Breton Woods Roots

In 1944, with the approaching defeat of Germany all but certain, representatives of forty-four nations met in Bretton Woods, New Hampshire to create a new international monetary system. This Bretton Woods System, which became fully operational in 1958, was essentially a mechanism to settle international accounts in dollars that were convertible to gold by the U.S. government at a fixed exchange rate of thirty-five dollars per ounce. Other currencies were pegged to the dollar, and the dollar to gold, therefore this committed the U.S. to back every dollar overseas with gold. The system seemed practical, logical and secure, for at the end of World War II the U.S. owned over half the world’s official gold reserves. But between 1950 and 1969, as Germany and Japan recovered, the U.S. share of the world’s GDP dropped from 35 percent to 27 percent. In the 70’s, a persistent negative balance of payments, inflation caused by the Vietnam War, Great Society programs, military budgets greater than the next seven nations combined and by the Federal Reserve caused the dollar to become increasingly overvalued. France, which viewed the scheme as “America’s exorbitant privilege, an asymmetric financial system whereby the rest of the world supported American living standards and subsidized American multinationals,” wanted the dollar pegged to gold at a fixed price . Even American economist Barry Eichengreen noted, “It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods in order to obtain one.” In May 1971 West Germany was the first to leave the Bretton Woods system, and shortly thereafter other nations began to demand redemption of their dollars for gold. On August 5, 1971, with unemployment and inflation rates of 6.1% and 5.84% respectively, the U.S. Congress issued a report recommending devaluation of the dollar. On August 15, 1971 President Nixon ordered the suspension of the convertibility of the dollar into gold or other reserve assets, imposed a 90-day freeze on wages and prices, and enacted an import surcharge of 10 percent. Thus, after thirteen years of effective life (1958-1971), Bretton Woods ceased to exist.

The Petrodollar

Following Nixon’s Shock, as his actions regarding the end of the convertibility of the dollar to gold became known, the dollar plunged by a third. This imperiled the dollar’s credibility as a safe depository of wealth, its status as RCW, and the global economy. In an effort to prevent that from happening, on Nixon’s instructions, in 1974 Henry Kissinger Treasury Secretary William Simon negotiated a deal with the House of Saud of Saudi Arabia so that in exchange for arms and protection the Saudis would denominate all future oil sales in U.S. dollars, and other OPEC countries soon followed suit. The deal created a permanent global demand for “petrodollars” that did not circulate within the U.S. and were thus not part of the domestic money supply. Thus, the dollars used to pay for oil were henceforth deposited in U.S. banks loaned them to developing economies so they could, in turn, buy U.S. manufactured goods and agricultural products. Essentially this allowed the U.S. to export some of its inflation, to overspend, and to print however many dollars it saw fit without international acquiescence. The Saudi deal meant that every oil consuming nation would have to earn dollars to pay for its oil. That created a permanent recurring demand for dollars and forced nations to keep dollar reserves. Thus, as a matter of convenience rather than a legally enforceable international agreement as Bretton Woods had been, the dollar became the common currency to settle almost all other international transactions.

The Debt

Chronic overspending and deficits have pushed the accumulated debt to $31 trillion, and counting . To put this in perspective, that is equivalent to $93,939.39 per person (including babies and the indigent), or the combined value of the economies of China, Japan, Germany and Great Britain. That much money would pay for a four-year degree for every graduating U.S. high school student for 73 years, an absolute necessity just to hold our own with the vast numbers of Chinese and Indian STEM (science, technology, engineering & math) students that are projected to graduate in the next few years . One point that is not often discussed is that most of the debt –$24 trillion- is carried by private individuals, not foreign governments. Given the yawning gap in wealth inequality, it’s safe to say that most of these investors, who represent a tiny minority of the population, stand to lose the most should the dollar lose its RCW coveted status. This of course has happened to other nations before , and it was never a pleasant experience for them.