The Euro, The Gold Standard And, Jimmy Carter

If you are wondering what one earth the euro, the gold standard and, former U.S. president Jimmy Carter have to do with each other, read on.

Let's begin with the gold standard. This is a system that is no longer used by any country in the world. The gold standard is the idea of basing a country's money on gold in order to provide currency stability. This used to be done by either actually making coins out of gold or, more often, issuing paper currency notes that are defined in value as being equivalent to a given quantity of gold. The notes may or may not be redeemable in gold on demand.

When a country begins printing money, particularly if it is a new country that came into being by fiat or upheaval, there may not be a lot of confidence in it's money. Backing the currency with gold provides the confidence that is necessary for the functioning of the economy. Backing a currency with gold also provides currency stability in troubled times, limiting any swings in value. If we want to virtually eliminate inflation, all we have to do is to peg the currency to gold.

But the gold standard also has disadvantages. It limits the power of a government to stimulate the economy by manipulating the currency supply. If all currency issued has to backed by actual gold, the government cannot just print money as it sees fit. The gold standard did not prevent the 1929 crash and Great Depression that followed, and it is no secret that countries that were on the gold standard at the time, including the U.S., took longer to recover from the crash than those that were not on it. The gold standard presumes that the price of gold itself is ideally stable which, of course, it isn't.

If the U.S. was on the gold standard today, the so-called quantitative easing being done by the Federal Reserve Bank to (hopefully) bring about recovery from the crash of 2008 and the Great Recession would not be possible. This refers to the government putting money into the economy by the purchasing of bonds to keep interest rates low by increasing the money supply so that business can more easily get loans to start or expand.

The Bretton Woods agreement of 1944 was to set up the postwar international economic structure by pegging various national currencies to the U.S. dollar, which was pegged to gold. This got the postwar world on track until the arrangement became outdated and countries began leaving it. In a landmark event, known as the "Nixon Shock", U.S. president Richard Nixon took the dollar off the gold standard on August 15, 1971, this effectively ended Bretton Woods and today no nation uses the gold standard.

Next, let's have a look at another former U.S. president, Jimmy Carter.

Jimmy Carter was elected U.S. President in 1976. He was a Democrat and had nothing to do with the gold standard because Nixon had taken the dollar off it in 1971 and his vice president and successor, Gerald Ford, had finally redefined the dollar with gold not being part of the definition.

My reason for bringing Carter into this discussion is that he has really been treated unfairly by history. The term associated with his presidency, in the late 1970s, is "stagflation", meaning a toxic mixture of stagnation and inflation. We usually see inflation in the economy when it is growing, but President Carter supposedly mismanaged the economy into a high rate of destructive inflation without the growth.

I realize now that this is nonsense and is the result of Reagan-era Republican propaganda from the 1980 election. The high rate of inflation during Carter's presidency was the result of the exit from the gold standard, combined with a perfect storm of other events which took place before Carter took office.

First, there was the spending on the Great Society social programs of the 1960s. This produced prosperity at the time, although inflation afterward. There was massive government spending on the Vietnam War, and for programs like the Apollo Space Program. Then, after Nixon had taken the dollar off the gold standard, there was the Oil Embargo of 1973 followed by a steep climb in the price of fuel. As we know only too well, when fuel gets expensive it not only cuts into everyone's purchasing power, but it makes everything else more expensive because the transportation costs of products factor in with production costs.

When a currency is taken off the gold standard, the government is free to print currency at will and it's value "floats" with the total value of goods and services produced in the economy divided by the amount of currency printed. Printing money can thus be expected to bring about inflation.

A very moderate amount of inflation, maybe a couple of percent per year, is not necessarily a bad thing because it acts as a cushion against deflation, which is worse. If prices are deflating, it doesn't make sense to manufacture things because, by the time they can be sold, the manufacturer might have to sell the goods for less than it cost to make them.

The gold standard became outmoded in the modern world, but leaving the standard brings a certain amount of risk because it almost inevitably results in inflation when the currency supply is no longer constricted. The most notorious inflation that the world has ever seen is, of course, Germany in the 1930s. According to the article on the gold standard on www.wikipedia.org , this was the result of the country being unable to return to the gold standard because of it's gold reserves being depleted by First World War reparations payments.

These factors all converged on Jimmy Carter's presidency, but in no way were they his fault. I am not faulting Nixon for taking the country off the gold standard in 1971, actually it should have been done sooner. Neither am I faulting Ronald Reagan for purposely inducing the recession of the early 1980s, because that was the only way to get the resulting inflation under control.

But blaming this on Carter is like blaming the government for a hurricane. Reagan's rightward economics is what it took to stop the inflation that had been unleashed by the end of the gold standard, and it's convergence with the other spending factors, but he stayed too far right throughout the 1980s and it resulted in the Crash of 1987.

Finally, for the euro.

My view of the common European currency, the euro, is that it acts as a kind of artificial gold standard. Instead of pegging their currencies to gold, Europeans have pegged them to one another's by joining a common currency. Like currencies on the gold standard, the euro has proven to have stability and has simplified transactions between countries on the same standard. Inflation has also not been much of an issue.

But the economies of the struggling countries in Europe are also manifesting the great disadvantage of the gold standard. The governments of these countries can no longer print their own currency and so are limited in what they can do to help bring about an economic recovery. It is much more difficult to put money into the economy to bring down interest rates, and make funding more available, so that businesses can start and expand. We looked at the debt of these struggling countries in Europe in the posting "Inflation And Debt", on this blog.

As of this writing China does not allow it's currency to float freely, although Xi Jinping's 2013 reform package included liberalizing currency policy. But the economy of China is still growing without requiring anything like the quantitative easing being done in the U.S. If the time ever came when the economy needed help from the government, pegging the currency would no longer make sense.