This chart shows spot exchange rates of the three major reserve currencies in relation to gold since 1600. We will examine all of this in depth later. For now I would like to focus on both the spot currency returns and the total returns of interest-earning cash in all the major currencies since 1850.
As the next two charts show, devaluations typically occur fairly abruptly during debt crises that are separated by longer periods of prosperity and stability. I noted six devaluations, but of course there were many more of minor currencies.
To properly compare the returns of holding cash in a currency to gold, we have to take into account the interest one would earn on cash. This chart shows the total return (i.e., price changes plus interest earned) on cash in each major currency versus gold.
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Here are the most notable takeaways:
Big devaluations are abrupt and episodic rather than evolutionary.
Over the last 170 years, there were six time frames when really big devaluations of major currencies occurred (and plenty more of minor currencies).
In the 1860s, during its civil war, the US suspended gold convertibility and printed paper money (known as “greenbacks”) to help monetize war debts.
Around the time the US returned to its gold peg in the mid-1870s, a number of other countries joined the gold standard; most currencies remained xed against it until World War I. Major exceptions were Japan (which was on a silver-linked standard until the 1890s, which led its
exchange rate to devalue against gold as silver prices fell during this period) and Spain, which frequently suspended convertibility to support large
scal de cits.
During World War I, warring countries ran enormous de cits that were funded by central banks’ printing and lending of money. Gold served as money in foreign transactions, as international trust (and hence credit) was lacking. When the war ended, a new monetary order was created with gold and the winning countries’ currencies, which were tied to gold.
Still, between 1919 and 1922 several European countries, especially those that lost the war, were forced to print and devalue their currencies. The German mark and German mark debt sank between 1920 and 1923.
Some of the winners of the war also had debts that had to be devalued to create a new start.
With debt, domestic political, and international geopolitical
restructurings done, the 1920s boomed, particularly in the US, in ating a debt bubble.
The debt bubble burst in 1929, requiring central banks to print money and devalue it throughout the 1930s. More money printing and more money devaluations were required during World War II to fund military spending.
In 1944–45, as the war ended, a new monetary system that linked the dollar to gold and other currencies to the dollar was created. The currencies and debts of Germany, Japan, and Italy, as well as those of China and a number of other countries, were quickly and totally destroyed, while those of most winners of the war were slowly but still substantially depreciated. This monetary system stayed in place until the late 1960s.
In 1968–73 (most importantly in 1971), excessive spending and debt creation (especially by the US) required breaking the dollar’s link to gold because the claims on gold that were being turned in were far greater than the amount of gold available to redeem them.
That led to a dollar-based at monetary system, which allowed the big increase in dollar-denominated money and credit that fueled the in ation of the 1970s and led to the debt crisis of the 1980s.
Since 2000, the value of money has fallen in relation to the value of gold due to money and credit creation and because interest rates have been low in relation to in ation rates. Because the monetary system has been free-
oating, it hasn’t experienced the abrupt breaks it did in the past; the devaluation has been more gradual and continuous. Low, and in some cases negative, interest rates have not provided compensation for the increasing amount of money and credit and the resulting (albeit low) in ation.
Now let’s take a closer look at these events: The returns from holding currencies (in short-term debt that collects interest) were generally pro table between 1850 and 1913 relative to the returns from holding gold. Most currencies were able to remain xed against gold or silver, and lending and borrowing worked well for those who did it. That prosperous period is called the Second Industrial Revolution, when borrowers turned the money they borrowed into earnings that allowed their debts to be paid back at high interest rates. Times were turbulent nevertheless. For example, in the early 1900s in the US, a debt- nanced speculative boom in stocks grew overextended, causing a banking and brokerage crisis. That led to the Panic of 1907, at the same time that the large wealth gap and other social issues (e.g., women’s su rage and trade unionization) were causing political tensions. Capitalism was challenged, and taxes started to rise to fund the wealth redistribution process. Both the Federal Reserve and the US federal income tax were instituted in 1913.
Though a world away, China was impacted by the same dynamic. A stock market bubble led by rubber production stocks (China’s equivalent of the railroad stock bubbles that contributed to panics in the US throughout the 19th century) burst in 1910, causing the crash that some have described as a factor in the debt/money/economic downswing that brought about the end of Imperial China.
But throughout most of that period, Type 2 monetary systems (i.e., those with notes convertible into metal money) remained in place in most countries, and the holders of those notes got paid good interest rates without having their currencies devalued. The big exceptions were the US devaluation to nance its civil war debts in the 1860s, the frequent devaluations of Spain’s currency due to its weakness as a global power, and the sharp devaluations in Japan’s currency due to its remaining on a silver-linked standard until the 1890s, while silver prices were falling relative to gold.
When World War I began in 1914, countries borrowed a lot to fund it. This led to the late-debt-cycle breakdowns and devaluations that came when war debts had to be wiped out, e ectively destroying the monetary systems of the war’s losers. The Paris Peace Conference that ended the war in 1918 attempted to institute a new international order around the League of Nations, but those e orts at cooperation could not forestall the debt crises and monetary instability caused by the huge war indemnities that were placed on the defeated powers, as well as the large war debts that the victorious Allied powers owed each other (particularly the US).
Germany su ered a complete wipeout of the value of money and credit, which led to the most iconic hyperin ation in history during the Weimar Republic (which I describe in great detail in Principles for Navigating Big Debt Crises). The Spanish u pandemic also occurred during the period, beginning in 1918 and ending in 1920. With the exception of the US, virtually every country devalued its currency because they had to monetize some of their war debts. Had they not done so, they wouldn’t have been able to compete in world markets with the countries that did. China’s silver-based currency rallied sharply relative to gold (and gold-linked currencies) near the end of the war as silver prices rose, and then mechanically devalued as silver prices fell sharply amid the post-war de ation in the US. That period of war and devaluation that established the new world order in 1918 was followed by an extended and productive period of economic prosperity, particularly in the US, known as the Roaring ’20s. Like all such periods, it led to big debt and asset bubbles and large wealth gaps.
Di erent versions of the same thing happened during the 1930s.
Between 1930 and 1933, a global debt crisis caused economic contractions that led to money printing and competitive devaluations in virtually every country, eroding the value of money moving into World War II. Con icts over wealth within countries led to greater con icts between them. All the warring countries built up war debts while the US gained a lot of wealth in the form of gold during the war. Then, after the war, the value of money and debt was completely wiped out for the losers (Germany, Japan, and Italy) as well as for China, and was severely devalued for the UK and France, even though they were among the winners. A new world order and a period of prosperity followed the war. We won’t examine it, other than to mention that the excessive borrowing that took place set in motion the next big devaluation, which happened between 1968 and 1973.
By the mid-1950s, the dollar and the Swiss franc were the only currencies worth even half of their 1850s exchange rate. As shown in the
following chart, the downward pressure on currencies and upward pressure on gold started in 1968. On August 15, 1971, President Nixon ended the Bretton Woods monetary system, devaluing the dollar and leaving the monetary system in which the dollar was backed by gold and instituting a at monetary system. (I will cover this episode in more detail in
Chapter 11.)
Since 2000, we have seen a more gradual and orderly loss of total return in currencies when measured in gold, consistent with the broad fall in real rates across countries.
In summary:
The average annual return of interest-earning cash currency between 1850 and the present was 1.2 percent, which was a bit higher than the average real return of holding gold, which was 0.9 percent, though there were huge di erences in returns at various periods of time and in various countries.
You would have received a positive real return for holding bills in about half of the countries during that period and a negative real return in the other half. In the case of Germany, you would have been totally wiped out twice.
Most of the real returns from holding interest-earning cash currency would have come in the periods of prosperity, when most countries were on gold standards that they adhered to (e.g., during the Second Industrial Revolution, when debt levels and debt-service burdens were relatively low and income growth was nearly equal to debt growth).
The real return for bills since 1912 (the modern at era) has been -0.1 percent. The real return of gold during this era has been 1.6 percent. You would only have made a positive real return holding interest-earning cash currency in about half of the countries during this era, and you would have lost meaningfully in the rest (over 2 percent a year in France, Italy, and Japan, and over 18 percent a year in Germany, due to the
hyperin ation).
CURRENCY AND GOLD REAL RETURNS OF MAJOR COUNTRIES SINCE 1850 (VS CPI, ANN)
Country Real Returns (vs CPI), Ann
1850–Present 1850–1912 1912–Present
Continuous Govt Bill Investment
Gold Continuous Govt Bill Investment
Gold Continuous Govt Bill Investment
Gold
United Kingdom 1.4% 0.7% 3.1% -0.1% 0.5% 1.1%
United States 1.6% 0.3% 3.6% -1.0% 0.4% 1.0%
Germany -12.9% 2.0% 3.0% -0.9% -18.2% 3.1%
France -0.7% 0.6% 2.6% -0.3% -2.6% 1.1%
Italy -0.6% 0.3% 4.7% -0.5% -2.6% 0.5%
Japan -0.7% 1.0% 5.0% 0.4% -2.2% 1.2%
Switzerland 1.5% 0.0% 3.4% -0.5% 0.5% 0.3%
Spain 1.4% 1.1% 4.5% 0.1% 0.3% 1.5%
Netherlands 1.4% 0.5% 3.3% 0.0% 0.4% 0.7%
Country Real Returns (vs CPI), Ann
1850–Present 1850–1912 1912–Present
Continuous Govt Bill Investment
Gold Continuous Govt Bill Investment
Gold Continuous Govt Bill Investment
Gold
China — 3.3% — — — 3.3%
Average 1.2% 0.9% 3.6% -0.3% -0.1% 1.6%
Data for Switzerland is since 1851; data for Germany, Spain, and Italy is since 1870; data for Japan is since 1882; data for China is since 1926 (excluding 1948–50). Average return is un-rebalanced and doesn’t include China.
The next chart shows the real returns from holding gold between 1850 and the present. From 1850 to 1971, gold returned (through its appreciation) an amount that roughly equaled the amount of money lost to in ation on average, though there were big variations around that average both across countries (e.g., Germany seeing large gold outperformance, while countries with only limited devaluations, like the US, saw gold prices not keep up with in ation) and across time (e.g., the 1930s currency devaluations and the World War II-era devaluations of money that were part of the formation of the Bretton Woods monetary system in 1944). After the war, gold stayed steady in price across most countries, while money and credit expanded until 1971. Then, in 1971, there was a shift from a Type 2 monetary system (notes backed by gold) to a Type 3 at monetary system. That delinking of currencies from gold gave central banks the unconstrained ability to create money and credit. That led to high in ation and low real interest rates, which led to the big appreciation in the real gold price until 1980–81, when interest rates were raised signi cantly above the in ation rate, leading currencies to strengthen and gold to fall until 2000. That is when central banks pushed interest rates down relative to in ation rates and, when they couldn’t push rates any lower by normal means, printed money and bought
nancial assets, which supported gold prices.