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Chapter 5 - Hi$tory II - Fading Gold (1914 - 1971)

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“Mother of all catastrophes” is how we German speakers[1]  refer to World War One (WWI). The war brought death and agony on an unimaginable scale. It created trauma that reverberates to this day. WWI also changed the map of Europe and the nature of money. 

Nobody had a clue what they were in for. Least the soldiers. Heading to war in August 1914, they often did so joyfully, waving their felt caps. Not a singly army had equipped their fighting men with steel helmets at the onset of what would become an industrial butchery of humans.

Over the next four years, mostly very young men were ground to death in their millions by shelling and trench warfare. The technological breakthroughs that had brought so much betterment for humanity were now adapted and perfected to maim or kill: long-range artillery, tanks, chlorine gas, airplanes, submarines and, deadliest of all, the machine gun.

The agony went on … and on … and on. Partially because callous power brokers wanted it to. Partially because of the eternal logic expressed in a letter from a Bavarian infantryman to his wife in 1916: “And now it starts. Anger grips us all, and an excited feeling that we finally shall get revenge for the previous days”[2]. Violence begets violence. 

By the end of the war in November 1918, some 15 million people lay dead, 8 million were invalid, and millions more traumatized. Europeans were impoverished and in places like Germany, starving. The Spanish flu that seamlessly followed the war killed millions more.

War is costly – then and now.

To finance war, huge dollops of money were needed. But gold was in short supply. So new money was printed not backed by gold. Austria-Hungary and Germany were the first to suspend the gold standard within days of the start of the war. In time the other belligerent nations scrapped the gold standard, or imposed limitations on who could exchange money for gold and how much.

During the war, all participating countries experienced high inflation, including the United States after it joined the slaughter in 1917. No surprise: production became geared towards military use. Millions of workers were sent to the front, missing from factories and farm fields. Supplies of everyday goods became scarce, so prices rose and living standards fell – in Germany by as much as two thirds during the war[3].

To finance the insanity of war, coercion and appeals to patriotism were applied in large dosage. Citizens were urged to subscribe to war bonds. Germany’s 8th War Bond promised the buyers in March 1918 final victory. It was the government’s last cry for financial support. “The last slash” [Der letzte Hieb] would bring victory. It was not to be.


The catastrophic living conditions of soldiers’ F&F at home was one element sapping German soldiers’ fighting spirits. In the summer and fall of 1918 hundreds of thousands of them preferred desertion, surrender and mutiny to fighting. In November, Germany succumbed and agreed to an armistice.

The Versailles treaty formally ended the war and settled the terms among the parties in June 1919. A war guilt clause held Germany singularly responsible for the war. The terms were harsh: Germany was to give up 13% of its territory and its colonies, and the right to have a military deserving the name. Germany was also required to make giant reparation payments over coming decades to the winning nations, particularly England and France. Those in turn had huge loans to repay to the US.

When German workers refused to deliver coal shipments to France as part of the reparations and went on strike in early 1923, the German government showed sympathy and paid striking workers. The cost of supporting this “passive resistance in the Ruhr”, a ballooning public sector payroll, and handouts to the war-ravaged population, fueled giant public finance deficits. With little tax revenue, the German government instructed the Reichsbank, Germany’s central bank, to print more money. By late 1923, hyperinflation had gripped the country. You have likely seen pics of folks carting cash in wheelbarrows to buy a loaf of bread.

The experience of high inflation during the war enforced the view that money needed to be tied to something scarce and valuable. Otherwise it would lose its value quickly. The common view held that the gold standard had to be reinstated. In 1922, 29 countries affirmed the objective to restore the gold standard in a weakened form[4] at a conference in Genua, Italy.

But Humpty Dumpty could not be put together again. At least not reasonably at the old pre-war “parities[5]” of gold to currency. The attempt was doomed.

With vast quantities of money and government bonds in circulation, highly varying price developments in different countries and large debts between nations as a result of the war, the international financial system was a mess. And nobody was in the position to organize the practicalities of the gold standard like the Brits had before the war.

To attract gold to a country to restore “parity” required central banks to increase interest rates and shrink the paper money supply. This resulted in sharp recessions right after the war. The US saw its economic output drop by nearly 9% in real terms between 1920 and 1921. Prices fell even more sharply.

Then recovery set in, first in the US. There, an economic boom and a stock market bubble fed on each other. Leaps in productivity, manifested by mass production of cars, turbo charged economic growth. The “roaring 20s” brought fun and frivolity and a new dance, the Charleston, to express it all.

The actions of the American central bank, the Federal Reserve, helped inflate the bubble. It was keen to keep interest rates low to support the United Kingdom in its effort to get back on the gold standard. High interest rates in the US would have attracted gold flows to the US and not the UK, which was more in need of the shiny metal to back the outstanding pound in circulation. Low interest rates in the US and financial deregulation made it easy to borrow funds and speculate on margin, fueling the stock market.

For a while Humpty Dumpty seemed back together again. By 1925 the British pound was back at “gold parity” along nearly 40 other currencies. But high unemployment and a weak economy left Britain a shadow of its pre-war self. The empire was on its last legs.

With American diplomatic help and money, Germany emerged from its deep crisis in 1924. After a bout of hyper-inflation, that peaked at the very moment a nobody named Adolf Hitler led his ill-fated Beerhall putsch in Munich in November 1923, the German economy came back to life. American loans helped resuscitate the German and other Central European economies. “American bank representatives raced to Germany, Austria, Hungary, Poland and Italy with loan offers” as a contemporary banker noted[6]. The American financial crutches lifted the old continent back on its feet.

It all changed for the worse when the fortune of the German economy reversed in 1928. Signs were for storm in Germany even before the stock market crashed in New York in September 1929. It didn’t help Europe that the Federal Reserve began to increase interest rates to dampen the overheating US economy and stock market. This stopped the money flow from the US to Europe in its tracks. As higher returns were now on offer at home in the US, the carpet was pulled from underneath the still shaky European economies. Promptly they tumbled. Ferocious deflation, i.e. price declines, set in. Unemployment skyrocketed and businesses and banks collapsed – on both sides of the Atlantic. People were keen to get their deposits out of banks, keep them in cash under the proverbial pillow or convert them into gold and hoard the yellow metal.

The tidal wave of defaults and bankruptcies sweeping over Europe and the US led to lengthening queues of the unemployed and strained government finances. Speculators wondered: what country would find itself unable to maintain “gold parity”?

In September 1931, the UK was first to pull the plug, taking the pound off gold. Sir Isaac Newton’s “parity” set over two hundred years earlier, was finally history. Other countries in the British empire followed, along with Scandinavian and Latin American nations.  A number of nations imposed exchange controls to preserve gold holdings and so defend the gold standard[7].

In April 1933, newly elected President Roosevelt took the US dollar off the gold standard and let the dollar float freely. In Executive Order 6102 Roosevelt declared illegal the private possession of gold coins and bullion in the same month. American citizens were forced to hand in their gold in exchange for paper money at a rate of USD 20.67 per ounce. A year later, the Roosevelt administration did a full U-turn. It fixed the US dollar to gold again, but at a much lower value: One ounce of gold was now worth USD 35. With that, the government had taken a 40% cut from its citizens who handed in gold a year previous. Those had to wait until 1974 to legally acquire gold again for personal use.

France, the Netherlands, and Switzerland held on to the old “parity” for longer. Within a few years, all would be forced to devalue their currencies against gold, too.

Hitler came to power in Germany in January 1933. He set his country straight on the path of rearmament and war. The German public was broadly not eager for war, but they had made a pact with the devil. Hitler’s early “successes” of expanding the Reich by repossessing the Rhineland, grabbing parts of the Czech Republic and “bringing home” his native Austria made him appear invincible to many. Early military successes after the start of World War II (WW ÌI) in September 1939 supported his aura.

An often-underappreciated reason for German battlefront successes was motivation: Young German soldiers generally fought ferociously. Their generation had lost their fathers or seen them mentally or physically devastated by WWI. The drive to restore their fathers’ honor was powerful. If only violence and revenge ever restored anything.

Another key reason for the astonishing staying power of Nazi Germany was rooted in its economic regime. The Nazis were keen to prevent a repeat of an economic collapse on the “home front” as had happened in WWI. Throughout WWII the standard of living remained astonishingly high in Germany and inflation low. Tacit support for the war never ebbed. The fear of inflation and its impact on morale in Germany was driving Nazi war tactics and targets.

To spare the German population from bearing the full cost of war, the Nazis pillaged and looted the conquered territories. This included extracting the gold holdings from their central banks. High occupation costs were imposed on top. Already before the start of the war, the German government had substantially expropriated its Jewish citizenry. With the declining fortune on the front came total brutality, culminating in the Holocaust. Other “Untermenschen”, including millions of Soviet PoWs, met a horrible fate too.

The entry of the US in December 1941 sped up the end of Hitler’s Nazi regime. The Nazi’s brutal conquest and exploitation never won foreigners over. Staggering human losses on the Eastern Front in the battles with the Red Army in the last year of war sealed Germany’s fate. The ultimate price of the war was paid by c 55 million people, half of which were from the Soviet Union. Germany recorded 7 million deaths, the US less than half a million.

In July 1944, almost a year before the end of the war, representatives of 44 allied nations assembled in a resort town in New Hampshire named Bretton Woods. Their task – to plan the global financial architecture after the war. Firmly in charge of the process was the United States.  The US was now an unrivalled champion presiding over the world’s largest and most competitive economy by far. It also possessed 70% of the world’s monetary gold. The latter was substantially the result of selling military hardware and other supplies to allied nations.

Once more gold was assigned a key role in the new monetary system.

The Bretton Woods system was set to allow qualifying countries to fix their currencies against the US dollar, which created a regime of fixed exchange rates among all participating countries. The US dollar in turn was fixed to gold at the pre-WWII “parity” of USD 35 per ounce. This setup made the US dollar the reserve currency. Other nations were now happy to accumulate and hold US dollars, knowing they could exchange them for gold if need be. In practice, US dollars were more useful to conduct global trade so little pressure built for using the “gold window” … at least for some time.

The Bretton Woods system only became fully operational in 1958. Once up and running, stresses emerged. For one, Bretton Woods put the US in a unique – and uniquely favorable – position. It allowed the US to run persistent trade deficits and pay for imports with newly printed dollars. For another, the US government started to record larger budget deficits. These substantially came about for the same old reason government finances often went lopsided before. War.

War is costly – then and now.

After America’s engagement in the Korean war in the early 1950s, the US gradually increased its military presence in Vietnam in the early 60s. The presence of “military advisors” mushroomed into a large fighting force of American GIs. Eventually, around half a million American soldiers “rotated” through Vietnam, with over 56’000 dying there. Over three million Vietnamese, from the North and South, shared the same fate. The financial cost strained US government finances and forced the Treasury to issue more debt.

Not enough with a foreign war, President Lyndon Johnson also declared a domestic war … on poverty. New well-meant government programs were implemented to tackle this calamity. Like any war, it was a financially costly one, further driving up government deficits. The combo of trade and budget deficits and ever more dollars circulating around the world put pressure on the US dollar in the foreign exchange market. The “fixed” exchange regime turned wobbly. Suspicion about “gold parity” of the US dollar grew.

To maintain the value of the US dollar, successive US administrations came up with all kinds of well-intended “fixes” to keep dollars (and so gold) at home.

President Eisenhower made it illegal for Americans to buy gold overseas in 1959. President Kennedy followed up with a proposed Equalization Tax, which was passed after his death in 1964. The tax on foreign currency deposits was to prevent Americans from investing overseas. President Johnson even discouraged Americans from traveling overseas to keep US dollars at home. By the late 1960s the stresses to the system became so strong that a number of currencies were adjusted to new rates and the overall bands that foreign currencies could trade to the US dollar were widened. It didn’t stop the growth of the line of foreign central banks eager to exchange US dollars for gold.

On August 15, 1971 President Nixon pulled the plug. He announced to the nation that the United States would “temporarily” close the gold window. Foreign central banks could no longer exchange US dollars for gold at USD 35 an ounce. With that Nixon unhooked the anchor of Bretton Woods.

A late rescue attempt of Bretton Woods was undertaken in December 1971. The Smithsonian agreement concluded in Washington, sought to restore the gold link, by devaluing the dollar around 10 percent. Its life was short.

By 1973, the global financial system had fully detached from gold. Now it was freely floating FIAT currencies. Money was backed by belief only. And under control of central banks, foremost the American Federal Reserve.



[1] Urkatastrophe is the German term, which means seminal catastrophe, or more loosely “mother of all catastrophes”

[2] Hirschfeld, G., Krumeich, G., & Renz, I. (Eds.). (2006). Die Deutschen an der Somme 1914-1918: Krieg, Besatzung, verbrannte Erde. Klartext. p. 127

[3] Aly G. (2005), Hitlers Volkstaat, S. Fischer

[4] This new gold standard is referred to as the “gold exchange standard”. It allowed central banks to keep a part of their reserves in foreign currencies which were backed by gold. This reduced the need for direct gold acquisition.

[5] Gold parity is the official par value in terms of gold of the currency of a country on the gold standard.

[6] Somary F. (1960), The Raven of Zurich, English Translation, C. Hurst & -Company, London, St. Martin’s Press New York, p. 149, Translated from the German by A.J. Sherman

[7] Abegg, W., & Baltensperger, E. (2007). The Swiss National Bank, 1907-2007. Swiss National Bank, p. 50

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