immense amounts of its currency, which ended up in the vaults of other central banks (sound familiar?). If Britain didn’t abandon gold in 1931, the Bank of England’s vaults would have soon filled up with paper pounds and emptied of gold bars!

Other countries stayed on gold, only to suffer the deflationary consequences. The US jumped ship in 1933 while France and others finally relented in 1936.

Following World War II the gents got together and came up with the Bretton Woods system. For the purposes of international trade, the US dollar was tied to gold at $35 dollars an ounce. The dollar was therefore as good as gold, and other countries stored gold AND US dollars as a part of their international reserves. It was the ‘Gold-Exchange Standard’ all over again.

But as we said, gold, democracy and the welfare state are incompatible. The US started to lose gold from its vaults as its trading partners realised the dollar wasn’t as good as gold at all.

So Bretton Woods ended in 1971 and since then we’ve been on a dollar standard. And what a party it’s been! In fact, the good times lasted so long that everyone began to think of it as normal. But of course, it just led to another credit bubble, this time bigger than the one in the 1920s.

That bubble burst spectacularly in 2007/08 but the boys wanted to keep the party going. So they manufactured a government debt bubble, effectively cashing in all the goodwill and ‘credit’ governments had built up over previous generations to do so.

The party is again in full swing. It’s like the music never stopped. But as history shows, it does, and it will. Only to start back up again…perhaps next time we get a different tune and a different tempo. After such a large hangover, the boys might be after a change of pace.


Greg Canavan
for Markets and Money

From the Archives…

The Trade Deficit Dilemma That’s Alive and Well
14-12-12 – Greg Canavan

The Fed’s Poppycock Monetary Policy Targets the Unemployment Rate
13-12-12- Dan Denning

The Price of Risk in the Stock Market
12-12-12 – Murray Dawes

Recessions the World Over
11-12-12 – Dan Denning

A Victory Over the Zombies!
10-11-12 – Bill Bonner

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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