Big Change 1971

The US Treasury debt replaces the Gold Exchange Standard 1971.

The US Treasury kept the dollar’s exchange rate stable by selling gold via the London Gold Pool at $35 an ounce. Finally, in August 1971, President Nixon stopped the drain by closing the Gold Pool and halting gold convertibility of the dollar (so called Nixon shock) and declared the dollar to be a floating currency. The suspension of dollar convertibility marked the end of the Bretton Woods system. Other major currencies became under pressure and finally in early 1973 all became floating. The international monetary system had evolved to a regime of generalized floating among the major currencies.

There was no clear-cut plan for what would happen next. The move to generalized floating was widely regarded as a temporary solution. Most observers viewed cutting the dollar’s link to gold as a defeat for the US. It certainly ended the postwar financial order as designed in 1944. But what happened next was just the reverse of a defeat.

Although European monetary integration created EMS, EMU, ECB and finally euro believing in its own omnipotence, the central banks worldwide found in practice only one asset in which to hold their balance-of-payments surpluses: the US Treasury debt. These securities no longer were “as good as gold but nearly.” The US issued them at will to finance soaring domestic budget deficits.

By shifting from gold to the dollars thrown off by the US balance-of-payments deficit, the foundation of global monetary reserves came to be dominated mainly and factually by the US military spending that continued to flood foreign central banks with surplus dollars. America’s balance-of-payments deficit thus supplied the dollars that financed its domestic budget deficits and bank credit creation – via foreign central banks recycling the US foreign spending back to the US Treasury.

In effect, foreign countries have been taxed without representation over how their loans to the US Government are employed. European central banks, at that time, were not yet prepared to create their own sovereign wealth funds to invest their dollar inflows in foreign stocks or direct ownership of businesses. They simply used their trade and payments surpluses to finance the US budget deficit.

The system may have developed without foresight, but quickly became deliberate. Financial markets and aftermarkets for US Treasury bonds and other US obligations have become enormous in size worldwide.