Brief History of Money

Money has been part of human history for at least the past 5,000 years. Money was introduced to increase the speed at which business could be done, and the first currencies came in the form of metal coins that were made of precious metals such as silver and gold, meaning that the coins themselves had value. Around 700 CE however, the Chinese moved from coins to paper money. Paper money was quickly adopted by banks as it was much easier to carry around. People were also given the choice to exchange their banknotes at any point of time for their face value in silver/gold coins at the bank.

Fast forward to The Gold Standard. The Gold Standard was a system under which most countries connected the value of their currencies to gold to stabilize currency exchanges markets. However, when World War I broke out, many countries suspended their use of the gold standard, which devalued their currencies. By this time, the U.S. had already established itself as the world’s largest economy, and before the U.S. entered World War II, their reserves served as the Allies’ main supplier of weapons and other goods. Most countries paid in gold, making the U.S. the owner of the majority of the world’s gold by the end of the war. This made a return to the gold standard impossible for the countries that chose to pay in gold.

In 1944, forty four Allied countries met together to come up with a system to manage foreign currency exchange markets that would not disadvantage any country. They came to a conclusion that the world’s currencies should no longer be linked to gold but instead be pegged to the U.S. Dollar because the U.S. held most of the world’s gold supply. This is now known as the Bretton Woods Agreement. This established the authority of central banks to maintain fixed exchange rates. The U.S. on the other hand allowed dollars to be redeemed for gold on demand, allowing other countries to regulate their money supply. This is what made the U.S. Dollar the world’s reserve currency.

However, the demand for U.S. treasury securities and deficit spending that was needed to finance the Vietnam War and domestic programs, caused the U.S. to flood the market with paper money. Eventually, the supply of dollars abroad became higher than the value of gold held by the States. This created a possibility of a gold run and there was a loss of confidence in the U.S. to meet its obligations. With inflation on the rise and a gold run looming, President Nixon decided to end dollar convertibility to gold. This officially turned the U.S. dollar into a free-floating currency.

Today, the U.S. dollar is still regarded as the world’s reserve currency. Nearly 60% of the $12.8 trillion in world-wide currency reserves are held in dollars. However, if you think about it, there is nothing backing the U.S. Dollar except for the future tax-generating ability of the U.S.'s growing productive economy and a defense structure to defend that economy’s strength. But is that really a good reason? Let’s dive into the risks that the U.S. faces.