Gold News

The Monetary System: A Degenerate Party

A century ago much of the world was on the gold standard. It's been a wild ride since...

AS FAR AS we can tell, writes Greg Canavan for the Daily Reckoning Australia, the international monetary system is devolving.

Let's quickly run through the history of it over the past 100 years or so...

From the late 1800s we had a classical gold standard. This worked well for a time but its mild deflationary tendency was incompatible with a growing democratic movement and the rise of the state.

As the age of capitalism morphed into the age of imperialism, the interests of great powers bumped up against each other and led to war. War and a gold standard cannot exist together. To execute a war, you need to unleash the inflation tax on society to help pay for it.

So the Great War in 1914 saw the end of the Classical Gold Standard. Following the war, the blokes in charge tried to get something similar happening and held a conference in Genoa in 1922 to do so. They came up with the 'Gold-Exchange Standard', a precursor to the US Dollar standard we are on today.

This monetary system allowed central banks to keep part of their reserves in currencies (like the pound) that were tied to gold. While it sounded good at the time, it led to a huge global credit inflation and ended in disaster in 1929.

Following the depression, no one really knew what was going on. Britain got off the 'Gold Exchange Standard' quick smart. As manager of the world's reserve currency at the time, it had the most to lose by staying on gold. That's because it had printed immense amounts of its currency, which ended up in the vaults of other central banks (sound familiar?). If Britain didn't abandon gold in 1931, the Bank of England's vaults would have soon filled up with paper pounds and emptied of gold bars!

Other countries stayed on gold, only to suffer the deflationary consequences. The US jumped ship in 1933 while France and others finally relented in 1936.

Following World War II the gents got together and came up with the Bretton Woods system. For the purposes of international trade, the US Dollar was tied to gold at $35 Dollars an ounce. The Dollar was therefore as good as gold, and other countries stored gold AND US Dollars as a part of their international reserves. It was the 'Gold-Exchange Standard' all over again.

But as we said, gold, democracy and the welfare state are incompatible. The US started to lose gold from its vaults as its trading partners realized the Dollar wasn't as good as gold at all.

So Bretton Woods ended in 1971 and since then we've been on a Dollar standard. And what a party it's been! In fact, the good times lasted so long that everyone began to think of it as normal. But of course, it just led to another credit bubble, this time bigger than the one in the 1920s.

That bubble burst spectacularly in 2007/08 but the boys wanted to keep the party going. So they manufactured a government debt bubble, effectively cashing in all the goodwill and 'credit' governments had built up over previous generations to do so.

The party is again in full swing. It's like the music never stopped. But as history shows, it does, and it will. Only to start back up again...perhaps next time we get a different tune and a different tempo. After such a large hangover, the boys might be after a change of pace.

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Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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