The US dollar may be a safe haven in choppy waters, but a storm continues to brew
Most commentators now agree that President Nixon’s ending of the Dollar’s direct link to a weight of gold in 1971 was the precursor to the gradual erosion in the values of paper currencies. But what is not generally appreciated is that this outcome was predicted with mathematical precision by the French economist Jacques Rueff as far back as 1944. Rueff gave a warning about America’s monetary system that central bankers continue to ignore to this day. What Rueff calculated in 1944 came true with precision in 1971, and the exact same pattern is playing out with America’s $34 trillion debt crisis today.
The mathematical impossibilities that destroyed the gold standard in 1971 are built into the current system, and the equivalent officials that dismissed these concerns in the 1960s merely as jealousy of the Dollar’s dominance, are using similar rhetoric today. These mathematical impossibilities are affecting everything from retirement savings to the prices of groceries as the values of FIAT currencies continue to erode. American strength and dominance meant that these mathematical rules were not considered applicable, such was the level of dominance provided by the need for foreign trading counter parties to accumulate ever-increasing numbers of Dollars, without ever demanding their conversion into gold. A pattern of ignoring financial warnings until crises force their hand has been repeated for the past eight decades.
If we go back to the UK’s experience, following the First World War, the Bank of England had insufficient reserves of gold to fund the war loans that the nation had incurred. The Bank of England was therefore forced to repay these debts in ‘IOU’s’ - paper currency promises to pay. The subsequent American experience has been somewhat similar. Rueff’s calculations forecast that America would also lack the reserves of gold required to back the growing need for their currency. As the world’s reserve currency, Dollars were required both to fund trade and expensive wars, until the US had insufficient gold reserves to provide backing for the increased number of dollars in circulation.
As each additional Dollar could be exchanged for a specific weight of gold, the end of the currency’s link with gold was inevitable. In August 1971 the inevitable happened, but at the time this was advertised as merely a temporary suspension, in the hope that more ‘normal’ monetary conditions would allow a return to the previous gold-backed regime. In 1960 Triffin’s Dilemma had confirmed Rueff’s warnings that the system was unsustainable, but Triffin’s warnings were also dismissed as theoretical economics removed from the real world. Rueff kept publishing his updated calculations and even forecast that it would be termed a temporary measure required to deal with extenuating circumstances. Meanwhile, every increase in America’s trade deficit and each ton of gold leaving the reserves validated Rueff’s calculations.
America continued its policy of trying to discredit any theory that questioned the Dollar’s supremacy. Between 1958 and 1961 Rueff had published detailed updates of his calculations - a countdown to financial catastrophe when foreign Dollar holdings exceeded the country’s gold reserves by such a margin that confidence collapsed. Between 1957 and 1960, US gold reserves fell from 20,312, to 17,804 tons, at a time when foreign Dollar claims rose to over $18 billion. This was playing out as Rueff’s calculations had forecast, but his work continued to be dismissed as European jealousy.
In 1965 President De Gaulle announced that France would no longer accept the exorbitant privilege of American monetary dominance, demanding a return to the gold standard and quoting Rueff’s mathematics. President Johnson dismissed this as the rantings of a fading power. However, Federal Reserve minutes published decades later indicate that privately these warnings were causing concern. Over this period, France systematically converted Dollar holdings into gold, repatriating over 3,313 tons from American vaults. Other countries followed suit. Harold McMillan tried to persuade President Kennedy to revalue the Dollar to $70 of gold to return balance to the system, but his suggestion was rejected, insisting that American economic strength made such a move unnecessary.
By 1968, the demise of a gold backed Dollar was becoming more inevitable.
Bullion was being depleted at an unsustainable rate, and panic buying only served to hasten the end of the London gold pool. American officials continued their narrative that these conditions were temporary, with Treasury Secretary Henry Fowler maintaining that the Dollar’s fundamentals were strong and that convertibility was never in question, while privately discussing emergency measures to limit gold outflows. By1969 even American economists were reaching the same conclusions as Rueff had published twenty-five years previously, and by 1970 his became the consensus view.
On August 13, 1971, after twenty-seven years of dismissing Rueff’s models, America was facing the exact scenario that he had predicted. US gold reserves had fallen to just over 10,000 tons, while foreign claims on this bullion exceeded $40 billion. At the conversion rate of $35 an ounce, America owed more gold than existed in their vaults. John Connolly, the Treasury Secretary, admitted that the game was up and this was not a temporary liquidity crisis. Still President Nixon’s public announcement of a temporary suspension of the Dollar’s link with gold was blamed on foreign speculators. Floating rate currency uncertainty followed. Without the discipline of gold convertibility, inflation accelerated, trade imbalances widened, and currency instability became a permanent feature.
The discretionary monetary system was as Rueff had predicted and reshaped the world’s economy for the decades that followed. We are now living through his warning all over again, and the US administration is responding as before, denying and dismissing the concerns expressed about the unsustainability of America’s monetary trajectory. Rueff’s mathematics haven’t disappeared with the gold standard, they have merely taken a new form. Instead of offering to back currencies with limited reserves of gold, holders of currency are being offered no more than faith in governments to service the impossible arithmetic of the debt load.
One mathematical impossibility has been exchanged for another and, yet again, there has been little pre-emptive reaction from Western central banks. Governments will continue to react only to crises - and they may not have to wait for too long. In commodity transactions, the BRICS are already systematically decreasing their reliance on the Dollar as a store of value, or even a means of exchange. While the US dollar has characteristics of a safe haven, it is an accolade tarnished by weak alternatives.
About the author
Jo Welman had a career in the City spanning 45 years and worked in a wide variety of financial sectors. After graduating from Exeter University in 1979 with a degree in economics, Jo spent ten years at Baring Asset Management where he managed a range of UK and US pension funds and unit trusts, investing across multiple sectors including bonds, international equities, commercial and residential property and private equity.
In 1989 Jo became Managing Director of merchant bank Rea Brothers’ institutional and private wealth investment management division. Over the following decade Jo launched a series of specialist investment trusts and funds in a variety of industry and property sectors, before forming a joint venture with reinsurance broker Benfields (now Aon Benfield) and raising one of the first limited liability corporate capital vehicles for the Lloyds insurance market in 1993. As part of his long-standing involvement in the insurance industry, Jo co-founded the Benfield Re-Insurance Investment Trust plc (Brit) in 1995. Following the sale of Rea to Close Brothers in 1999 Jo became Chairman of Brit Insurance Holdings Plc and in 2001, in partnership with Brit and Benfields, he co- founded specialist asset management firm, EPIC Investment Partners (EPIC).
Jo continues to provide corporate finance and investment advice to entrepreneurs and private investors. He sits on the board as a non- executive director of ARK Syndicate Underwriting
“Feet up by the pool”
Jo does not receive any remuneration for his EPIC commentary. Instead, EPIC is pleased to promote the latest edition of his book “Feet up by the pool”.
Profits from sales of the book go to The Money Charity, a charity that shares Jo’s objective to help fill in some of the worrying gaps in the school curriculum. These omissions leave many young adults lacking in the financial awareness that they need to survive in a world where they will rely on their own savings if they are ever to stop working. Even if they earn the right to a full State Pension, today this amount hardly covers council tax and utility bills, and so they need to save and build up a sum of capital amounting to around twenty times their desired retirement income. A frightening number.
As Jo eloquently says, “If we can do our bit to raise awareness of the impending UK saving and pensions crisis, the exercise will have been worthwhile.”