WTF happened in 1971?

Why we actually left the gold standard

WTF Happened in 1971 is a useful website loaded with charts that show how life changed dramatically in the United States after 1971. It argues that a host of society-wide changes were caused by the abandonment of the gold standard. But to really answer WTF happened in 1971, we need to go back one year earlier.

The shift to a fiat currency in 1971 may have caused a host of issues, but it is only a symptom of a deeper reality – the peaking of conventional oil production in the United States in 1970.

The concept of a fiat currency, which is to say the ability to print money into existence with no tangible backing, is discussed as though it is a form of magic. Ostensibly right wing economic thinkers believe we need to return to a gold standard in order to fix the related problems of ever-growing inflation and decreasing standards of living. Whereas some on the left view money printing as a means to end poverty through the literal act of handing out money created from nothing.

But I think both sides misunderstand the actual reason we made the shift to a fiat currency. Let me lay out some relevant events to help explain what I mean:

• July 1944 – the Bretton Woods system is created near the end of WW2, establishing the United States as the world’s financial hegemon

  • Allied countries agree to guarantee convertibility of their currencies into US dollars, with the dollar convertible to gold bullion at a fixed price

  • At this time, the US held around 3/4ths of the world’s supply of gold, which in part allowed for this to be viable

• The US enters the Vietnam War in 1965 (and would remain involved until 1973)

  • The war effort, coupled with LBJ’s “Great Society” domestic programs, led the US to run trade and budget deficits by the late 1960s

• As a result of these deficits, several European countries, most notably France, began to lose confidence in the value of the dollar and started converting their dollar reserves into gold (as allowed in the Bretton Woods system)

• August 15^th, 1971 – the US abandons the gold standard and the US dollar becomes a fiat currency

This is the common explanation for why the US left the gold standard. It simply needed to print more money to finance the war in Vietnam and large domestic programs.

But the idea that the US can simply print dollars to finance deficits doesn’t make sense in a vacuum (despite what Modern Monetary Theory advocates would have you believe.) It needed something to give it legitimacy.

This is where oil enters the picture. Let’s take a look at some oil-related events that took place around the time the US left the gold standard:

• 1948 – Saudi Arabia discovers the Ghawar oil field

  • Often called the “elephant” oil field, it is by far the largest conventional oil field in the world.

  • It is believed to contain upwards of 120 billion barrels of oil in total

• 1951 – production comes online at the Ghawar oil field

• 1956 – M. King Hubbert, a geophysicist for Shell Oil, presents a paper at a meeting of the American Petroleum Institute which predicts that the production of oil in the US would peak in the late 1960s / early 1970s

• 1965 – the US enters the Vietnam War and begins to run growing budget deficits

• 1970 – oil production peaks in the United States

  • Production would generally decline until the advent of “fracking” technology in the mid-to-late 2000s

• August 15th, 1971 – the US abandons the gold standard and the Bretton Woods system collapses

• 1972 - 1973 – the Petrodollar system is born

  • The US enters a series of agreements with major oil-producing Middle Eastern countries, including Saudi Arabia, in which the countries would sell their oil exclusively in US dollars in exchange for US military protection and infrastructure development

  • This secured the US dollar as the world’s hegemonic currency (because anyone buying oil from these countries needed to first acquire dollars) and secured the US’ access to a growing supply of oil

• October 1973 – oil crisis

  • The Organization of Arab Petroleum Exporting Countries (OAPEC) cut oil production and imposed an embargo against countries that were seen as supporting Israel during the Yom Kippur War

  • Oil prices quadrupled by the end of the embargo

• March 1974 – oil embargo is ended

WE ARE ABOUT TO ENTER SPECULATION TERRITORY

Since the first commercial oil well was drilled in Pennsylvania in 1859, US oil production had been on an upswing for over 100 years. And with it came a tidal wave of domestic industrial growth and development. And as I’ve shown before, real economic growth is only possible with energy growth.

But only 25 years after the end of World War II, when the US became a global hegemonic power, that supply of oil was about to start shrinking. The ambitions of the nation were not.

Though I cannot prove this (at least not at this moment), I believe that the people running the proverbial show in the United States in the 1960s were aware of the domestic oil production situation. Hubbert wasn’t some crank, after all. It would seem to me that the energy reality presented them with a choice. They could either:

• Pull back from global ambitions that could no longer be powered by a growing energy supply (and growing economy), and therefore cut back on spending to maintain the dollar’s tie to the gold standard; or

• Secure an alternative (growing) energy source to tap and a means of maintaining the dollar’s supremacy

Obviously, they chose the latter. And despite the litany of depressing charts on WTF Happened in 1971, I think it was actually the best choice given the situation. In an ideal world, the Ghawar oil field would have been found in the middle of Kansas and we wouldn’t have found ourselves embroiled in the cauldron of the Middle East. But life doesn’t work that way.

When I came to learn that economic growth is tied to energy growth, a lot of things started to “click” for me. If the US made the alternative choice, it would’ve set down a path of stagnation. What’s more, the decision was not made in a vacuum. Who’s to say that the Soviet Union wouldn’t have quickly taken our place as the world’s premiere superpower?

It is through this lens that something like the offshoring of industrial production and the broader financialization of the economy starts to make some sense. I do not like that these things happened, but I believe they were driven by underlying realities. Running an industrial machine is much harder when you don’t have the fuel on hand.

People tend to look at Big Decisions that drive society and think they are made for nefarious reasons. As though some fellas got together in 1971 and said “screw the proles, let’s get to printin’!” as they puffed on cigars. And though it’s entirely fair to take issue with the Big Decisions being made (I do all the time), one has to look at the full picture to understand why a decision HAD to be made in the first place.

Frankly, the more you understand the fact that these decision points are imposed by underlying realities, the better you will be able to navigate the world.

Despite its flaws, this system worked well for decades. But as we’ve previously discussed, it seems that Saudi Arabia’s oil production started showing signs of a peak in 2005. This, as shown by Simon Michaux, is the root cause of the Global Financial Crisis.

And though the miracle of fracking helped the US pick up the energy supply slack soon thereafter, it’s been argued by natural resources investors Goehring & Rozencwajg that the production from these unconventional oil sources may have also peaked (in 2018.)

If past is prologue, then this helps explain the absolute fever rush into alternative energy which kicked into hyperdrive in 2020. But that’s a discussion for another day.