The aim of this article is to explain the dollar milkshake, the theory to those who haven't heard of it before.
https://www.theinvestorspodcast.com/dollar-milkshake-theory/
https://youtu.be/zHzFLoMLfpA?si=fbuHEYWW0JZzZ5D0
In Part I, we will look at when and why America came off.The gold standard and the immediate consequences.
1. When did America come off the gold standard?
1. Nixon took the U.S. off the gold standard on August 15, 1971. This event, known as the Nixon Shock, ended the direct convertibility of the U.S. dollar to gold and marked the beginning of the fiat currency system.
2. Saudi Arabia agreed to price all its oil contracts in U.S. dollars in June 1974. This agreement, known as the Petrodollar System, was part of a deal between the U.S. and Saudi Arabia where the U.S. provided military protection and economic aid in exchange for Saudi Arabia selling oil exclusively in dollars. This system was later adopted by other OPEC nations.
2. Why did America come off the gold standard??
Nixon took America off the gold standard on August 15, 1971, because the U.S. could no longer maintain the fixed gold-to-dollar exchange rate set by the Bretton Woods system. The main reasons were:
1. Trade Deficits and U.S. Dollar Overhang
After World War II, the U.S. became the world’s economic leader, and the dollar was the global reserve currency.
The Bretton Woods system (1944) required the U.S. to exchange dollars for gold at a fixed rate of $35 per ounce.
However, U.S. trade deficits increased, flooding the world with more dollars than the U.S. had gold to back.
2. Foreign Nations Redeeming Dollars for Gold
Countries like France (under Charles de Gaulle) and West Germany began exchanging their dollars for gold, depleting U.S. reserves.
Gold outflows accelerated, and the U.S. was at risk of running out of gold.
3. Inflation and U.S. Spending (Vietnam War & Social Programs)
Massive U.S. government spending on the Vietnam War and Great Society programs (social welfare) increased inflation.
More dollars were printed without an increase in gold reserves, making the fixed $35/oz gold peg unsustainable.
4. Speculation and the Run on Gold
By 1971, investors and foreign central banks began dumping dollars for gold, fearing devaluation.
The British requested $3 billion in gold from the U.S. Treasury, worsening the crisis.
5. Nixon’s Solution: The “Nixon Shock”
On August 15, 1971, Nixon suspended gold convertibility, effectively ending the gold standard.
This meant foreign governments could no longer redeem dollars for gold, making the dollar a fiat currency.
He also imposed wage and price controls to curb inflation, but these were temporary measures.
Outcome of the Decision
The U.S. dollar weakened, but Nixon’s move prevented a total depletion of U.S. gold reserves.
This led to the modern floating exchange rate system, where currencies fluctuate based on market forces.
It also led to high inflation in the 1970s (the stagflation era) until the Federal Reserve raised interest rates sharply in the 1980s.
Summary
Nixon ended the gold standard to prevent a total gold reserve collapse, stop a run on U.S. gold, and maintain economic stability amid rising inflation and trade deficits.
3. What happened between these two dates to the dollar?
Between August 15, 1971 (when Nixon took the U.S. off the gold standard) and June 1974 (when Saudi Arabia agreed to price oil in U.S. dollars), the U.S. dollar lost significant value due to inflation and market uncertainty. Here’s what happened:
1. Immediate Impact of Leaving the Gold Standard (1971-1973)
The dollar devalued sharply because it was no longer backed by gold, leading to a loss of confidence.
Inflation surged, as the U.S. printed more money to cover deficits, especially due to the Vietnam War and domestic spending.
The Bretton Woods system collapsed, and the dollar was allowed to float freely against other currencies.
By December 1971, the U.S. devalued the dollar by 8.57%, resetting the exchange rate from $35 per ounce of gold to $38 per ounce.
2. Oil Crisis & Further Dollar Devaluation (1973-1974)
In 1973, the U.S. dollar devalued again, increasing the price of gold to $42.22 per ounce.
The 1973 Oil Crisis erupted after OPEC imposed an oil embargo in response to U.S. support for Israel in the Yom Kippur War.
Oil prices quadrupled, causing major inflation in the U.S. and further weakening the dollar.
3. Why Saudi Arabia's 1974 Petrodollar Deal Stabilized the Dollar
By mid-1974, the dollar was at risk of further collapse due to the oil shock and economic instability.
The petrodollar agreement required Saudi Arabia to sell oil only in dollars, creating artificial demand for the U.S. dollar.
This stabilized the dollar’s decline and strengthened its global reserve currency status.
Overall Change in Value
Between 1971 and 1974, the U.S. dollar lost purchasing power due to inflation and devaluation.
However, the petrodollar system in 1974 helped stop the freefall and ensured continued demand for dollars in global trade.
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