The History of Money - Post-World War II Developments

Near the end of World War II most of the Allied nations joined together in a conference held at Bretton Woods, N.H., to set up a new international monetary system, replacing the international gold standard that had collapsed during the Great Depression. The conference also provided for the establishment of the International Monetary Fund. The U.S. dollar played a key role in the new system, becoming, in effect, the world’s currency. This was true, first, because all IMF members defined the value of their own currencies in terms of the dollar and, second, because the U.S. agreed to convert all dollars held by foreign governments into gold on demand and at the exchange rate agreed on when the IMF was established. Officially, this meant that the world was on a gold-exchange standard, since governments could change their currencies into gold via the U.S. dollar.

Gold no longer serves as a medium of exchange.

So long as the U.S. had most of the world’s gold supply, as was true after World War II, this system worked fairly well. When the quantity of dollars held by foreign governments began to exceed U.S. gold holdings by large amounts, however, the system started to falter. By the early 1970s foreign government holdings of U.S. dollars were over five times greater than the U.S. gold stock. In August 1971 President Richard M. Nixon suspended gold payments of U.S. dollars. This closing of the “gold window” effectively ended all ties between the U.S. dollar and either gold or silver. Since then the U.S. has had a fully managed currency system, one with no metallic base whatsoever. U.S. citizens are free to own, buy, and sell gold, but its price is determined in the same way as any other freely traded commodity—on the basis of supply and demand.

Gold bars waiting to be smelted at the U.S. Mint in Philadelphia (1876).

Gold no longer serves as a medium of exchange. Federal Reserve notes are overwhelmingly the dominant form of currency in circulation today.

Two important developments took place in the U.S. monetary system in 1980. The Federal Reserve redefined its measures of the money supply, setting up five categories of money: M-1A, M-1B, M-2, M-3, and L. The differences between these categories are technical, but essentially they reflect the extent to which various kinds of financial and monetary instruments serve as money under diverse circumstances and for different purposes. M-1A is the best-known measure of money, consisting of currency and demand deposits. As of January 1999 it totaled $833 billion.

In March 1980 the Depository Institutions Deregulation and Monetary Control Act was passed. It expanded the range of monetary instruments used by the financial community, gradually eliminated the ceiling on interest rates that savings and loan institutions are allowed to pay depositors, and made all banks subject to the reserve requirements of the Federal Reserve System by 1989.

Portrait of George Washington inspecting the first money coined by the United States (1915).

Recent experience with policy and legislation shows that the U.S. monetary system is still evolving. Historically, the nation has gone from a wholly metallic system, when coins were the primary money in circulation, to a managed system, in which, aside from the currency in people’s pockets, most of the money consists of entries in the books of banks. At the beginning of 1999 only about 42 percent of the primary money supply consisted of currency; the remaining 58 percent of total M-1 consisted of demand and other deposits, much of which came into existence through borrowing. In the continuing evolution, as more money is exchanged and transferred electronically, the U.S. money supply will increasingly be represented by entries in computer data banks.

implementing monetary policy

U.S. monetary policy is carried out through commercial banks and the Federal Reserve System. Monetary policy involves action to influence the economy’s performance—its output and employment level as well as the inflation rate—by controlling the money supply and the rate of interest. The Federal Reserve specifically initiates and carries out monetary policy. It is relatively easy for the Fed to increase the reserves of commercial banks, thus making possible an expansion of the money supply if businesses and individuals are willing to borrow. Still, there is no assurance that borrowing will take place, even when credit terms have eased and loans are readily available; the early 1990s provides a case in point. However, the experience of the 1970s and ’80s shows that when the Fed “tightens up,” making credit more costly and loans less plentiful, the economy is affected rapidly, falling into recession with rising unemployment. This happened in 1969, 1974, and 1980–81. In the late 1970s the Federal Reserve began to “target” the money supply; that is, the Fed tried to establish a stable rate of growth for the money supply. This tactic was abandoned in mid-1982, and the Federal Reserve went back to the practice of targeting interest rates as the primary control variable.