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Dollar: good as gold?

Updated: May 3, 2013 12:14PM

Until April 15, 1971, the United States dollar was as good as gold. While ordinary citizens couldn't own gold in 1971, foreign central banks could trade in their dollars and receive gold, at a fixed price of $35 an ounce.

Then as the United States "printed" record amount of dollars to pay for the Vietnam War, those central banks redeemed $22 billion worth of gold in the first six months of 1971. President Nixon slammed the gold window shut.

The world's currencies then went on a "floating exchange rate" -- with the dollar as the linchpin. And behind the dollar was the "full faith and credit" of the United States.

It was a system that worked until the late 1970s when people started measuring the growth of the "money supply" -- and realized the U.S. was surreptitiously printing more and more money to finance the war and social programs, as well as to offset the rising price of oil.

Inflation took off, people switched dollars for gold, or soybeans, or real estate. And interest rates soared to compensate for the fact that if you left money on deposit, it would have less buying power when your money was returned.

It took Federal Reserve Chairman Paul Volcker raising interest rates until the prime rate hit 21 percent in 1981 to slow the economy, and break the cycle of inflation expectations.

Now, fears for the future value of the dollar are returning. When the current crisis struck last month, everyone wanted dollars again after several years of dollar decline. In a crisis, the United States' currency was the "best of the worst" -- the place every global investor wanted to store wealth. Interest rates fell as big investors rushed into dollars, pushing interest rates down to very low levels.

But now as investors see the Treasury and Federal Reserve creating money that is backed by questionable paper, gold is again becoming the "safe haven."

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