Gold News

Underground Gold Standard

Plaza, Louvre, and now $1250 per ounce...

OFFICIALLY, the gold standard is regarded as superstitious nonsense, especially by academics, writes Nathan Lewis at New World Economics in this item originally posted at Forbes.

The fact that it worked very well for centuries, produced results that nobody seems able to achieve today, and – unlike any other "superstition" in the history of human civilization – has been shared by the ancients and moderns, Chinese, Romans, Persians and Aztecs, apparently means little to these people.

But unofficially, gold was not only the basis of the global monetary system for centuries until the breakup of Bretton Woods in 1971, it has been – in rough form – the basis of the global monetary system for most of the time since 1971 also. Humans apparently cannot live without it, even if they want to.

Life was good in the 1960s. It was the most prosperous decade of the last century, not only in the US but worldwide. The US middle class reached a level of prosperity that hasn't been seen since.

After 1971, the US economy crashed and burned. As the Dollar fell from the Bretton Woods parity of $35 per ounce of gold to over $350 per ounce during the decade – a devaluation of 10:1 – the US and the world economy was mired in an intensifying stagflationary slump that many feared would lead to hyperinflation, revolution and war.

In 1979, then US president Jimmy Carter flailed around for a solution like his hair was on fire. But neither he nor his economic advisors could make much sense of what was going on.

Nevertheless, he did make one key decision, that seems amazing in hindsight. He kicked out Federal Reserve Chairman G.William Miller, in the middle of his term, by offering him the position of Treasury Secretary. Miller took it. In his place, Carter installed Paul Volcker.

Volcker had spent much of his earlier career at Treasury defending the Bretton Woods gold parity at $35 per ounce You might think that, in his new position at the Fed, he would quickly act to reinstate the gold standard system that worked so well in the 1960s. But he didn't do that.

Instead, Volcker followed the academic fashion of the time, and began a project that had never been tried before – the "monetarist experiment". It seemed like a good idea on paper.

But in the real world, the result was a disaster. The value of the Dollar crashed, from around $350 per ounce as Volcker began to a nadir of $850 per ounce only a few months later, in early 1980. Interest rates soared, and some people hoarded canned goods. Then the Dollar screamed higher in value, to $300 per ounce in 1982. The US economy tumbled into the worst recession since the Great Depression.

It was even worse elsewhere: the move blew apart weak "Dollar pegs" that had become common in the developing world. As their currencies collapsed, governments and corporations that had borrowed in Dollars defaulted en masse. All of Latin America exploded into hyperinflation for a decade.


In mid-1982, Volcker gave up. The "monetarist experiment" was a failure. Then what?

Here's economist Arthur Laffer:

"In the early 1980s under gifted Federal Reserve chairman Paul Volcker (1979-87), the United States once again returned to a price rule, only this time the Dollar wasn't pegged to gold. Following a meeting I had with Chairman Volcker in 1982, I co-wrote an article for the editorial page of the Wall Street Journal. In this article Charles Kadlec and I outlined in detail Chairman Volcker's vision of a price rule, a vision that is as relevant today as it was in 1982. Volcker essentially said, 'Look, I have no idea what prices are today. Or what inflation is today. And we won't have those data for months. But I do know exactly what the spot prices of commodities are.'

"In short, what Chairman Volcker did was to base monetary policy on the secular pattern of spot commodity prices (the market price of a commodity for current delivery)....It's very similar to a gold standard, except that Chairman Volcker was using twenty-five commodities instead of just one. Every quarter from 1982 on, monetary policy has been guided by the spot price of a collection of commodities, save for our present period [2005-2010]."

Although a basket of commodity prices may have been the main tool, the effect was to gradually stabilize the Dollar's value against gold.

At first, the swings were wild. Only a few months later, in 1983, the Dollar was back down to $500 per ounce; then up to $300 per ounce again at the beginning of 1985. Once again, the strong Dollar was causing problems worldwide, leading to the Plaza Accord that year in which the G7 agreed to temper the Dollar's strength.

In February 1987, after the Dollar had fallen again to $400 per ounce, the G7 met again and formed the Louvre Accord, which was to temper the Dollar's weakness. Now two lines had been drawn in the sand, one at $300 per ounce (Plaza Accord) and one at $400 per ounce (Louvre Accord). The world was moving toward $350 per ounce as the new consensus value of the Dollar vs. gold.

Alan Greenspan stabilized the Dollar still further against gold during the 1990s, the "Greenspan gold standard". The Dollar then had a long decline under Ben Bernanke, falling from $300 per ounce to a low around $1900 per ounce in 2011. Official CPI figures were "strangely" quiet, but the price of oil soared from $20 a barrel to $140 along the way. Just as people panicked in 1979 and threw Volcker at the problem, I think somebody panicked in 2011-2012. A further decline in the Dollar's value would not be tolerated. Serious firepower was brought to the task, probably including financial market manipulation at an unprecedented level.

The result was the "Yellen gold standard" from 2013 to the present, in which the Dollar's value vs. gold has been "strangely" stable between $1150 and $1350 per ounce, with a midpoint around $1250 per ounce.

The results have been pretty good. During this time, nobody has complained much about either "inflation" or "deflation". Unlike Greenspan, who gave a lot of hints that he was actively stabilizing the Dollar vs. gold, Yellen and now Powell have kept mum. But, it is hard to believe that this outcome was purely by accident. Actually, even if it was, the result would be the same. The gold standard works even when it is by lucky chance.

Thus, if we look back on the 47 years since 1971, we find that we seem to have had a crude – very crude! – but nevertheless intentional effort to stabilize the Dollar's value vs. gold, otherwise known as a gold standard system, for more than half of that time. The times when we haven't had this, in the 1970s and the Bernanke years, it's been either a one-way trip south, or a rollercoaster of chaos.

The effective choice has been either a gold standard or a "PhD standard", and the PhD standard hasn't amounted to much more than overt currency debauchery.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn




Market Fundamentals