So many of the distortions in our economy began with going off the Gold Standard in 1971, and America's trade deficit is no different. If we look at Census Bureau statistics, a bleak picture emerges. America ran trade surpluses every year during the 1960s, and we had a trade surplus of 2 billion dollars in 1970. In 1980, we had a trade deficit of 19 billion dollars. By 1995, it had risen to 96 billion. Last year, our annual trade deficit was a staggering 552 billion dollars. It seems clear that America's trade deficits soared after we abandoned the Gold Standard, but we need to look back further to understand why.
In 1944, the Bretton Woods Agreement set up the post-war international financial system. The US dollar was directly backed by gold, while other major currencies were pegged to the US dollar. The dollar became a substitute for gold over the next several decades, and international trade was conducted in US dollars. Crucially, most internationally traded goods continued to be priced in dollars even after America went off the Gold Standard.
Before most other countries can trade with each other, they have to earn US dollars. For example, firms in India that want to buy oil from the Middle East usually pay with dollars. In total, 88% of foreign exchange transactions took place in US dollars in 2016 according to the Bank of International Settlements.
The situation of foreign firms and governments should be very familiar to American consumers, and their response is the same. Because we need dollars to obtain goods, nearly everyone keeps some cash on hand for day to day needs and even more at the bank to deal with unforeseen expenses. This money that we keep is a reserve. When foreign governments stockpile US dollars, those are their foreign exchange reserves.
IMF data on the composition of foreign exchange reserves shows that foreign countries held reserves of over 6.2 trillion US dollars at the end of 2017. In contrast, America's reserves were only worth about 400 billion dollars according to the World Bank. Approximately 300 billion of that was in gold, leaving only 100 billion dollars worth of foreign currency. For this to occur, foreign countries had to sell 6.1 trillion dollars worth of goods and services to Americans and buy nothing from us in return. The dollar's status as the world's reserve currency is one of the leading causes of our chronic trade deficits.
6.1 trillion dollars represents an enormous amount of debt and lost jobs, and that is just foreign governments. Foreign businesses have also accumulated US dollars. While the rest of the world buys US dollars, the US government sensibly holds most of its reserves in gold. Our government knows that the day will come when Americans can no longer shoulder the burden of supporting the world's reserve currency. On that day, it would be wise to have gold reserves of your own.
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