In 1971, President Nixon permanently dislodged the USD from the gold standard, ending nearly forty years of global monetary policy in which the USD was equal to a fixed price for gold. In its place, Nixon decided to introduce a floating currency exchange system called Fiat which remains in place today.
The impact was disastrous any which way you look at it. The real estate market ballooned to obscene levels and the cost of living induced the consumer market to shrink. The ‘Great Inflation’ had set in.
What is Fiat money?
Fiat money refers to the government bonds, securities, and banknotes sold by central banks to prop up the value of their currency. Every currency in the world is now a Fiat currency, which means it’s currency does not have any intrinsic value — it only gains value because governments buy and sell each other’s money on the open exchange market.
In this system, central banks can influence the value of their currency by printing more money or pegging their currency lower than others.
Why did Nixon end the gold standard?
The gold standard was ended by Nixon as he did not want foreign nations trading in their currency for American gold. Under the Bretton Woods system, the USD was chosen to be a stand-in for gold; a currency that foreign governments could peg their currency to and trade with. Thirty-five American dollars was worth one troy ounce of gold, the idea being that countries would only want to swap their USD reserves for gold if the dollar depreciated below the price of gold.
And that’s exactly what happened. The purchasing power of the USD dropped from $40 in 1950 to $20 by 1970 as the Federal Reserve printed more paper money. As the USD began losing value, foreign countries like France asked to redeem their USD reserves in gold instead. Nixon was not having this, so he took the USD off a fixed conversion rate.
The Domestic Impact on Asset Prices
Before too long, it was clear that the Fiat system would do no favors for the American economy.
Nowhere is the contrast more vivid than in the real estate market. The average cost of a home in 1969 was $24,600. Only ten years later, the average had ballooned to $60,300. The primary cause was due to inflation derived from an oversupply of credit in the form of morgages in the markets. But not only was the cost of land going up — Interest rates on a thirty-year mortgage hit 15% by the end of the decade, making property unaffordable for most families.
The spike in real estate prices was reflected across the board in the cost of living. The essentials in life became incredibly pricey. Gas, insurance, energy, and even food became more expensive than ever before — without a complimentary rise in average income for the majority.
Worried that the economy would sputter to a halt, the Fed allowed inflation to continue so that the economy could grow. But instead of stimulating real growth, the unemployment rate increased, and people stopped spending money on consumer goods. The vicious cycle of inflation and deficit spending was afoot, and millions of Americans felt the pinch.
Five Devastating Consequences of Fiat money
- The cost of housing dramatically increased and continues to take up a greater and greater portion of people’s income. Fiat money gave banks access to unlimited credit. This may seem like good news as commercial banks are able to give more people bigger loans with better terms. However, house prices keep going up, not because people are making more money but because banks are making it possible to pay more for a house with lower interest rates. They have labelled this increase in the value of your home ‘the American dream’ but let’s face it, it’s not a dream it’s a nightmare. As the price of your house goes up so does your neighbors the net gain is negligible. If your mortgage had been smaller or non-existent your money could have gone into savings or investments which have a positive return and would be worth a lot more than your house after 30 years.
- Credit Cards are a direct consequence of Fiat money. Credit Cards have expanded the purchasing power of consumers. While wealthy people use credit cards as a convenience and service, poorer people use credit cards as a means to get by paying more in interest the poorer they are. This of course sets many people on the course to bankruptcy as the bills come due while their earnings don’t materialize. The real problem however is that poor people are forced into working multiple jobs to pay off their bills. This means that employers can hire people part time instead of full time since everybody is working multiple jobs to get buy. If there were no credit cards, people could simply get by on what they earn with one job. If everyone worked less, then employers would need their employees to work longer making it a full-time job and easier to make ends meet.
- Student Loans are a consequence of Fiat money. Student loans have become a big business in America. If commercial banks didn’t have access to unlimited capital, then they could not make so many student loans. If student loans were not available, then college tuition would not be getting more expensive because there would be no way of paying for it.
- Cars are being purchased using credit as well. This subprime market has a very high default rate. However, the banks make money by charging high rates to people with poor credit scores. This way on average they make money anyway, even though many customers wind up not being able to pay off the loan they used to buy the car. If Fiat money was not available, then there would not be a subprime auto market either. People would have to buy cars they could pay cash for or use mass transportation. One could argue that the reason mass transportation is in such poor shape in America is because of Fiat money and the subprime car market making less people use public transportation.
- One over looked problem Fiat money has created is that almost the entire economy runs on debt. Debt has taken center stage on all spending. The problem with debt is that it has to be paid back. Look at it this way, taking out a loan is like digging a hole in the ground and walking away with the dirt. If everyone, every company and every government have all dug holes then everyone is busy filling up those holes again. This leaves very little room for anything else. In essence, the debt driven economy is busy refilling holes instead of making life better for all of us. Most people are too busy trying to figure out how to get some of your dirt to refill their hole. “Personal Responsibility” for repaying your debts is the common slogan but people need to recognize the economy is structured to make it almost impossible to get by without using debt.
The Nixon shocks were supposed to be a piece of enlightened economic maneuvering to keep the American consumer market afloat. Instead, it caused an expansion in USD credit market that impacted average hard-working citizens the most. It is high time for a new economic approach that does away with the negative consequences of the out of control expansion of debt and puts debtless money where it belongs — in the hands of consumers!