Thus far:

  1. Petrodollar Wars 101: what was the Gold Standard? – where I gave the briefest possible history of currency, and the British Empire brought the world onto the Gold Standard.
  2. Petrodollar Wars 102: The US Dollar Gold Standard – where I talked about the various failures of the interwar period, Keynes’ grand idea that never was, and how the Americans got their way in the end.

At which point, the American Dollar was tied to gold (at $35 per ounce), and the World was tied to the American Dollar. Even then, economists were aware of some problems that history had shown with this particular approach:

  1. if America wanted to maintain a fixed exchange rate of the dollar to gold, she would have to balance on the edge of her trade;
  2. if she didn’t, someone would take advantage of the committed conversion of the dollar into gold; and
  3. no funny business with monetary policy.

Why Europe and Japan Got The Marshall Plan

Almost immediately, everyone realised that there was a problem. Some factors:

  1. The United States of America was the country that everyone was importing products from, having been left largely untouched (at least infrastructurally) by both of the World Wars.
  2. This reliance on imports was not helping the economies of Europe and Asia to recover. Especially when the newly-formed IMF told everyone that it was not permitted to make loans for capital and reconstruction purposes – its function was to cover short-term shortfalls.
  3. Which resulted in a massive US dollar shortage in everywhere but America, because all the dollars were being used by the rest of the World to pay for their American imports.



The situation was not good for the rest of the World. And it wasn’t even good for America (people that buy your goods on credit, but show no signs of getting a job, will one day go bankrupt).

So US Secretary of State, Mr George Marshall, announced his plan to fix Europe. And the United States forced itself into a position where it held a Balance of Trade Deficit. There were also Aid programs put in place to Japan; and the Truman Doctrine meant that money flowed to anti-communist causes.


So to summarise:

  1. The USA is looking ridiculously munificent.
  2. She is buying up raw materials from developing countries, processing them at home, then exporting the finished goods at great profit.
  3. She is then giving that money away in Aid Programs and under the Marshall Plan to rebuild the European and Japanese economies, thereby expanding the market for American goods and creating future destinations for American capital.
  4. Would we call this global fiscal stimulus?


The Trouble Begins

The problem with running grand balance of trade deficits (ie. you’re exporting less than you’re importing) is that eventually, people begin to wonder whether it wouldn’t safer to hold gold, actually. I mean – how can you say “$35 will always buy you an ounce of gold” when you’re also saying “we’re handing out more dollars that we receive in”. Which is almost the economic equivalent of saying: “I’ll always be a size 10. Even though I eat ice-cream all day long and I’ve stopped going to gym.”

So here is the awkward dilemma that the United States found itself in (known as Triffin’s Dilemma, after the economist that first noticed it):

  1. The US had to run trade deficits in order to maintain the world’s liquidity (otherwise, the rest of the world suffers dollar shortages like just after the war, and global trade grinds to a halt); but
  2. Constant trade deficits were eroding faith in the dollar.

At the same time, the United States had not monopolised the world’s gold markets. It only held about 65% of the world’s gold reserves at the end of World War II, which meant that there was still gold out there, people were still mining it, and all the young ladies were still adorning themselves with it.

Which meant that the gold market, like any other, was subject to fluctuations in price. In dollar terms. And if, let’s say, you could only get gold for a wedding ring at $42 per ounce: would you buy it, or would you send a small note to the Federal Reserve asking them to hand you an ounce for $35? The higher the free market price of gold, the higher the risk that people might take advantage of the arbitrage opportunity.

A Short How-To Guide for Gold Arbitrage

Let’s say that gold was trading at $70 per ounce on the free market (it would never have been this high – but it makes my numbers easier). But because this was 1960, you could also exchange $35 for an ounce of gold at the Federal Reserve. Here’s a plan:

  1. Exchange $35 for an ounce of gold at the Fed.
  2. Sell the ounce of gold for $70 on the free market.
  3. Take the $70 back to the Fed and exchange it for two ounces of gold.
  4. Sell the two ounces of gold for $140 on the free market.
  5. Take the $140 back to the Fed and exchange it for four ounces of gold.
  6. Sell the four ounces of gold for $280 on the free market.
  7. And so on.

Now obviously, if everyone is doing this, it should drive the free market price of gold down. But in those short periods where these trades are ongoing, you can expect some decimation of the Fed’s gold reserves…

The Speculative Runs

So the speculators started gathering. And some of them were large-scale. I mean – “France” was a primary protagonist. Those French…

And at this stage, the banking world had expanded across borders, forming international banking consortia that allowed for huge capital flows between countries.

Which made the 1960s a decade of increasing measures to try and maintain the price of the dollar relative to gold. There were restrictions on imports into the USA, and restrictions on trade outflows. There was talk of export subsidies. Basically: anything to strengthen the value of the dollar.

But then the Vietnam War happened.

The Johnson administration refused to fund the war effort from taxes, so American monetary policy became expansionary. Borrowed dollars flooded out of the United States to pay for the war effort, causing the dollar to depreciate significantly.

In order to borrow from the Federal Reserve, Congress had to repeal the requirement that the Fed maintain a 25% reserve of gold backing to the dollar. Which meant that at least 75% of the world’s gold was now floating around in private markets, leading to a sharp diversion between the free market gold price and the dollar-gold fixed exchange rate.

Taking full advantage of this opportunity, France and a few other nations began to build their gold reserves, swapping out their dollars. Far from a dollar shortage – there was now a dollar glut.

By 1970, the US was in reserve deficit.

Mr Nixon

On 15 August 1971, President Nixon issued an executive order (number 11615) and “closed the gold window”. That is: he declared that the dollar would no longer be directly convertible to gold. The only way to exchange it would be on the open free market.

And the world bid the Gold Standard farewell.

But the real problem: how would the American Dollar continue to maintain its reserve currency status now that it was just as free-floating as any other currency?


Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at Or both.