Did The Great Financial Crisis Start With The End Of The Gold Standard?

Tyler Durden's picture

It’s perhaps no co-incidence that the trend towards persistent deficits started around the final collapse of the last link to a quasi-Gold standard back in August 1971. As Deutsche Bank's Jim Reid notes, in a world of the Gold Standard or equivalent, those countries loosening policy too much would have seen a rush to convert their currencies into Gold thus destabilising their economic policy framework. Multi-year (let alone multi-decade) deficits and the GFC could not have occurred under a gold standard.

So with the shackles off and with nothing backing paper money, the post 1971 period has seen a uniquely long period of fiat currencies globally with a beggar-thy-neighbour rolling period of credit creation. Never before in observable history have so many countries been off a precious metal type currency system for so long. This move in 1971 helped create the conditions (alongside ever looser financial regulation) for almost unlimited credit and debt creation potential that would have been inconceivable through the annuls of economic history. The developed world in particular went on a 36 year credit/debt binge which probably lasted longer and was more aggressive than it would have been had it not been for China's globalisation moment 30 years ago. From this point they almost single handedly started a three decade period of suppressing global inflation thus allowing the credit/debt binge to become ever bigger without the inflationary check that would have likely otherwise occurred.

It’s worth reminding ourselves that this graph is compiled on a log scale which can visually understate the scale of the loss of purchasing power seen against Gold over the last century. Such losses did occur in stages though.

 

As can be seen from the graph, the 1930s Depressionary period, and the war-torn 1940s, saw sizeable devaluations against Gold from most countries as many re-valued or left the Gold Standard due to high economic stress. Post WWII, the Bretton Woods system then broadly stabilised currencies by creating a Dollar standard where the US agreed to convert Dollars into Gold at around $35 per ounce. After 20 plus years of relative currency stability (helped by heavy post WWII capital controls), the late 1960s started to see pressures building on this Dollar/Gold peg as some countries chose to switch their Dollars into Gold as concern mounted about the loosening of US monetary policy and on the other side some countries had to devalue within the system.

By 1971 President Nixon had decided that this peg was unsustainable and on 15th August he suspended convertibility - which leads to the inflationary debacle in our previous post.

 

So after 41 years of global fiat currencies and an unparalleled amount of debt that is proving very difficult to shift, we really are venturing into the unknown.