All that glitters is not gold, but nothing shines like the real thing. That’s why our brightest element has served as a store of value and medium of exchange for thousands of years. Its scarcity sustains its value and has kept a check on governments throughout history. Until fifty years ago today.
When Nero was building his palace two thousand years ago, he realized there wasn’t enough silver and gold in the Roman treasury to pay for the job, so he conceived his most lasting legacy, monetary debasement. To meet the shortfall of precious metals coming from plunder, tariffs and taxes, Nero had the ingenious idea of adding base metals to make a precious mix go farther. He also lowered the weights of Roman coins to make more and satisfy his extravagant wishes. Popular with the masses until the end, his monetary policies didn’t work out well for the asset holders. Nero was sentenced to death as a public enemy, marking the end of the Julio-Claudian dynasty.
In 1914, the German Empire was dominating Europe with an economy supplied by 6 billion gold backed German marks. The First World War cost Germany 160 billion marks and the gold guarantee was repealed. The 1919 Treaty of Versailles burdened an already stressed government, but the magic elixir of money printing eased their pain. By 1923 there were 1,280 billion marks in circulation and the exchange rate with the US dollar had gone from 7.5/1 to more than a trillion/1. The German mark became worthless as a store of value or a medium of exchange while the political instability sowed the seeds of humanity’s worst disaster.
Franklin D. Roosevelt struggled with monetary policy and the gold standard. He wanted to follow the advice of the world’s leading economist, John Maynard Keynes, to use activist government policy to relieve economic distress. Keynes called the gold standard “that barbarous relic” and FDR lowered the official exchange rate and banned individuals from owning gold. That didn’t prevent the ongoing economic crisis from becoming the Great Depression, which was only solved by another horrifying world war. Expecting victory in 1944, the Allied nations met at a lodge in New Hampshire and devised the Bretton Woods monetary agreement, which set a gold backed US dollar as the world’s reserve currency. A quarter century of exceptional economic growth and stability followed throughout the world.
As strong as the US economy became, it wasn’t enough to sustain the Great Society social programs of the late 1960s. Foreign central banks became uncomfortable with all the dollars being printed, so they began to redeem their dollars for gold. On August 15, 1971, Richard Nixon responded to the threat of depleting US gold reserves with the most consequential economic act since Nero, when he ended the US dollar’s convertibility into gold. Thus, the world entered the era of fiat money, whose value comes only from government decree.
The Era of New Money
Economic growth and stability gave way to a decade of stagflation, a new term describing low growth with high inflation, something Keynes said would be impossible. It took the heroism of Fed chairman Paul Volcker to kneecap the economy with 20% interest rates in 1980 as the only way to slay the inflation beast and set the stage for economic rebirth. Good times returned, but so did periodic crises at home and abroad. South American countries got in trouble borrowing dollars from US banks that blew up after their home currencies depreciated.
The US Federal Reserve stood ready to protect the banks with an unconstrained ability to print dollars, and the power alone proved enough to provide stability. The Fed records the amount of money it creates on its balance sheet, which remained steady around $800 billion for the next few decades. During that time, bank balance sheets ballooned along with the financial sector of the US economy. When markets got too hot, the Fed would raise interest rates which could be lowered again when the economy slowed. The inflation threat was gone and the price of gold fell by half.
The Great Moderation brought the era of financialization, when any asset could be turned into a security, even low income housing. The business of banking went from making loans to trading securities, and bigger balance sheets meant bigger profits. Loopholes were written to allow banks to get around regulations meant to ensure financial stability. Risky assets were moved to related party hedge funds without removing the actual risk. Mortgages written to unqualified borrowers became a toxic poison infecting the global financial system.
The 2008 Global Financial Crisis gave the Federal Reserve another opportunity to bring monetary policy to a new era. Lowering interest rates to zero was not enough to relieve the stress, so they embarked on their program of “quantitative easing,” which means buying bonds in the open market to provide liquidity to the banks. Their initial purchases were enough to get the financial system running smoothly again, but they had to keep the additional money flowing.
With the economy back on a growth trend in 2013, the Fed suggested a tapering of their monthly money printing. The Dow Jones Average went into a “taper tantrum” and dropped almost 6%. Chairman Ben Bernanke changed course and maintained the monetary accommodation, and the stock market cheered with a rally to new highs. By 2019, the balance sheet stood at $4.5 trillion and a modest decline over several months brought a disruption in esoteric financial markets that required a $300 billion emergency infusion. The stock market celebrated with a 29% gain for the year.
That was before anyone had heard about covid. When the world economy shut down in March 2020, the Fed embarked on their “nuclear response” consisting of $120 billion injected into the bond market every month, including direct purchases of corporate debt. Never had the US central bank invested directly in private companies. It was truly a new era in monetary policy.
The Fed is continuing their $120 billion monthly covid response even with the economy back open and growing at the fastest pace in decades. The banking system is not showing any stress and unemployment is lower than job openings, yet the Fed is keeping the pedal to the metal as the politicians think up new ways to spend all the free money.
When Nixon ended the gold standard, he said “we are all Keynesians now,” but a new paradigm has taken hold of monetary policy. Modern Monetary Theory calls for printing as much money as it takes to solve all of society’s problems. We should only turn off the spigots if inflation comes. Unfortunately, Paul Volcker is no longer here to remind us of the dangers of inflation, while the last three Fed chairman have proven unable to even turn down the spigots.
Any hint of monetary restraint has been met with a stock market selloff, which the Fed has consistently rescued with greater accommodation, resulting in record prices. With the Fed’s balance sheet now exceeding $8 trillion, investors in risk assets have gotten all the gains with none of the risk. Those without the means to take on risk can only watch their savings earn nothing and buy less, as the rich get richer. The consequence has been a fraying of our social fabric and a return of inflation like we haven’t seen since the 1970s.
The Fed tells us today’s inflation will be transitory and they are going to continue their policies until everyone is benefiting from them. That ought to keep the asset holders fat and happy while everyone else waits for it to trickle down. The Federal Reserve is among our last respected institutions, but even PBS’ Frontline is now pointing out the damage they are inflicting on society.
Gold is rallying to new highs as cryptocurrencies provide another alternative to central banks’ half century experiment in fiat money. The Fed congratulates itself on how well it has worked, even as they are unable to reverse course. Fifty years is a blink of history’s eye and the rise of novel forms of money suggests we could be at a turning point. Central banks could neutralize the threat from cryptocurrencies by banning exchanges with their fiat currencies. Even if forced into that extreme action, gold would remain as earth’s shiniest element.