On the fifteenth of August, 1971, a man sat down in front of a television camera and, with carefully chosen sentences, changed the nature of money for every human being on the planet.

Richard Nixon, the thirty-seventh president of the United States, announced that the US dollar would no longer be convertible to gold. The agreement that had tied the value of the US dollar to a fixed quantity of gold was, as of that moment, dissolved.

This moment is called the Nixon Shock, and is one of the most consequential financial decisions ever made. To understand why, it is necessary to step back a few decades and explain what the dollar had been before the Nixon Shock.

After the Second World War, leaders of nations gathered in a small town in New Hampshire and tried to hammer out a new framework for global finance. The war had devastated most of the major economies of Europe and Asia. The United States, whose mainland had been untouched by the fighting, emerged as the world’s dominant economic power.

The currencies of the participating nations would be pegged to the US dollar at fixed exchange rates, and the dollar itself would be backed by gold at a fixed rate. The United States promised that any foreign government or central bank could exchange dollars for gold at that price, on demand.

This was the gold standard in its final institutional form. Money had a tether (connection). The amount of currency that could exist was, in theory, constrained by the amount of gold sitting in vaults.

The system worked well for a while. But the postwar boom, the enormous cost of the military and the growing social spending of the US created a pressure that the gold standard was not built to absorb.

The United States was spending more than it could justify with its gold reserves. Foreign governments, noticing the imbalance, began converting their dollars to gold. The vault was draining. The promise was becoming harder to keep.

Nixon’s decision was not entirely a surprise. It was, in many respects, an acknowledgement of a reality that had already taken place. The dollar could not be fully backed by gold and simultaneously serve as the engine of a rapidly expanding global economy.

The tether had to go.

What followed was the world that exists today. A world in which every major currency is fiat money. Fiat money is money that has value because a government declares it to have value, and because the people and institutions that use it agree among themselves that it has value.

There is no vault of gold sitting behind the number on a banknote. There is no physical commodity that can be demanded in exchange. There is only the authority of the state and the collective faith of everyone in the currency.

To someone hearing this for the first time, let me ask the question on your behalf.

If all of a sudden everyone stopped believing in banknotes, would it all crash?

Hmm. The answer to this is interesting, and it is important to get it right.

Money has never derived its value solely from the material it was made of. Even when currencies were backed by gold, the gold itself was only valuable because human beings agreed it was. The gold standard was still a consensus; it simply anchored that consensus to a scarce physical object, which made the consensus more credible, but did not change its fundamental nature.

The move to fiat money removed the physical anchor but kept the consensus. What keeps fiat money stable is not gold but something more robust: institutions, laws, taxation systems, and the enormous productive capacity of the economy that the currency represents.

When a government issues currency, it does two things simultaneously. It creates money, and it creates a demand for that money by requiring taxes to be paid in it.

Every worker, every business, every property owner in a country needs the local currency because their obligations to the state (taxes) are denominated in it. This mandatory demand forms the floor of the currency’s value, the baseline demand of money.

Interestingly, fiat money introduces a danger. When money is no longer tied to a physical commodity in limited supply, the authority that issues it gains a powerful and dangerous tool: the ability to create more of it.

This is where inflation enters the story.

Inflation is one of those words that people use constantly but rarely think about. In its simplest form, inflation means that prices are rising. But that is an effect, not the mechanism.

The mechanism is this: when there is more money circulating in an economy relative to the goods and services available, each unit of money becomes worth less, because there are more units competing to buy the same amount of stuff. The price of things rises not necessarily because things have become more valuable in themselves, but because the money used to measure their value has become less powerful.

Think of it this way. Imagine a small economy with 10 people, 100 coins, and 100 loaves of bread. Each loaf costs 1 coin. Now, imagine the authority in charge doubles the number of coins, so there are 200 in circulation, but the number of loaves stays at 100. Each loaf now costs 2 coins, not because bread has become more precious, but because each coin is now worth less in relation to the available supply of things to buy.

This is a simplification, but it captures the essence. When a central bank expands the money supply without a corresponding expansion in the productive capacity of the economy, the result is inflation. And inflation is, in a very real sense, a tax.

It is a tax on savings. It is a tax on anyone who holds cash, because the cash they hold quietly loses its purchasing power.

This is why sitting on cash, over long periods, is almost always a losing strategy. Not because cash is bad, but because fiat money exists in a system designed to expand, and expansion dilutes the value of existing currency.

Understanding this single dynamic changes how a thoughtful person approaches the question of where to put their money. Not in any prescriptive sense, but at the level of fundamental logic. If the purchasing power of idle cash slowly erodes over time in a fiat system, then the question of what to do with money becomes, at its core, a question of what can grow at a rate that outpaces that erosion.

But before getting to that question, it is necessary to understand who manages the expansion of the money supply, what tools they use, and how those decisions ripple through the entire economy. Because the answer to those questions explains almost everything about why financial markets behave the way they do.

That is the subject of the next part.