1944 – 1970
The Second World War left behind a toxic atmosphere that took a toll on human, economic and political societies worldwide. Governments’ primary concern was quick recovery, although ironically spending reduced significantly post-war (for example, in the U.S. it climbed to over 55% of GDP during the war, but dropped to merely 16% of GDP by 1947). As public spending decreased, the private sector boomed: men once drafted to war became peaceful labour workers, consumption flourished and factories turned their production to cars and televisions. The thriving atmosphere trickled down to foreign policy and improved the dynamic between Western Allies and democratic states, creating a new coalition to fight against the Communist threats (the most feared were Russia and Cuba).
As foreign policy tightened across the globe, so did the economy. Under the Bretton Woods agreement, 44 countries created a new international monetary system that defined a set of laws for exchange rates, whereby currencies were pegged to the U.S. Dollar. Countries had to buy and sell the greenback to remain within the prescribed 1% to limit rate fluctuations. At the same time, to bolster confidence in the Dollar, the U.S. Government tied it’s value to $35 per ounce of gold, making it effectively ‘as good as gold’. As a consequence, the demand for Dollars came in two forms: 1) the demand for foreign exchange used for imports, and 2) the demand for liquidity reserve. In the first instance, most countries imported U.S. products so the majority of the currency circulated back to the home country. On the other hand, the need for liquidity lead to a ‘stockpiling’ of Dollars which prompted an unexpected build-up of the greenback overseas.
The system was designed to stimulate international trade post-war but instead had one serious drawback. As the Dollar became a new substitute for gold, the demand for it skyrocketed even though its worth in gold remained the same. The greenback, in all of it’s glory, was highly overvalued. Investors initiated huge sell-offs knowing very well that the Government’s only choice would be to devalue the currency (quick sell-offs ensured protection from further loss in the future). The lengthy romance to gold ended in 1971 when Central Banks interrupted the convertibility of Dollars. Gold was free at last and the Dollar became fiat currency. Such currency is not backed by a physical commodity meaning its price is determined by forces of supply and demand, speculation and faith in the economy.