Gold to shine on 40th anniversay of Nixon Shock

http://www.telegraph.co.uk/finance/commodities/8687368/Gold-to-shine-on-40th-anniversay-of-Nixon-Shock.html

As we approach the 40th anniversary of the Nixon Shock, which ended the convertibility of the US dollar into gold, the price of the metal continues to hit new highs.

With S&P's downgrade of the US's credit rating on Friday, the long-term outlook for the dollar is pretty shaky – but prospects for gold continue to sparkle.

On August 15 1971, President Richard Nixon ended the convertibility of dollars into gold as he attempted to battle soaring inflation and a deteriorating balance of payments.

The move brought to an end the Bretton Woods system, which was established after the Second World War. This made the US dollar convertible into gold at the rate of $35 an ounce. Other currencies were then pegged to the dollar as a means of stabilising the system.

However, US citizens were already banned from hoarding gold. Executive Order 6102 was signed by Franklyn D Roosevelt in 1933 which effectively criminalised the possession of gold bullion by individuals and organisation. People had to surrender their gold to the Federal Reserve – or face up to ten years in prison.

"Those who handed in their gold got $20.67 an ounce for it, which was the dollar price under the inter-war gold standard. Then the government fixed the price $15 higher," said Ben Traynor, an economist at Bullion Vault, which holds more than $1bn (£610m) of gold for clients.

It was actually Gerald Ford who finally restored US citizens' right to own gold, with Executive Order 11825 issued on the very last day of 1974," Mr Traynor added.
But Nixon's action in 1971 had paved the way for this to happen, since by closing the gold window he scrapped the fixed dollar gold price of $35 an ounce. This eventually allowed it to trade and the price to rise – to its current $1,663.80 an ounce.
The reason President Roosevelt issued Executive Order 6102 was because the big problem in the depression was deflation.
"Roosevelt – on the advice of economist George Warren – sought to introduce monetary inflation. And the way to do this was to lower the value of the dollar relative to the monetary standard, gold," Mr Traynor said. "In other words, raise the dollar gold price.
"The president's advisers would fix the gold price over breakfast, always making it a very specific number to several decimal points so that it looked scientific and accurate – when all they were doing was just pushing it a bit higher each day," he adds.
The London gold market reopened in 1954, following its closure since the Second World War.
Central banks were trying to keep their currencies in line with the exchange rates agreed at Bretton Woods, and gold made itself a bit of a nuisance. "As we know, it didn't work," Mr Traynor says. "Central banks tried for a while to keep the gold price in line with the $35 peg. They set up the London Gold Pool, whereby central banks co-ordinated sales to keep the price down if it looked like getting too high."
Where this became a specifically American problem is that the US had most of the gold, and it was the US that guaranteed convertibility at $35. With central banks piling up the paper currency they'd got for their gold sales, they started to exercise that convertibility – especially when the world became awash with dollars during the Vietnam War. Also, as the global economy became less US-centric, countries would need deutschemarks and yen, so cashed in dollars for gold.
"This exacerbated the gold drain from the US – as did the existence of a two-tier market after the Gold Pool collapsed in 1968 – and culminated eventually with Nixon closing the gold window in 1971," notes Mr Traynor.
The end of Bretton Woods and convertibility into gold resulted in free floating currencies. Many now argue that the dollar as a global reserve currency is doomed because of the level of debt the country is unsustainable.
China's call for a new global reserve currency over the weekend is a sensible proposition – but until then investors world wide will continue to view gold as the ultimate safe haven to escape devaluing paper money.