What happened in 1971 and why is it so important for cryptocurrencies?

Main

• The abandonment of the Bretton Woods monetary system, which took place in 1971, was a mistake and led to structural problems in the world economy, society and politics – a popular concept in the crypto community.
• Proponents of this theory cite as evidence the growing social inequality in Western countries, the stagnation of real wages and other socio-economic indicators that began to deteriorate after 1971. Opponents of the concept point to the absence of direct causal relationships between the emergence of a new monetary system and negative trends.
• Perhaps Satoshi Nakamoto and his associates were critical of economic policy after 1971, and bitcoin was intended to be a response to the shortcomings of the new monetary system, including the need for trust in state institutions, constant crises and the depreciation of fiat money.

What happened in 1971

To restore the world economy, which was badly damaged due to the Second World War, in 1944, representatives of 44 states that were part of the Anti-Hitler coalition adopted an agreement on a new monetary system, called Bretton Woods, after the conference was held.

The new system was based on a fixed price of gold ($35 per troy ounce) and fixed exchange rates of the participating countries, set in relation to the key currency – the US dollar. The binding was due to the fact that even then the United States economy was the largest and least affected by the war.

The US also held about half of the world’s gold reserves. Although the Bretton Woods system replaced the gold standard system, it was in many ways a continuation of it: the value of currencies was backed by gold reserves.

The new system guaranteed the dollar’s convertibility and made it the world’s reserve currency. Thanks to this and other measures, the post-war economy was able to fully recover by the early 1950s and continued to grow rapidly. In the West, this period of about 25 years was called “post-war economic miracle“.

During this time, there was a high demand for dollars in the world. To meet this demand, the US Federal Reserve (Fed) printed money faster than the amount of gold in reserves increased. In addition, since the early 1960s, the United States has become increasingly involved in the Vietnam War, which required increased government spending – they were also partially covered by the “printing press”.

By 1969, when Richard Nixon became president of the United States, the total issue of the dollar exceeded the backing in gold by 4 times. By according to Yale professor Jeffrey Gartner, who wrote a book about subsequent events, the country’s leadership seriously feared economic destabilization. In addition, the “strong dollar” made US exports very expensive. In May 1971, the FRG, and later Switzerland, left the Bretton Woods system. Other countries also began to gradually exchange the American currency for gold.

In early August 1971, the US Congress recommended that the dollar be devalued. It was this decision that had been secretly prepared in the Nixon administration for some time. On August 15, the American president recorded an address to the nation, in which he announced the decoupling of the dollar from gold. This event became known as the Nixon Shock.

“What does this decision <…> mean to you? <…> If you want to buy a foreign car or travel abroad, market conditions may mean that dollars can buy a little less. But if you’re among the vast majority of Americans who buy American-made products, your dollar will be worth as much tomorrow as it is today,” Nixon said in part in his speech.

Consequences of the Nixon shock and Reaganomics

The main consequence of the abandonment of the “gold standard” was the emergence of a global market for national currencies and free exchange rates of money. Central banks got the opportunity to pursue a much more flexible monetary policy, including large-scale printing of money to solve the problems of the state and the economy.

The new monetary system manifested itself in the early 1980s, after Reagan proclaimed neo-liberalism in the economy and neo-conservatism in politics.

During the 1970s, the United States and Western countries were struck by stagflation – the gradual depreciation of the currency in the absence of economic growth. The Reagan administration cut taxes significantly, especially on businesses, to increase investment and reduce unemployment. Reagan actively reduced government spending on social programs, but at the same time significantly increased the military budget and the cost of the state apparatus.

As a result, inflation and unemployment were defeated, but the reduction in tax revenues and the increase in military spending led to a sharp increase in the US budget deficit, which was actively covered by increasing the national debt. As a result, by 1988, its figure tripled, and the United States for the first time in many decades turned from the world’s largest lender to the largest borrower.

Reaganomics also had long-term socio-economic consequences: real incomes continued to fall, and social stratification began to rise sharply. This trend has not been stopped to this day: in the period from 1964 to 2018. American income adjusted for inflation increased by only 10%.

How cryptocurrencies are connected to the final abolition of the “gold standard”

Many researchers of the publications of Satoshi Nakamoto and his associates agree that bitcoin was created influenced by the Austrian School of Economics and its followers. In their forum posts and letters, the future creators of the cryptocurrency mentioned economists such as Ludwig von Mises, who supported the gold standard and opposed the principle of fractional reserve banking. Also, the creator of bitcoin drew inspiration, probably, were Friedrich Hayek, who developed private money conceptAnd Murray Rothbard.

Bitcoin was the answer to the financial crisis of 2008 and the chosen ways to deal with it. Then the authorities of the United States and other countries for the first time applied the policy of “quantitative easing”: central banks bought up distressed debt instruments through large-scale currency issuance, while maintaining low interest rates. There was a risk of hyperinflation, which nevertheless managed to be avoided.

“A key issue with traditional currencies is the trust that is required to make them work. The central bank needs to be trusted not to devalue the currency, but the history of fiat money is full of breaches of that trust. Banks need to be trusted to store money there and transfer it, but they use it for loans, repeating credit bubbles, leaving only a small part in reserves, ” wrote Nakamoto.

Simply put, cryptocurrency is the answer to the problems of the new monetary system, which led to long-term negative effects. And the starting point of this new system was the Nixon shock of 1971. This view in the crypto community was popularized by the authors of the site W.T.F. Happened In 1971, who published a lot of graphs about him, dedicated to various socio-economic trends in the United States. Here is one of the charts:

Criticism of the concept

Despite the negative attitude towards the abolition of the “gold standard”, the decision made by Nixon in 1971 is generally positively perceived in the scientific community. Survey of professional economists, held in 2012showed that none of them see the return of the gold standard as a way to improve the economic system.

In addition, a direct link between the change of the monetary system, on the one hand, and the growth of inequality and stagnation, on the other, has not been proven. The authors of the WTF Happened In 1971 website showed a correlation, but not a causal relationship, that often confused. In one of the comments, they even admitted that their project is more of an attempt to raise a question, rather than answer it, and the site is a meme. After all, the standard of living both in the West and in the world as a whole did not fall after 1971, but has grown significantly.