"If you come to a fork in the road, take it." So said Yogi Berra, and America certainly did in 1971, when Richard Nixon publicly declared that the country was abandoning the Gold Standard. Many people will espouse the virtues of Gold, "store of Wealth", "inflation hedge", "an asset without a counterparty risk", but the real issue that is being strived for is fiscal discipline. The promise of fiscal discipline manifests itself in various forms over the last century, gold, silver, Britain in the early 20th Century, America since World War 2, the Eurozone since the 1990's. Invariably each system has broken down, as Governments refused to face the realities of the day and perverted their good intent for the populist demands of the quick fix.

Our current economic environment manifested itself in 1971, and it is difficult to get a perspective on an alternative structure since it was nearly 40 years ago. So what happened, and are we even aware of the cause and effect of that fateful decision.? Probably not.

Debasement of currencies has a long history with the Roman Government reducing the content of the silver used in coins from 4.5 grams to 2 grams, in a not to unfamiliar form of currency devaluation to reduce the burden of debts. In an attempt at fiscal discipline they began to mill the edges to prevent shaving of the coins. Until the early 1800's, a standard of Gold and Silver was used by most countries. The UK adopted the Gold Standard in 1816, and the US used a combination of both metals until Congress passed the Gold Standard Act in 1900. It is said that the book "The Wizard of Oz" is actually an allegory of the fight of the dominance between silver and gold, published in 1901, that reflected the political fight of the day to include silver with gold as a monetary standard, that was the then attempt to inflate the economy. Yes, Dorothy's slippers were originally silver in color, walking down the path of Gold.

Governments have always circumvented policies and in the 1930's it was no different. The great power of the day, Great Britain, announced that it was abandoning the Gold Standard, devaluing its currency, and thereby lowing the value of the debts it owed. In United States, Herbert Hoover announced that the Gold Standard would be maintained. But as spending demands exceeded the value of Gold owned, the new presidency of Franklin D Roosevelt was politically able to abandon the Gold Standard in 1933. Countries have, and will forever, abandon fiscal restraint in favour of solving the crisis of the day.


In 1944, the Bretton Woods agreement was established by 44 nations whereby a Gold Standard was introduced. All currencies were valued in US dollars, but the US dollar was convertible into Gold at $35 per ounce. So the US dollar became the World's reserve currency, based on the "promise" of convertibility in Gold. Like the Euro, the promise was never going to work.

With the US with a licence to print money, it did. Like Great Britain in the 1930's, the World demanded Gold for their US dollars, until 1971, with the US firmly entrenched as the Reserve Currency, the promise was broken. The World had to adjust to this new scenario, so the immediate reaction was a period of high inflation, skyrocketing oil prices and a breakout in the price of Gold. Gold reached a price of $653 per ounce in 1980, reflective of the fear of the time, and not reached again until 2007. Average Weekly wages were $70 in 1971. In 1980, they had risen to $208, nearly triple over 9 years. Today, 30 years later, based on the same source (RBA - G6 release), wages are only $968. Based on Gold/Wage ratio of 1980, Gold today would be $3,000 per ounce. I am not trying to promote Gold as the new, best investment, but I am trying to highlight the measure of fear as expressed by the price of Gold, which was clearly apparent after moving away from the Gold Standard (fiscal discipline) in the 1970's.

We need to understand the fiscal discipline Gold (or any standard) imposed. Countries could only spend what it earned. The current account must balance, you can't run deficits. This was behind the ideal of the Euro. Deficits are limited to 3% of GDP. Why 3%? Well economists figured that inflation would be in that range, so Government revenue would always grow to match the excess spending. Great ideals, but, as usual, rules were made to be broken.

So, prior to 1971, you could only buy something if you could sell something, ie a balanced budget, but the Nixon administration broke this nexus, creating the World we have today. The US discovered that it could just buy, and then buy some more. All it had to do was to give dollars, which it had plenty of. The genius of the system was that it didn't have to make or sell anything. The flipside was even more interesting. Japan discovered it could sell exports without having the need to buy imports. It exchanged cheap labor and manufacturing for US dollars. Japan was happy, the US was happy, and the Japanese boom of the 1970's commenced. In 1970 the Australian dollar bought 400 Japanese Yen. By 1986 it dropped to 92 Yen.

Similarly, China, which was locked out of Trade in the early part of the 20th Century, could now participate. OK, China has accumulated $2.5 Trillion of US debt in exchange for their labor and goods, so you would need to question who got the better bargain. This financial nirvana created the demise of Western manufacturing. Factories and jobs in the US, UK, Australia and Europe have been exported to the developing countries like China, India and other Asian countries. Margaret Thatcher in the UK (1979 - 1990), Ronald Reagan in the US (1981 -1989) followed the same path, with Reagan legacy expanding national debt from $700 Billion to $3 Trillion. It all works as long as the debt can continue to expand. Goods in exchange for paper - it works until it doesn't. I actually don't fully believe that developing countries produce more cheaply. They undervalue the human cost in their work conditions, and they undervalue the enviromental costs that Developed countries impose. A friend of mine was required to install a new metal press with all the latest safety features. He asked the scrap merchant what was going to happen to the old machine. It was being shipped to Asia because they didn't have any safety requirements. Reports are coming out of China, from the factory making Apple iPhones, where workers are committing suicide due to depressing and low paid working conditions.

Government Debt is future taxation. Unfunded pension liabilities around the World will eventually need to be paid for, but the only payment appears to be more debt. The time of printing money and debt will come eventually come to a close. China will not ask for payment to quickly, but like Great Britain and the US before it, the combination of the Chinese Yuan and a commodity basket will become more attractive to World Trade relative the deficits of the US.