Because the U.S. dollar is no longer backed by gold or any other commodity, it is known as a “fiat” currency backed by confidence. The final break from gold occurred in 1971, when President Richard Nixon declared that foreigners could no longer convert their dollars for gold. Since then, the dollar has remained the global reserve currency due to the vast influence of the U.S. economy on the world and the depth of its markets. Because it is the global reserve currency, foreigners eagerly buy dollars for security during global economic uncertainty.
Because the dollar can be printed very easily when freed from the constraints imposed by a gold standard, which limits the amount of dollars that can be printed due to the finite supply of gold, it has steadily been losing value relative to gold. Most economists believe that low annual inflation is good for the economy by stimulating buying, as consumers are incentivized to spend before their money loses more value, though too much inflation is bad as it erodes consumer confidence and economic stability. As well, low inflation has the positive effect of making the national debt more bearable, as the debt can then be repaid with devalued dollars.
Gold’s Long-term Uptrend
Since the end of the dollar’s link with gold, the price of gold has risen from about $35 in 1970 to over $1,200 today, with notable bull market spikes of $850 in 1980 and $1,900 in 2011. Though the general price of gold has been up, there have been bear markets following these spikes. Notably, both of the spikes occurred during periods of high inflation or market expectations of high inflation. In 1980 inflation had reached about 14 percent, and in 2011 the Federal Reserve, the central bank of the U.S., was printing massive amounts of money to artificially lower interest rates, thus stoking fears of high inflation or hyperinflation among many investors.
Though gold has generally moved higher over time and is likely to do so into the future under a fiat currency, there are powerful deflationary forces in the economy that have brought both volatility and uncertainty for the dollar. The Baby Boomer generation, which for decades has been a major driver of the economy for decades, is retiring, leaving a major vacuum in the economy. Other industrialized nations, notably Japan and Germany, are or have been likewise experiencing the effects of an aging population due to low birth rates.
Additionally, there are limits to which credit can be expanded, and right now American consumers are saturated with debt. In particular, student loan debts have topped $1 trillion. As consumers are burdened with debts and the interest they carry, they must forego other expenses, which hinders economic growth.
The Federal Reserve thus has a mammoth task of steering the economy around these demographic and financial icebergs. Time will tell if they will succeed.