The Bretton Woods system was ultimately undermined by the decline in U.S. power. In 1944, the United States produced half of the world’s manufactured goods and held more than half its reserves ($26 billion in gold reserves out of an estimated total of $40 billion globally). Over time, the burden of the Cold War and being at the center of the global financial system weighed heavily on the United States.
In the 1960s, President Lyndon Johnson’s administration ran large budget deficits to pay for the Vietnam War and its Great Society programs. This created inflation and increased dollar outflows to pay for the expenditures. The dollar became overvalued relative to the German Deutsche Mark and the Japanese yen. Faced with the choice of devaluing the dollar or imposing protectionist measures, President Johnson argued: “The world supply of gold is insufficient to make the present system workable—particularly as the use of the dollar as a reserve currency is essential to create the required international liquidity to sustain world trade and growth.”19 It was the Triffin dilemma, identified by Belgian-American economist Robert Triffin in the 1960s. As the dollar was the global reserve and trade currency, the United States had to run large trade deficits to meet the world’s demand for foreign exchange.
By the early 1970s, the ratio of gold available to dollars deteriorated from 55 percent to 22 percent. Holders of the dollar lost faith in the ability of the United States to back currency with gold. On August 15, 1971, President Richard Nixon unilaterally closed the gold window, making the dollar inconvertible to gold directly. The Nixon Shock was announced in an address on national television on a Sunday evening. The President risked antagonizing fans of the popular TV program Bonanza to make the announcement before markets opened.
Frantic efforts to develop a new system of international monetary management followed. The Smithsonian Agreement devalued the dollar to $38/ounce, with 2.25 percent trading bands. By 1972, gold was trading at $70.30/ounce. Other countries began abandoning the link between their currency and the dollar. In February 1973, the world moved to the era of floating currencies with no link to dollars or gold. It was the final transformation of money. The last link to something tangible was severed. The greenback was no longer as good as gold. It could not be exchanged into anything except identical notes—itself.
Max Weber, the father of social science, defined the state as the agency that successfully monopolizes the legitimate use of force. Now the state, through its monopoly over the printing presses, controlled money and the economy. Money would be henceforth a matter of pure trust. American dollars still bear the words: “In God We Trust.” But God was not directly responsible for control of money; it was governments and central banks.
In Lewis Carroll’s Alice in Wonderland, Humpty Dumpty observes: “When I use a word it means just what I choose it to mean—neither more nor less.” Alice responds: “The question is whether you can make words mean so many different things.” Unhesitatingly, Humpty Dumpty cuts through to the heart of the issue: “The question is which is to be master—that’s all.”20 Governments could create money, making them undisputed masters. Keynes recognized the risk: “By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”21
Some found the prospect of governments controlling money disturbing. In his study of the human unconscious, Sigmund Freud noticed a striking association between money and excrement: “I read one day that the gold which the devil gave his victims regularly turned into excrement.”22 Many feared that governments would turn their money into human waste.
Former U.S. Federal Reserve Chairman Alan Greenspan once flirted with this problem:
- Under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth.... The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit.... In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.23