The Historic Rise (Money) and Fall (Currency) of the U.S. Dollar (2024)

52 years ago today, President Richard Nixon took the U.S. dollar off the gold standard, how did we get here?

A Case Study: The U.S. Dollar

Let’s rewind a couple hundred years and look at the U.S. dollar (take note, every other empire in human history has followed the same path as the U.S. Dollar, and we know how those empires ended up).

The founding fathers of the United States, when they created the U.S. Dollar in 1792 understood the very distinct feature of money when compared to currency – its ability to be a store of value. That is why when the U.S. dollar was formed, it was backed by gold.

The Gold Standard Act of 1900 officially set the value of gold at $20.67 U.S. dollars per ounce. Meaning one could exchange $20.67 worth of U.S. dollars for one ounce of gold.

In 1913, with the creation of the U.S. Federal Reserve, which is the U.S. central bank that manages the U.S. currency (which at the time was backed by gold), began to inflate the currency by introducing more currency than there was gold to back it (thus devaluing the U.S. dollar), this was in part to fund the war effort in War World 1.

In 1934, in response to the Great Depression, the U.S. Government passed the Gold Reserve Act of 1934 which officially revalued the price of gold to $35 U.S. dollars per ounce, up from $20.67, which had the effect of devaluing the U.S. dollar because it now can be exchanged for less gold. This was in effect a 41% devaluation of the U.S. dollar overnight. This is effectively “right sizing” the amount of gold in reserve at the U.S. Federal Reserve to the amount of U.S. dollar currency in circulation.

Have a look at the visual below to see how U.S. dollar currency volume compares to the gold reserves backing it.

World War 2: The Turning Point for the U.S. Dollar

Then along came World War 2 in 1939 and changed everything for the United States. World War 2 made the U.S. into the world super power we know today, but likely not in the way that you think.

During World War II, the United States experienced significant inflows of gold from around the world for a plethora of reasons:

• As the war intensified in Europe and Asia, many countries viewed the U.S. as a safe haven for their assets, as it was geographically distant from the main theatres of war and its political and economic stability made it an appealing safe haven for many.
• With the rapid advance of Nazi Germany across Europe, many European countries at risk of occupation moved their gold reserves overseas to the U.S. to protect them from being seized by the Germans.
• The U.S. quickly became the “arsenal of democracy”, sending vast amounts of weapons, vehicles and other war related goods for the Allies. These countries paid for these in gold. Even countries that couldn’t pay (and issued credit), later paid the U.S. after the war in gold.

In 1944, near the end of the war, representatives from the Allied nations met to form Bretton Woods, the monetary system that would reign supreme over the world until 1971 (more on that in just a moment). The Bretton Woods agreement set the conversion rate of U.S dollars as $35 USD to one ounce of gold, and the majority of other Allied countries would have their currencies pegged to the U.S. dollar, effectively making their currencies “as good as gold”, because they were pegged to the U.S. dollar. This system created the foundational base for the U.S. as the World Reserve Currency. As the U.S. dollar was backed by gold (convertible to one ounce of gold for $35 U.S. dollars), transacting globally in the U.S. dollar was effectively transacting in gold and you could be [somewhat] confident about the store of value.

Post World War 2: The Beginning of the End of the U.S. Dollar

Unfortunately, this is also what would begin to sow the seeds of the demise of the U.S. Dollar.

Enter the military industrial complex, and the numerous wars the U.S fought in the years subsequent to World War II, including the Korean war and the Vietnam war.

To fund these wars, the government ran massive budget deficits which were funded by in large through an increase in the money supply (issuing more U.S. dollars into circulation) and thus devaluing the U.S. dollar relative to the gold it held in reserve.

Recall back the Bretton Woods agreement where many countries who wanted to transact globally had to do so in U.S. dollars, because the U.S. dollar was “as good as gold”. As the U.S. government ran these massive deficits to fund the wars and funded the debt through an increase in the monetary supply (supply of U.S. dollar currency), foreign governments that were holding U.S. dollars as reserves began to convert their U.S. dollars into gold, for fear of losing more of their value at the expense of the U.S.’ empirical ambitions. This led to a duality in pressure as the volume of U.S. currency increased, and the amount of gold in reserve decreased, both having the effect of de-valuing the U.S. dollar.

The U.S. Dollar: From Gold to Oil

This loss of confidence in the U.S. dollar from foreign countries triggered what nearly could have transpired into a bank run on the U.S. Federal Reserve as countries holding U.S. dollars in reserve looked to exchange their U.S. dollars for gold. Knowing that there wasn’t as much gold in reserve to support an exchange at the stated U.S. dollar to gold conversation ratio ($35 U.S. dollars to one gold ounce), President Richard Nixon in 1971, took the U.S. off the gold standard.

It was on that fateful day of August 15, 1971 that the U.S. dollar officially became a full fiat currency (backed by nothing but faith in the U.S. government and U.S. Federal Reserve to uphold its value).

As the U.S. dollar was no longer backed by gold, the U.S. dollar currency (note: not money!) was potentially valueless, and risked losing its status as the world reserve currency.

Look at what happens to the volume of U.S. currency to gold reserves in 1971:

In the after-math of the oil crisis of 1973-1974 due to significant geopolitical tensions in the Middle East, the U.S. negotiated with OPEC (Organization of Petroleum Exporting Countries) that they would transact only in U.S. dollars (enter the Petrodollar!), and in exchange the U.S. would provide OPEC nations with military protection and assist with weapons deals and infrastructure investment. As oil was, and continues to arguably be the most valuable asset on the planet, because OPEC would only transact in U.S. dollars, the U.S. dollar effectively became backed by oil, because U.S. dollars were needed by countries around the world if they wanted to purchase oil. So in order to purchase oil, those countries would have to first purchase U.S. dollars, which allowed the U.S. dollar to continue its dominance as the world reserve currency.

Arguably, although there is no concrete evidence to prove this hypothesis, the U.S. wars in the Middle East since 1970, were to ensure the continued dominance of the U.S. dollar in world markets, specifically oil.

What has happened to the U.S. dollar in terms of its value relative to the price of gold (this chart is dated, but it has only gotten worse since 2011:

Why U.S. Dollar Dominance Matters (and how it shapes the world order)

You may ask the question why would the U.S. fight so hard to maintain the U.S. dollar as the world reserve currency? Well, there are a number of reasons – most importantly of them all to keep the sinking ship afloat as long as possible, amongst others:

• Demand for U.S. Assets: Being the world's primary reserve currency means there's a significant demand for U.S. financial assets, including government bonds, corporate bonds, and equities. This demand helps keep U.S. interest rates relatively low, reducing the cost of borrowing for the U.S. government and private sector.
• Trade Balance Flexibility: The U.S. has been running trade deficits for decades. Under normal circ*mstances, persistent trade deficits can lead to currency devaluation. However, the global demand for U.S. dollars due to its reserve status provides a buffer against this, allowing the U.S. more flexibility in its trade balance.
• Lower Transaction Costs: Since many international transactions are quoted in U.S. dollars, American companies don't incur the same currency exchange costs that companies in other countries might face.
• Economic Leverage: The U.S. can exert economic influence and leverage due to the dollar's dominant position. For instance, the U.S. can impose economic sanctions that are more effective because of the dollar's central role in global finance.
• Seigniorage Benefits: Seigniorage is the profit made by the government by issuing currency. Because the world demands U.S. dollars, the U.S. government can essentially "print money" in exchange for goods and services from other countries.
• Stability in Times of Crisis: During economic downturns or global crises, investors often flock to "safe-haven" assets, and U.S. assets, especially government bonds, are seen as a safe bet. This means that in times of global economic uncertainty, the U.S. can borrow more cheaply.
• Geopolitical Influence: The dollar's dominance enhances the U.S.'s geopolitical power. Countries aiming to maintain reserves of U.S. dollars might be more inclined to align with U.S. foreign policy or establish favorable trade relations.
• Commodity Pricing: Many global commodities, most notably oil, are priced in U.S. dollars. This means that fluctuations in the dollar's value can influence global commodity prices, and the U.S. economy is somewhat insulated from currency fluctuations in the global commodities market.

In essence, having the U.S. dollar as the world reserve currency bestows specific benefits to the United States that would otherwise be unavailable to them, and allows them to maintain their status as a world superpower, although the supremacy of the U.S. is being significantly challenged by rising powers, most notably, China. The changing world order as it unfolds in front of us will be the subject of another day.

Remember, your dollars are not money, they are currency. You want money – as money is a store of value over time.