WTF Happened in 1971?

The question “WTF happened in 1971?” trended on Twitter in August 2021 as the 50th anniversary of President Nixon decoupling the U.S. dollar from gold reserves approached. This Twitter query is answered by a story that starts in 1944 in a New Hampshire vacation town. It receives a jolting plot twist from Richard Nixon in 1971. Since 1971, the story has been in its third act, highlighted by the government’s unbridled printing of money as the proposed cure for major economic maladies. The fiat-deficit monetary system formalized by Nixon’s actions in 1971 has led to a decades-long devaluation of the U.S. dollar, real inflation, and wealth disparity that now compels many people to look away from bank savings accounts, bonds and even gold, and towards Bitcoin for wealth preservation.

From 1880 to the start of World War I, the United States and Europe maintained gold standard monetary systems. The gold standard limited the expansion of money supply, which restrained inflationary pressures. The system was not without its weaknesses. If nations failed to keep their currencies pegged to gold (which some did from time to time by expanding money supply beyond their gold reserves), inflation would arise, which led in some cases to recession. These recessions, however, were short-lived as nations did not materially stray from the gold standard. The annualized inflation rate during this 35-year gold standard period was only 0.1 percent.

World War I compelled many nations to abandon the gold standard and engage in money printing and deficit spending. Following the war, a return to gold-standard monetary systems faced obstacles, including European hyperinflation in the 1920s, global depression in the 1930s, and World War II. Near the end of World War II, countries sought the economic stability provided by a gold standard. Seeking to achieve this stability, and cognizant of the lack of adequate gold reserves in many countries, 44 nations met in Bretton Woods, New Hampshire in 1944 to establish a global monetary system. The U.S. dollar was pegged to a weight of gold. Other countries deposited large portions of their gold in the safe haven of the United States, and their currencies were pegged to the U.S. dollar. The exchange rates between currencies were held in prescribed ranges to facilitate trade, and an International Monetary Fund and U.S. federal reserve bank system were put in place to make it all work. Under the Bretton Woods system, “countries settled international balances in dollars, and U.S. dollars were convertible to gold at a fixed exchange rate... [with] [t]he United States [having] the responsibility of keeping the price of gold fixed and [adjusting] the supply of dollars to maintain confidence in future gold convertibility.” If the U.S. followed the rules, every country’s currency was indirectly based on a gold standard.

The Korean War, Vietnam War, space race, and President Lyndon Johnson’s Great Society program came with a huge aggregate price tag. Despite the provisions of the Bretton Woods agreements, by the late 60s the U.S. had been regularly issuing dollars into supply beyond its gold reserves in order to meet expenses. Fiscal deficits and money supply growth led to inflation and U.S. trade imbalances, with a considerable portion of the U.S. dollar supply held by foreign nations. Entering 1971, foreign banks and governments held $64 billion U.S. dollars against $10 billion of gold held by the United States. The United States could not fulfill its obligation to redeem dollars for gold should a material percentage of foreign-held dollars be redeemed. Countries began to lose faith in the U.S. dollar and in July and August 1971 Switzerland redeemed $50 million and France redeemed $191 million U.S. dollars for gold. Britain then put in a request to redeem $3 billion. Seeking to prevent something akin to a Depression-era bank run (or the calling of a poker bluff), Nixon took to the airwaves on August 15, 1971 and stated that he had “… directed [Treasury] Secretary Connally to suspend temporarily the convertibility of the dollar into gold… except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.” As noted by economist Milton Friedman, however, “Nothing is so permanent as a temporary government program.” By moving off the gold standard, the United States formalized a policy of economic control through money supply expansion and gave birth to the modern U.S. fiat-deficit monetary system. Knowing that he was unilaterally walking away from an agreement that involved the economic foundation of dozens of countries, Nixon attempted to alleviate global fears that his actions would devalue the dollar stating that the “effect of [his order]… will be to stabilize the dollar.”

In 1970, the average annual income of a family ($9,870) was more than 58% of the average home price ($17,000). By 1980, the average annual income of a family ($21,020) was only 44.5% of the average home price ($47,200). The fiat-deficit system contributed as much to rising oil prices as OPEC policy, with prices going from $1.21 per barrel in 1970 (before Nixon’s action) to $1.82 per barrel by 1972 (after his action and before the oil crisis). By 1980 oil had reached $35.28 per barrel. The price of per kilowatt hour of electricity increased from 1.8 cents in 1970 to 5.8 cents by 1980. The average annual inflation rate from August 1973 to August 1981 was 8.1%, with the dollar losing more than half its purchasing power compared to 1971.

Despite intense devaluation of the U.S. dollar since 1971, the current post-Great Recession era of near-zero interest rates, low unemployment, and stock market growth has created a perception that the system works. It has only “worked,” however, because as the system’s inherent problems have arisen (e.g., recessions), governments have flooded the markets with even more money supply to solve the problems. And if it has in fact “worked,” it has only worked for a portion of the population. In 2020, the average annual income of a family ($67,521) was only 17.3% of the average home price ($389,400).

Despite the materially increased prices Americans have experienced during the past decades when buying houses or cars, and the high consumer goods inflation the country has experienced at many times during the post-Nixon era, proponents of the current (i.e., Post Great Recession) fiat-deficit system contend that it has not affected consumer inflation. Yet, the inflation has been there. It has been hidden from the average consumer by the divergence of monetary inflation and price inflation. In 2008, the Federal Reserve began paying interest to banks for depositing their money with the Fed. This has reduced banks’ incentive to lend money out to average consumers, which would have broadened spending power across the population and driven price inflation on “main street.” Instead, as the government expands money supply, the new dollars go directly to banks that then lend them to corporations and other large clients. As a result, inflation has been seen most quickly in stocks, real estate and other assets of limited concern to many people. Thus the price run up in the stock markets and high-end real estate. General inflation is now catching up, however. The CPI increased 6.2 percent from October 2020 to October 2021, the largest 12-month increase since November 1990. The negative effects of fiat-deficit have in fact come to main street again.

Larger troubling signs are apparent. The debt of the United States has grown from $398 billion in 1971, when such debt was equal to 35% of our GDP, to almost $28.4 trillion today, and equal to 125% of our current GDP. Proponents of the post-Nixon fiat-deficit system contend that the U.S. can forever finance its growing debt through the sale of more and more U.S. treasury bonds. Yet, U.S. treasuries are backed by the U.S. dollar, which, in turn, is backed by nothing more than the confidence the world has in the United States to pay its obligations. Historically, the purchase of billions of U.S. treasury bonds each year demonstrated that confidence. Based on this metric, however, confidence is now materially waning. Between 2010 and 2020, the share of U.S. Treasury securities owned by foreign entities fell from 47% to 29%. The U.S instead has become the biggest customer of its own bonds, using money it makes out of nothing to support its bond sales.

In response to these circumstances, in February 2009, Satoshi Nakamoto (a pseudonym) published a white paper entitled "Bitcoin open source implementation of P2P currency," creating Bitcoin. Nakamoto noted that “the root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust." Bitcoin is an attempt at a democratic, decentralized, bankless, governmentless, technological-driven return to a gold standard-like currency system.

In a nutshell, Bitcoin is both a digital accounting ledger and a digital currency. It is hosted on a network of thousands of independent computers globally, which allows “two willing parties to transact directly with each other without the need for a trusted third party (such as a bank).” It is safe and secure because every transaction is based on the network’s computers working collectively to solve complex cryptographic proofs. As noted in the Bitcoin white paper, “Transactions that are computationally impractical to reverse… protect sellers from fraud.”

The ideological root of Bitcoin is found in the writings of early 20th century Austrian economists, such as Ludwig von Mises, who wrote "the principle of sound money is an instrument for the protection of civil liberties against despotic inroads on the part of governments…" He noted that "the postulate of sound money was first brought up as a response to the princely practice of debasing the coinage." Bitcoin is a response to governmental devaluation of currencies. Essentially, in Mises’ ideology, inflation is as much a theft as actually taking a person’s property. Bitcoinists see Bitcoin as a route to escape such theft by escaping the fiat-deficit system in whole or part. They see in Bitcoin a form of digital gold that can serve as the foundation of a new “sound money” system.

Gold has numerous qualities that has allowed it to serve as “sound money” for thousands of years. With unique density, it cannot be counterfeited, as no other metal will weigh the same as gold at the same volume. It is physically divisible and will not age, die or rot, unlike other forms of commodity-based value, such as livestock or grain. It is fungible, as gold has the same price from country to country throughout the world. While modern currencies generally have these same characteristic, they do not possess the characteristic that ultimately makes gold “sound money,” which is scarcity. In 1950, there was about 65,000 tons of gold mined, with another 135,000 tons of gold mined in the ensuing years. It is estimated that there is about 50,000 tons left in the ground globally. Additional gold is costly to mine. The total supply as of 2020 can only be increased throughout the rest of time by about 25% based on the foregoing estimates. In the post Nixon fiat-deficit system, money supply can be increased 25% in an instant with the push of a button.

Nakamoto designed Bitcoin with all the elements of gold, including scarcity, as well as numerous improvements. Like gold, Bitcoin can only be obtained through “mining,” which involves the solving of increasingly complex cryptological problems, using increasingly massive computing power and yielding fewer coins over time. In fact, Bitcoin is ultimately finite, and 90% of all coins are already mined. The total supply of Bitcoin is fixed at 21 million and cannot be altered as this supply limit is embedded in the source code of Bitcoin. This creates a fixed economic system, where additional money supply cannot be created and the system’s entire purchasing value is embedded into the 21 million coins now and forever. In a world where Bitcoin is fully accepted, it could never be a force creating inflation (as its money supply cannot be expanded), and in the face of natural inflation of goods and services caused by other factors, the value of Bitcoin would rise to meet those inflating prices (as no additional coins can be created, each coin would rise in value). Bitcoin is easier to manage and use than gold. It is portable (it weighs nothing). The entire capital of a company could be stored in Bitcoins and moved instantly. The same value in gold would weigh thousands of pounds and would require moving dollies, armored trucks, and numerous personnel to move it. Bitcoin is technology based. It can improve over time, its functionality enhanced by new software developments. Gold is what it will forever be.

Perhaps most importantly, Bitcoin is apolitical. It is governmentless. It cannot be censored. Short of all governments conspiring together to destroy the Internet, it cannot be stopped. A person can leave a country that is in turmoil and retrieve their Bitcoin in another country. A person living in the United States can get money to relatives in a war-torn country, so long as that relative can access the Internet through a phone or computer. As noted by Roger Ver, an early Bitcoin adopter sometime known as “Bitcoin Jesus,” “Price is the least interesting thing about Bitcoin. We saw Bitcoin as…a way to separate money from the state.” More pragmatically, as Austrian economist F.A. Hayek stated “… we can do much better than gold ever made possible. Governments cannot do better. Free enterprise... no doubt would." Many believe free enterprise has done better, through Bitcoin.

Bitcoin does not have to replace government issued currencies to help the world unravel from the post-Bretton Woods hole that has been dug. Bitcoin merely needs to provide a means for all people to take a portion of the value they have created through their sweat and toil and move it off the fiat-deficit system in order to store value relative to a U.S. dollar that has steadily devalued since 1971. The problems of the fiat-deficit system will not be going away. Many believe that during the coming decades, as Bitcoin becomes more accepted, and the credit worthiness of the United States and other nations continues to be undermined by the fiat-deficit systems they have embraced, businesses, individuals and even countries will use Bitcoin as a way of off-loading some of the fiat-deficit system risk. As this paper is written, El Salvador has implemented Bitcoin into its economic system. More than 76 million people as of August 2021 have created unique Bitcoin wallets on Blockchain.com, a site that makes buying Bitcoin possible – a 171% increase since 2018.