The Nixon shock was the effect of a series of economic measures, including Incomes policy and Price freeze, surcharges on imports, and the unilateral cancellation of the direct international convertibility of the Gold standard, taken by United States president Richard Nixon on 15 August 1971 in response to increasing inflation and threats of a currency crisis.
Although Nixon's actions did not formally abolish the existing Bretton Woods system of international financial exchange, the suspension of one of its key components effectively rendered the Bretton Woods system inoperative.
Background
Bretton Woods system
In 1944, representatives from 44 nations met in Bretton Woods, New Hampshire, to develop a new international monetary system that came to be known as the Bretton Woods system. Conference attendees had hoped that this new system would "ensure exchange rate stability, prevent competitive devaluations, and promote economic growth".
The Bretton Woods system became fully operational by 1958. Under the system, countries settled their international accounts in United States dollars, which could be converted to gold at a fixed exchange rate of $35 per ounce, which was redeemable by the U.S. government. Thus, the United States was committed to backing every U.S. dollar overseas with gold, and other currencies were pegged to the dollar.
For the first years after World War II, the Bretton Woods system worked well. Under the Marshall Plan, Japan and Europe were rebuilding from the war, and demand for American goods and dollars were high, and because the U.S. owned over half the world's official Gold reserve—574 million ounces at the end of World War II—the system appeared secure.
Criticism and decline
In France, Minister of Finance Valéry Giscard d'Estaing criticized the Bretton Woods system as "America's exorbitant privilege",
as it permitted the United States to avoid a
currency crisis and resulted, in the words of American economist Barry Eichengreen, in an "asymmetric financial system" where non-U.S. citizens "see themselves supporting American living standards and subsidizing American multinationals."
In February 1965, French president Charles de Gaulle announced his intention to redeem U.S. dollar reserves for gold at the official exchange rate.[Margaret Garritsen de Vries, The International Monetary Fund, 1966–1971 [1]] By 1966, non-U.S. central banks held $14 billion in U.S. dollars, while the United States had only $13.2 billion in gold reserves, of which only $3.2 billion was available to cover foreign holdings.
In March 1968, the London Gold Pool collapsed.
In May 1971, West Germany left the Bretton Woods system, unwilling to sell further Deutsche Mark for U.S. dollars.
By August 15, there were only 10,000 metric tons of gold remaining in the U.S. reserves, less than half of their peak amount.
American policy response
To combat these problems, Nixon consulted
Federal Reserve chairman Arthur F. Burns, Treasury Secretary
John Connally, and
Paul Volcker. On the afternoon of Friday, August 13, 1971, Nixon, Burns, Connally, Volcker, and twelve other high-ranking White House and Treasury advisors met secretly at
Camp David to discuss policy solutions to the growing crisis. Nixon, relying heavily on the advice of the Connally, ultimately decided to abandon the Bretton Woods system by announcing the following actions on August 15:
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Nixon directed Connally to suspend the convertibility of the dollar into gold or other reserve assets (with certain exceptions), such that foreign governments could no longer exchange their dollars for gold, thereby ending the Bretton Woods system.
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Nixon issued (pursuant to the Economic Stabilization Act of 1970), imposing a 90-day freeze on wages and prices.
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Nixon instituted a 10 percent import surcharge in anticipation of the expected fluctuation in exchange rates.
On Sunday, August 15, when American financial markets were closed, Nixon explained the policy agenda in a national address:
This was the first time the U.S. government had enacted wage and price controls since the Korean War.
Impact and aftermath
The Nixon shock has been widely considered to be a political success but an economic failure for bringing on the 1973–1975 recession, the
stagflation of the 1970s, and the instability of floating currencies.
Domestic political effect in the United States
Politically, Nixon's actions were a great success. The American public believed the government was rescuing them from
price gougers and an exchange crisis which they blamed on foreign powers.
[Hetzel, Robert L. (2008), p. 84][ cited in ] The Dow Jones Industrial Average rose 33 points on August 16, its largest daily gain ever at that point, and
The New York Times editorial read, "We unhesitatingly applaud the boldness with which the President has moved."
[Nicky Marsh, Credit Culture: The Politics of Money in the American Novel of the 1970s (2000) pp. 52–53.]
Nixon was re-elected president in 1972 by a historic landslide margin over George McGovern.
Immediate impacts
Following Nixon's announcement, the Bank of Japan (BOJ) intervened significantly in the foreign exchange market to prevent the Japanese yen from appreciating. On August 16–17, 1971, the BOJ had to buy $1.3 billion to support the U.S. dollar and maintain the yen at the old rate of 360 Japanese yen/USD. As a result of its fixed exchange rate policy, Japan's foreign exchange reserves rapidly increased to $2.7 billion a week later and $4 billion the following week. Nevertheless, the large-scale BOJ intervention could not prevent the depreciation of the U.S. dollar against the yen. France also was willing to allow the dollar to depreciate against the French franc but not allow the franc to appreciate against gold.
Smithsonian Agreement and floating exchange rate
December 1971, representatives of the Group of Ten met at the Smithsonian Institution in Washington, D.C. to reassess exchange rates and revalue their currencies. At the meetings, the U.S. pledged to peg the dollar at $38/ounce of gold, effectively devaluing it by 7.9%, while the other countries agreed to appreciate their currencies against the dollar with ±2.25% Currency band against the U.S. dollar. The group also agreed on a plan to balance the world financial system using special drawing rights, and the U.S. import surcharge was dropped.
Although the Smithsonian Agreement was hailed by Nixon as a fundamental reorganization of international monetary markets, the dollar price in the gold market continued to cause pressure on its official rate. After a further 10% devaluation of the U.S. dollar was announced on February 14, 1973, Japan and the OECD transitioned to a floating exchange rate system. Over the next decade, most of the industrialized world followed suit.[ in ] Under the floating rate system, the value of the U.S. dollar plunged by a third in the 1970s and was subject to enormous speculation against foreign currencies.
Today, the governments and Central bank of most developed economies no longer utilize currency exchange rates to administer monetary policy; instead, they use interest rates and, to a lesser extent since the 1980s, adjustments to the money supply to prioritize price stability. In many developing economies, central banks continue to target a fixed exchange rate system.
Legacy
Even many years later, Paul Volcker expressed regret over the abandonment of the Bretton Woods system and failure to establish a replacement system of fixed exchange. In 2011, Volcker said,
See also
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Criticism of the Federal Reserve
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Economic Stabilization Act of 1970
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Impossible trinity
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Petrodollar recycling
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Triffin dilemma
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United States Bullion Depository
Further reading
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Butkiewicz, James L.; Ohlmacher, Scott. 2021. "." The Economic History Review
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Bordo, Michael D. 2018. "The Imbalances of the Bretton Woods System 1965 to 1973: U.S. Inflation, The Elephant in the Room". NBER Working Paper No. 25409.
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Gowa, Joanne. "State power, state policy: Explaining the decision to close the gold window." Politics & Society 13.1 (1984): 91–117.
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Gray, William Glenn. "Floating the system: Germany, the United States, and the breakdown of Bretton Woods, 1969–1973." Diplomatic History 31.2 (2007): 295–323.
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Odell, John S. "The U.S. and the emergence of flexible exchange rates: an analysis of foreign policy change." International Organization 33.1 (1979): 57–81.
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