The Electric Standard

Have you ever wondered why America never seems to have to worry about maintaining the value of it's currency? In 2022 we saw Russia prop up the value of the rouble by insisting that payment for hydrocarbon fuels be made in roubles, which maintained demand for the currency. The Bank of England later took action to prop up the pound. The value of a currency, unless it is "pegged" to something, operates entirely by supply and demand.

Near the end of the Second World War, in the Bretton Woods agreement of 1944, America took advantage of it's position on the winning side and as the only major nation not seriously damaged by the war, to get the dollar as the world's reserve currency. This ensured that there would always be demand for U.S. dollars and thus there would never be concern about propping up the dollar's value.

Has anyone ever noticed how the U.N. Building resembles the U.S. Dollar? I wonder if this was done purposely to boost the dollar as the unofficial global reserve currency. Images from Google Street View and the Wikipedia article "United States Dollar".

The Bretton Woods agreement also meant convertibility of the dollar into gold. The Gold Standard 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.

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 had disadvantages. It limits the power of a government to stimulate the economy by manipulating the currency supply. If all currency issued has to be 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 done by the Federal Reserve Bank to bring about recovery from the crash of 2008 and the Great Recession would not have been 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. Nixon's vice president and successor, Gerald Ford, redefined the dollar with gold not being part of the definition.

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.

Inflation is self-perpetuating. Workers are given periodic pay raises or cost of living adjustments to keep up with inflation. But this is actually what causes inflation. The currency in circulation exactly matches in value the total of goods and services being produced. So if there is an increase in the money supply, brought about by pay raises, without a corresponding increase in production, the inevitable result is 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 than inflation. 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 and there was nothing to prop up the value of the currency.

As the U.S. was taken off the Gold Standard, oil was becoming ever-more important. What effectively replaced the Gold Standard was the "Petrodollar System", although it was an informal arrangement. The United States would be a close ally of Saudi Arabia, guaranteeing it's security and access to markets. In return, oil would be sold in dollars and the Saudis would buy U.S. Treasury Bonds. But now that arrangement has effectively ended.

Electricity is quickly becoming the new economic "gold". It is becoming so expensive because AI and data centers use so much electricity. All of the wonderful things that AI can do are done with electricity. With the move toward electric vehicles replacing oil, the value of electricity is like that of gold and oil put together.

I have long thought that electricity should be money and our economic future is on the Electric Standard.