Thread by @ProfPaulPoast

How did the Gold Standard work? I mean ACTUALLY work?

The answer reveals a lot...including why a Gold Standard won't work today.

[THREAD]

When I write "actually" worked, I am not looking for an explanation based on the "specie flow mechanism", IS-LM-BP model, or something abstract like that

Instead, I want to know, for example, if governments actually loaded gold onto boats to move gold from country to country!

Important to note that there are different types of Gold Standards:

- coin: literally 🪙 circulated
- bullion: govts hold gold bars, which are redeemed with paper currency by anyone
- exchange: govt holds currency that can be exchanged for gold
eh.net/encyclopedia/g…

The most recent Gold Standard system, the one that Nixon ended in 1971, was of the third type (why he ended it is another story for another thread). Let's focus on understanding how that system worked!

That system, the Bretton Woods system, was based on the "Articles of Agreement" signed in 1944

Link: fraser.stlouisfed.org/files/docs/his…

We refer to the system established by the "Articles of Agreement" as the "Bretton Woods System" because the articles were negotiated and signed at the Mount Washington resort in Bretton Woods, NY

According to Article IV of the agreement, US $ was the "exchange currency" that other countries could use to acquire gold (and against which other countries would set the "par values" of their currencies)

Specifically, governments of other countries could buy gold from the United States at $35 per ounce.

Important note: the price of gold wasn't set in the Articles of Agreement. It was set by the US 1934 Gold Act

Link: fraser.stlouisfed.org/title/gold-res…

Not worth going into all of the details for WHY the Articles of Agreement were written this way. For more on that, see @BennSteil's excellent book
amazon.com/Battle-Bretton…

Suffice it to say that the key reason the $ and gold were the foundations of the system was because, by 1944, the US held most of the world's gold

Here's a key: under the Bretton Woods system, only other governments could directly exchange dollars for gold from the US government.

There were private gold markets, but only governments could use the US "Gold Window"

Before a government can acquire gold from the US, it first needs $. How did it acquire those?

Turns out, most governments DIDN'T have them. This was called the "dollar shortage" and was due to many of the economies of the world being devastated by WWII

But programs such as the Marshall Plan, large US military spending during the 1950s, as well as the US allowing imports of goods abroad with few exports going out (i.e. tolerating protectionism), enabled other countries to start accumulating dollars.

By the late 1950s, enough countries had enough $ that the "Bretton Woods system" could actually start working
federalreservehistory.org/essays/bretton…

Okay, now that we know what the Bretton Woods system was, let's get to the key part of the thread: how did a foreign government ACTUALLY acquire gold held by the US?

A foreign government, say France, would make a request directly to the US Treasury. This request usually went to the US Treasury's International Affairs department.
home.treasury.gov/about/offices/…

For a good portion of the time that the Bretton Woods system actually operated, the head of that Treasury division was Paul Volcker (yep, THAT Paul Volcker!)

That request would then get kicked over to the Treasury's Exchange Stabilization Fund
home.treasury.gov/policy-issues/…

The folks working at the ESF then call up the Federal Reserve Bank of New York

You see, the NY Fed is the "fiscal agent" of the US Treasury
newyorkfed.org/aboutthefed/fe…

More precisely, the Treasure request goes to the Fed's foreign exchange operations desk
newyorkfed.org/markets/intern…

For most of the Bretton Woods system's operation, that desk was headed by Charles Coombs. Coombs wrote about his experience in this book
amazon.com/Arena-Internat…

Once the Fed has the order from France to exchange dollars to gold, the order is processed by moving the gold. Literally.

But the gold USUALLY did not physically leave the US...or even the Fed.

The image that opened this thread is of a "crib". The Federal Reserve bank of New York has a bunch of these cribs.

Countries from around the world have their own "cribs". These countries leave the gold (usually for a small handling fee) in those cribs. Why? convenience

Side note: some folks might be thinking, "wait, wasn't that the basis of the plot to `Diehard with a Vengeance'"? Yep!

In sum, US $ have now been converted to gold, but the gold is still in the US.

At least, that's how it usually worked. Sometimes countries wanted to actually ship the gold back.

Shipping the gold back is what France did during the 1960s, which is when the Banque de France accumulated much of the physical gold that it holds today.
banque-france.fr/en/custody-and…

Why did France do that during the 1960s? Ask, Charles De Gaulle.

Another caveat: sometimes the Federal Reserve Bank of New York doesn't have enough gold on hand to meet the requested transaction. In that case, the gold is shipped from the US Bullion Depository, a.k.a. Fort Knox

One final caveat: sometimes the request for gold can be made by governments IN PERSON. That apparently is what the British did in 1971, when their ambassador (George Baring) literally walked over to the Treasury on August 12 to put in the order to convert dollars to gold

So why does all of the above suggest that such a system won't work today?

On the one hand, governments still seek out gold, from time to time, as a form of security during uncertain times
forbes.com/sites/greatspe…

On the other hand, the whole system "worked" because governments and people agreed (one could even say, pretended) to make it work. But that could be shut down at any time.

For instance, on August 2, 1971, Nixon's Secretary of the Treasury, said that the US "can stop convertibility very easily...by just saying no"

history.state.gov/historicaldocu…

That points to the problem with a gold standard system. Like ANY international arrangement, there is no way to enforce it.

Cooperation under anarchy...it's hard
cambridge.org/core/journals/…

So for anyone out there who wants to return to the gold standard, it's important to recognize that the thing is NOT automatic (no specie-flow). It requires a LOT of states (and people within states) to act cooperatively and follow "the rules of the game".

[END]

Addendum 1: As some have noted, I meant "NH" not "NY" for the location of Bretton Woods. 🤦‍♂️

Addendum 2: For more on Nixon's decision to end Bretton Woods (this year is the 50th anniversary), see 👇

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