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DANIEL LACALLE, PH.D., is chief economist at hedge fund Tressis. He holds the CIIA and master's in Economic Investigation and IESE. Daniel Lacalle
50 Years of Monetary Insanity
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What the end of the gold standard means for our monatary system
This year marks the 50th anniversary since President Richard Nixon suspended the convertibility of the U.S. dollar into gold. That began the era of a global fiat money debt-fueled economy. Since then, crises have been more frequent, but also shorter and always “solved” by adding more debt and printing more money.
The suspension of the gold standard was a catalyst to trigger massive global credit expansion and cement the position of the U.S. dollar as the world’s reserve currency, as it de facto substituted gold as the reserve for the main central banks.
The level of global debt has skyrocketed to more than 350 percent of gross domestic product (GDP), and what’s mistakenly called “the financial economy,” which is the credit-based economy, has multiplied.
The gold standard imposed a limit on the monetary and fiscal voracity of governments, and suspending it unleashed an unprecedented push to increase indebtedness, and the perverse incentive for governments to pass on current imbalances to future generations.
By substituting gold for the U.S. dollar as a global reserve, the United States has been able to borrow and increase money supply massively without triggering hyperinflation because it exports its monetary imbalances to the rest of the world. Other currencies follow the same monetary expansion without the global demand that the U.S. dollar enjoys, so the rising imbalances always end up making those currencies weaker versus the greenback and the economies more dependent on the U.S. dollar.
This race to zero, pursued by most central banks, has also achieved a state where there’s no real alternative to the U.S. dollar as a reserve, because the rest of the countries abandoned the monetary and fiscal orthodoxy at the same time, weakening their ability to be a world reserve alternative.
In the 1960s, any currency from a leading country could compete with the dollar if its gold reserves were sufficient. Today, none among the fiat currencies can compete with the dollar, either in financial capacity or as a reserve. The example of the yuan is paradigmatic. The Chinese economy is more than 17 percent of the world’s GDP and its currency is used in less than 4 percent of global transactions, according to the Bank for International Settlements.
With the suspension of the gold standard, Nixon cemented and guaranteed the financial and monetary hegemony of the United States for the long term, while unleashing a global credit-fueled economy where financial risk disproportionately exceeds the real economy.
The defenders of the suspension of the gold standard contend that financial crises are shorter and that the global economy has strengthened in the period. However, it’s more than debatable to consider that massive debt expansion is the cause of progress. Non-productive debt has soared and the tax wedge on citizens has elevated, while the severity of financial crises has also increased, which are always “solved” by adding more debt and more risk-taking.
A debt-fueled economy and massive money creation disproportionately benefit the first recipients of money and credit, which are government and the wealthy. This creates a larger problem for the middle classes and the poor to access better standards of living when asset prices are artificially inflated while real wages rise slower than the price of essential expenses, such as housing, health care, and utilities, while taxes rise.
A return to the gold standard may be unfeasible today given the size of the global monetary imbalance versus gold, which could create a giant financial crisis. But a Taylor-rulebased system in monetary policy that limits central bank balance sheet expansion, and a strict deficit and debt limit can be implemented if there’s a political will.
