What Happened In 1971? It’s a Question Everyone Should Ask

What happened in 1971? It’s a popular question on Twitter and other forms of social media. Around 1971 productivity increases that had been a long constant flatlined in concert with wildly gyrating oil prices. Indeed, the price of crude was largely flat right until 1971.

So what happened? The short answer is that the foot was redefined. It was suddenly 3 inches instead of 12…

Ok, that’s not what really happened, but it was something similar. Better yet, the foot instructs. To see why, ask yourself how tall you would be in feet if suddenly the foot were shrunk to 3 inches. Allowing for the differences among us all, shrinkage like the latter would render the vast majority of us over 20 feet tall, and many of us over 24 feet.

Of course, as the mildly sentient among us are aware, while we would be taller in “feet,” our actual height wouldn’t change one iota. We would be the same, but the foot would be different. This would result in many of us saying “I’m 24 feet tall, but only in modern feet.”

Back to 1971, it was in August of that year that President Nixon severed the dollar’s link to gold. From 1944 to 1971, the dollar was defined as 1/35^th of a gold ounce. Why gold? Was it religious reasons, mysticism more broadly, or because gold is so shiny? Actually, none of the three. Gold defined the dollar after thousands of years of trial and error with all manner of the different currency anchors including grain, cigarettes, shells, etc.

“Money” has had forever qualities as a medium of exchange, or as an agreement about value among producers eager to get in return for their production. Producers have long wanted equal value in return for what they brought to market. Over time markets happened upon gold as the global definer of money due to its remarkable stability. Gold in value terms has long had constant qualities. This made it ideal for money that would attain constant qualities through a gold definition.

So when Nixon severed the dollar’s gold link, he was pursuing an explicit devaluation of the dollar. It was the equivalent of Nixon going to the Bureau of Weights and Measures and demanding that the foot be redefined as 3 inches.

As a consequence of a shrunken dollar, all manner of prices skyrocketed in “modern” dollars. The dollar’s devaluation was the inflation, while rising market prices were a consequence. There were no “oil shocks” in the 1970s as so many still believe, rather there were dollar shocks that reflected themselves in higher prices for myriad goods and services, including oil.

Which brings us to productivity, which is another word for economic growth. The latter is a consequence of investment, and frequently investment in all new ways of doing things. Investment is risk. We all know this. Not every investment results in returns. The previous truth hopefully vivifies the why behind slowing productivity.

With the dollar declining, those with title to money sought to protect their money. They purchased hard assets including commodities (wealth that already exists) least vulnerable to devaluation (inflation hedges) instead of directing funds to stocks and bonds representing the future, or wealth that doesn’t yet exist.

Wealth is just another word for knowledge, and knowledge is created the hard way through lots of investment in “dry holes.” Currency devaluation is anti-knowledge and wealth precisely because it raises the cost of knowledge creation.

What happened in 1971 is that the dollar’s value declined, only for the cost of creating wealth to soar. It’s very simple.