Forty years ago today, on the morning of Sunday, August 15, 1971, the US president, Richard Nixon, declared the inconvertibility of the dollar into gold.
As a result, the Bretton Woods system officially ended, and the dollar became a fully fiat currency, backed not by gold but by the promise of the government.
With the burial of the last vestiges of the gold — that “barbarous relic” of the past, in Keynes’s words — the annoying limitation on the creation of money and credit was broken. Human needs, as well as political demands mobilized through democratic majorities (and minorities), are infinite.
Why stop spending? Why sacrifice immediate pleasures? The new fiat currency, devoid of intrinsic properties, releases governments from their commitment to convertibility, granting unlimited powers to the rulers of this statist system. With the burial of sound money, Keynes stands as the prophet of a new era of enjoyment and excitement under the new gospel of spending. Fiat money helps to remove the link between production and consumption, contributing to the delusion that the ineradicable scarcity of capital has been abolished.
But it was always backed by the promise of government…And it was the government reneging on this promise, much earlier, that brought things to a head in the early 1970´s.
Things went from bad to worse, not because the gold underpinning of the dollar was severed, but because from the mid 1960´s the government had embarked in inflationary monetary policies.
In the first half of the 1960´s, real growth was strong and inflation low and stable. As soon as it became clear that the nominal spending growth trend was incompatible with low inflation, inflation began to rise. The figures show this very clearly.
Just as it wasn´t the “break from gold” that caused inflation, it was not the oil supply shocks of the 1970´s that “perpetuated” inflation. Both were the consequence of the “monetary disorder” that began in the 1960´s! Incredibly, to some central bankers (Burns, for instance) “inflation was a non monetary phenomenon”!
The figure for NGDP growth clearly shows the “Volker transition” from high to low inflation which gave rise to the “Great Moderation”. Unwittingly, Greenspan´s “appropriate monetary policy” concept in practice did a good job of “targeting nominal spending growth along a stable level path”.
This was achieved because Greenspan, in contrast with Bernanke, never “targeted inflation”, even implicitly. And the big loss in stability (“Great Recession”/”Little Depression”) happened soon after a die-hard inflation targeter (Bernanke) came to power and became “obsessed” with oil and commodity shocks!