Gold Standard's Demise: A System Unravelled by Its Own Design

The Bretton Woods conference in 1944 established the US dollar as the world's reserve currency, pegged to gold at $35 per ounce. This arrangement was vulnerable from the start, relying on the US having enough gold to honour its claims, which it did in 1944 when its reserves were vast and other economies were ruined.

However, by the 1960s, currency devaluations became stigmatised, and governments defended unrealistic exchange rates, often without adjusting them gradually. Instead, fixed exchange rates would adjust abruptly after crises, as with sterling in 1967 and the dollar in 1971.

The London Gold Pool, established by the US in 1961, coordinated by the Bank of England, temporarily maintained the gold price at $35 per ounce. But when private demand pushed the price above this threshold, participating banks sold their bullion to bring it back down.

US government spending, particularly during the Vietnam War and Great Society programs, worsened the situation. The Johnson administration's decision not to raise taxes led to a surge in dollar supply, expanding Eurodollars. In March 1967, West Germany's Bundesbank President privately agreed with the Fed that it would not convert its large dollar reserves into gold.

France refused to continue subsidising the dollar peg after leaving the Gold Pool in June 1967. Britain devalued the pound in November 1967, and other Pool central banks were forced to sell more gold until they gave up on March 17. This marked the beginning of a two-tier system.

The $35 gold price was used only for transactions between central banks and governments, while another floating free-market price traded above it. US gold reserves halved by 1971 as foreign claims rose over $50 billion. When President Nixon unilaterally ended the dollar's gold convertibility obligation in August 1971, the debate shifted from whether the gold window could hold to how to close it without triggering a currency-market panic.