The US was on a bi-metal or 'gold standard' up until the 'Nixon Shock' of 1971.
What would the value of gold per ounce need to be today to backstop the amount of US currency currently in circulation?
While it is a purely hypothetical exercise at the moment, the answer may surprise you.
As many readers will know, the US monetary system is based on paper money which is backed by the federal government. The US currency is no longer valued in, backed by, nor officially convertible into gold. It is backed by the Government in whom we must trust.
Yet through much of American history, the United States had a currency that was linked to a metallic standard of one variety or another. The first devaluation of the US dollar was a result of the Coinage Act of 1834. This Act changed the 15:1 ratio of silver to gold to a 16:1 ratio by reducing the weight of the nation's gold coinage. The value in gold of the US dollar was thus reduced by 6%.
The Gold Standard
Through the years many developments, including large silver discoveries in the US and the Civil War affected the bi-metal backed US dollar. Yet the US dollar link to both gold and silver persisted until March 14, 1900 and the passage of the Gold Standard Act, which asserted that:
'the dollar consisting of twenty-five and eight-tenths grains (1.67 g) of gold nine-tenths fine, as established by section thirty-five hundred and eleven of the Revised Statutes of the United States, shall be the standard unit of value, and all forms of money issued or coined by the United States shall be maintained at a parity of value with this standard'...
At that point, the United States was on a 'gold standard', a standard which guaranteed the dollar as convertible to 1.5 g (23.22 grains) of gold.
The Nixon shock
There were many more twists in US dollar policy until the danger of a run on US gold reserves was deemed too high. As a result, in 1971 President Nixon issued Executive Order 11615, which ended the direct convertibility of US dollars to gold.
He said, 'we must protect the position of the American dollar as the pillar of monetary stability around the world. I am determined that the American dollar must never again be a hostage in the hands of the international speculators'.
This became known as the 'Nixon Shock' and marked the US dollar's transition from the gold standard to a fiat currency.
What price today?
What would the price of gold be today had the US remained on the gold standard as opposed to being backed simply by the 'full faith of the US government?' While this is a hypothetical exercise, it is important for three reasons.
1. The US dollar is currently recognised as the world's 'reserve currency' of choice and dominates payments in global trade transactions.
2. Gold is globally priced with the US dollar as the reference. The 'full faith' of the US government has arguably been compromised with the election of Donald Trump as President. With statements such as, 'the US dollar is too strong', 'I love debt', and the suggestion to renegotiate US sovereign debt. This, combined with Trump's opposition to commonly accepted 'big systems' like the Euro-zone, NATO, and trade pacts like NAFTA, as well as a relationship with Putin that at best is odd and at its worst quite disturbing. Do we still have 'full faith'?
3. To accurately answer the question of the price gold needs to trade at in order to back-stop the US currency, we need to know how much gold the US government really holds, as well as how much currency it has issued.
US Gold Reserves
According to the US Treasury, the federal government currently holds a total of 261,498,926.23 troy ounces of gold. However, some analysts and politicians question whether or not the US government truthfully reports its gold holdings considering the holdings have not been independently audited. In 2011, US Representative Ron Paul introduced a bill to audit the Fed's gold holdings. Paul, who was running for President at the time and pushing for the US to return to the gold standard, said, 'this is one of the few legitimate functions of government. To check our ownership and be fiscally responsible and find out just what we own and whether it's really there'.
The bill failed. It failed a Senate vote in early 2016 when Ron Paul's son once again pushed to audit the Fed's gold supply. As a result, we'll have to take the US Treasury's word for it, and use the figure of 261,498,926.23 troy ounces.
US Outstanding Currency
According to the Federal Reserve, as of January 11, 2017 there was approximately $1.5 trillion in circulation - $1.46 trillion of which was in Federal Reserve notes.
With $1.5 trillion in circulation it means that each ounce of gold held by the US government would need to be valued at $5228/ounce. Gold is currently trading at only $1230/ounce.
James Sanders is a London based trader and investor. He founded the UK’s largest independent derivatives broker in 2001 and left the City in 2009.