It is 40 years since the end of the Bretton Woods agreement and, indeed, the end of the gold standard. Bretton Woods had been a financial discipline put in place to prevent central bankers expanding the monetary supply in an irresponsible way and to introduce fiscal discipline. For those who believe in the power of happy coincidences, the answer to current financial issues might just lie in the number "40". I'll explain.
The Bretton Woods system collapsed exactly 40 years ago under the weight of US trade deficits and the cost of funding the Vietnam War, which meant that gold and international currencies were freely floated. It was to be the birth of fiat currencies (Latin for "let it be done"—in other words, the currency’s value is decreed by government) and it ushered in (initially) an era of unprecedented prosperity.
Ironically, fiat currencies have a long history, originating in China in the 11th Century during the Song Dynasty (they cannot say that they were not warned) but it died during a period of hyperinflation, something that fiat currencies have had a tendency to do.
A 40th anniversary is referred to as a "Ruby Anniversary" and in an act of irony we may find the answer to our current economic woes in another ruby—Dorothy’s 'ruby shoes' in the Wizard of Oz—a film thought by some to be a monetary allegory for the gold standard. More of that in a moment; you will need to wait for the punch line.
In 1944 at the outset of Bretton Woods the US government held 60% of global gold reserves. The US dollar was pegged to all currencies at a fixed exchange rate and gold was fixed at a price of $35 per ounce and redeemable by holders of dollars at that price. The Federal Reserve was thus constrained from expanding their monetary base without buying more gold. It placed financial constraints on central bankers. This artificial construct came under pressure and a number of countries—especially France but also later Germany and Switzerland—redeemed their dollars for gold with the US Federal Reserve.
During the period of Bretton Woods (1944-1971), gold coverage for dollars printed by the Federal Reserve had fallen from 55% to 22%. The US was in difficulty and on August 15, 1971, President Richard Nixon unilaterally decided without consultation with Congress to impose a wage freeze, a 10% duty on imports, and closed the gold window, ending convertibility. This was the so-called Nixon Shock, and it succeeded in liberating global economies so that markets flourished—for a while.
The Wizard of Oz, meanwhile, had been published in 1900 by William Baum (a keen political writer and Populist) and released as a film in 1939. In the original book, Dorothy's shoes were silver but this was changed to ruby by the filmmakers because Hollywood was going technicolor . The Populist Movement of 1894 had wanted silver (at a fixed ratio of 16:1), along with gold, to be used as the backing for US dollars, thereby creating more dollars, thus devaluing dollars and therefore reducing the debt burdens that workers (and especially farmers) were laboring under. It was a form of quantitative easing, if you like.
There is no solid evidence to support the view that the book was intended as a political satire or even a monetary allegory, but it does nevertheless serve a didactic purpose.
The interpretation of the film is clear. Dorothy (Everyman American) is lost in a (financial) storm. She is joined in her endeavors to find a solution by the Scarecrow (farmers), Tin Man (industrial workers), and Lion (pro-silver politicians). The Yellow Brick Road (gold standard) takes her some of the way there. However it leads to the Emerald City (fiat currency), with its false tricks and delusions. The answer to financial salvation lies in her ruby (silver) shoes. Of course the Wizard (President) was a fraud, his gifts were shallow, and much of what he said was fantasy. The message is clear at its simplest level—we have the power within us by clicking our heels to make the changes we need. At a deeper level we are urged to move beyond the constraints of a gold standard to make the economic changes necessary for growth—in this case silver.
Bretton Woods was devised precisely to prevent the sort of economic conditions that we suffer today. Excessive leverage, and politicians who lack the courage to give us what we need rather than what we want. This safety net was abandoned 40 years ago. The solution to today's problems is not, in my opinion, to head back down the yellow brick road and reintroduce a gold standard, although it might play a role in the solution. The gold market is insufficiently large to sensibly play that role by itself.
In 1942 John Meynard Keynes conceptualized and the UK proposed that the IMF introduce the "Bancor,” a supranational international currency used for trade and exchanged by barter. It could play a parallel role as the global reserve currency and, it would be backed in part by gold and other hard commodities.
In 2008 the governor of the People's Bank of China suggested Special Drawing Rights at the IMF as an alternative solution.
Whatever the solution —a Bancor (backed by gold), SDR's, or even silver slippers—the time has come to put global reserve assets on the IMF agenda. The US dollar suffers from a dilemma whereby short term domestic issues conflict with longer term international concerns.
This needs to change.
Ross Norman is the owner and chief executive officer of the London-based gold broker Sharps Pixley Ltd.