Closing the Gold Window: What Effect Did It Have on Gold?

On August 15, 1971, President Nixon officially closed the gold window, thus severing the last official link between the US dollar and gold. While US citizens had been banned from owning gold since 1933, foreign governments still had the opportunity to exchange their dollars for gold by redeeming them at the Treasury’s “gold window.” Thank to the Federal Reserve’s money creation through the 1950s and ‘60s, more and more dollars circulated, devaluing the dollar and aiding US exporters, while hurting European companies trying to export to the US.

As European countries got wise to what was going on, they began to redeem more and more dollars for gold. At some point, it was feared, US gold holdings would be completely exhausted. Even though US monetary authorities publicly like to proclaim that gold is an outdated relic, they nonetheless understand the importance of gold as the ultimate backstop of the world monetary system, and thus they continue to keep their hands on as much gold as they can.

US gold holdings when President Nixon closed the gold window had shrunk to 8,500 tonnes, down from over 20,000 tonnes in the early 1950s. Nixon claimed that the gold window’s closure was only temporary, yet as we all know there is nothing so permanent as a temporary government action. And what has the effect of the gold window’s closure been?

The Gold Window and Gold Markets

By severing the last link between the dollar and gold, the gold price was finally allowed to rise above the US government’s official $35 valuation, without intervention either by the US or other foreign governments. While the US government officially values gold at $42.22 per ounce, the actual gold price has long since outstripped that price.

Gold recently broke through its previous all-time high and pushed through the $2,000 mark for the first time. From the closure of the gold window to today, gold has grown at an annualized 8.1% rate, versus 7.3% for the Dow Jones Industrial Average and 7.5% for the S&P 500. That’s great news for those who invest in gold, although stock market investors may not realize that their investments have underperfomed gold during that period.

Gold’s performance in the 21^st century has been even more amazing, with the yellow metal growing at an annualized rate of over 10%, versus 5% or less for the Dow Jones and the S&P 500. And with stock markets on the verge of another correction and gold once again climbing in reaction to a weakening economy, there’s no telling how well gold will end up outperforming stocks for the next 20 years. But enough investors expect gold to grow significantly in the future that more and more are trusting their retirement assets to gold.

The Gold Window and the Dollar

The effect of closing the gold window on the value of the dollar has been as negative as closing the gold window has been positive for the gold price, or perhaps even worse. President Nixon promised Americans that the value of their dollar would remain constant. Yet, as anyone with a knowledge of economics could have predicted, that wasn’t to be the case.

According to the government’s official inflation data, what $1 would have purchased in August 1971 would take $6.35 today. That means that the dollar has lost about 84% of its purchasing power since then. Imagine having graduated high school or college in 1971. Today you’d be 67 or 71 years old and in the midst of your first few years of retirement. But the money you started saving back then lost 84% of its purchasing power over time.

Thankfully, many people who began working back then were able to take advantage of the bull market that lasted from 1982-2000, enabling them to build up their retirement savings. But for younger generations, those who are currently in their 40s and 50s, they largely missed out on that market, and have had fewer opportunities for asset growth through stock market investing. They have had to face a triple whammy: fewer opportunities to take advantage of bull markets in stocks; a steadily declining value of the dollar; and two major stock market crashes.

What Does the Future Hold?

Because the gold window severed the relationship between the dollar and gold, it removed the final restrictions on the Federal Reserve’s creation of money. And as a result, the US money supply has increased exponentially. The Federal Reserve even stopped publishing M3 money supply data nearly 15 years ago due to the fact that the money supply had grown so large.

As we’ve witnessed through this latest crisis, the lack of restrictions on the Fed’s ability to create money has profound negative effects on the economy. The Fed was able to create trillions of dollars out of thin air to combat the 2008 crisis, money that went on to fuel the current debt bubble that is in danger of bursting. And the Fed’s response to coronavirus has similarly been to create even more trillions of dollars out of thin air.

With no restrictions, and with politicians even calling for more money creation, there’s really no telling how far the Fed will go. The danger, of course, is that the Fed miscalculates and causes hyperinflation. That isn’t a danger that can be dismissed anymore either, as the federal government seems to have thrown caution to the wind, believing that only spending trillions more dollars can help fix the economy.

For investors looking to safeguard their wealth, hyperinflation is a fatal danger, as it severely diminishes the value of their assets. As many people have discovered during hyperinflationary crises throughout history, such severe devaluation of a currency greatly diminishes their ability to live, as their money doesn’t go as far as it used to. And as those crises have also demonstrated, among those best able to weather such crises are those who hold precious metals such as gold and silver.

With nearly 50 years of unbacked fiat paper money, the world is in uncharted waters. This is the longest that any experiment with paper money has lasted in the past few hundred years. But just as the Soviet Union survived 69 years before its collapse, so too the fiat paper money system could come crashing down just as suddenly. Are you going to be invested in gold so as to protect yourself and your savings, or will the next crash catch you unprepared?