The U.S. dollar, as we know it today, just turned 50.
Sunday marked the 50th anniversary of the dollar becoming a fiat currency. On August 15, 1971, President Richard Nixon announced the dollar would no longer be convertible to gold, but would instead be backed by the Full Faith and Credit Clause of the Constitution.
This was the end of what is colloquially known as the “gold standard” in America and the beginning of the U.S. dollar as a fiat currency.
Unknown to most, the dollar existed in many different forms prior to the 20th century. In fact, for much of the nation’s life, multiple types of U.S.-backed dollars were in circulation at the same time. There were gold certificates, silver certificates, privately-owned bank-issued notes, there was even a dollar that paid interest.
It wasn’t until after the creation of the Federal Reserve in 1913 that the dollar really started to become standardized.
And that took many decades.
Silver certificates, for example, which were U.S. banknotes exchangeable for physical silver, were issued in the United States up to 1964.
I point all this out to show the truth about a very common misunderstanding about the “gold standard” in America. And it’s this: Some banknotes prior to 1971 were convertible to gold, but not all of them.
A gold standard is a monetary system in which paper currencies are backed by gold at a fixed rate. That does not describe all banknotes prior to the end of the gold standard in ’71.
When economists speak of the “gold standard,” what they’re really referring to is the Bretton Woods system.
Bretton Woods was an international monetary agreement whereby nations were obligated to stabilize exchange rates within 1% by tying their currencies to gold. The agreement was made in 1944 during WWII.
On August 15, 1971, Nixon ended the Bretton Woods agreement, effectively ending gold convertibility of any U.S. banknote completely.
Since then, the dollar has been what has been called a “fiat” currency.
The word “fiat” comes from a 4th-century Latin translation of the Bible called the Vulgate. In fact, the word comes from what is perhaps the most well-known of Latin phrases of the book: dixitque Deus fiat lux et facta est lux (“God said let there be light and there was light”).
In both this and in the context of the current use of the word to describe the dollar, the word “fiat” means “let it be done” or “let it be made.”
In other words, the value of the dollar comes from the government’s declaration of its value. And it backs that declaration up with “the full faith and credit of the United States.”
It doesn’t seem like the whole fiat system should work. But here we are. Since 1971 the dollar has survived as a fiat currency. Truth is, although many people will say that the “full faith and credit” of the government is insufficient to support the dollar’s value, I’d challenge you to find one who would also turn down being handed a $100 bill.
The fiat currency system is, of course, not a perfect system. But neither is a gold standard.
The big idea behind implementing a gold standard in the Bretton Woods system was to stabilize foreign exchange rates and to prevent nations from competitively debasing their currency to gain unfair trade advantages.
The problem with the Bretton Woods System was nations could cheat. They could simply lie about the amount of money they put into circulation.
And they did.
In the 1960s the United States did not have enough gold to cover the volume of dollars that were in circulation. Once foreign nations became wise to that, they started to demand their gold. The U.S. took several measures to stabilize the system, but decided to completely abandon it in 1971. Since then the dollar’s value has come from the U.S. government’s fiat.
The main argument against a fiat currency system is generally that it gives the government the ability to create as much money as it wants. And it does. But creating new money isn’t as easy as flipping a switch. That needs congressional backing.
There’s a common misunderstanding that the Federal Reserve controls the supply of dollars. They don’t. The Federal Reserve essentially operates the accounting part of the dollar, among other things. They don’t get to dictate how many dollars are created. The group responsible for telling the Federal Reserve how much money to create is Congress.
In short, Congress dicates the federal monetary policy. And the Federal Reserve carries out the orders.
The Federal Reserve is very clear about this on their main monetary policy page saying:
Monetary policy in the United States comprises the Federal Reserve’s actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates — the economic goals the Congress has instructed the Federal Reserve to pursue.
In some ways, the Federal Reserve acts as a political buffer for Congress. The Fed takes the heat off of Congress’ back. But make no mistake about it, Congress is wholly responsible for the amount of money in circulation. And getting Congress to agree isn’t always easy.
So at the end of the day, we are 50 years into congressional control over the supply of U.S. dollars.
I don’t know if that’s a happy birthday or not.
