Nixon Shock

nixon by joe ciardiello

The Nixon Shock was a series of economic measures taken by U.S. President Richard Nixon in 1971 including unilaterally cancelling the direct convertibility of the United States dollar to gold that essentially ended the existing Bretton Woods system of international financial exchange.

The return to a gold standard is supported by followers of the Austrian School, largely because they object to the role of the government in issuing fiat currency through central banks. A number of gold standard advocates also call for a mandated end to fractional reserve banking.

In 1996, American economist Paul Krugman summarized the post-Nixon Shock era as follows: ‘The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987—which started out every bit as frightening as that of 1929—did not cause a slump in the real economy. While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible—and, in some countries, they have been quick to take the opportunity.’

By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance-of-payments deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, because foreign arbitrage of the U.S. dollar caused governmental gold coverage of the paper dollar to decline from 55% to 22%. That, in the view of neoclassical economics and the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits. By 1971, the money supply had increased by 10%. In the first six months of 1971, $22 billion in assets left the U.S. In May 1971, inflation-wary West Germany was the first member country to unilaterally leave the Bretton Woods system — unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, West Germany’s move strengthened its economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark.

Due to the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America’s ‘promise to pay’ – that is, the redemption of their dollars for gold. Switzerland redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On August 5, 1971, Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against ‘foreign price-gougers.’ Still, on August 9, 1971, as the dollar dropped in value against European currencies, Switzerland unilaterally withdrew the Swiss franc from the Bretton Woods system.

To stabilize the economy and combat the 1970 inflation rate of 5.84%, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, ‘closed the gold window,’ ending convertibility between US dollars and gold. The President and fifteen advisers made that decision without consulting the members of the international monetary system, so the international community informally named it the ‘Nixon shock.’ Given the importance of the announcement — and its impact upon foreign currencies — presidential advisers recalled that they spent more time deciding when to publicly announce the controversial plan than they spent creating the plan.

Nixon was advised that the practical decision was to make an announcement before the stock markets opened on Monday (and just when Asian markets also were opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular and raised the public’s spirit. The President was credited with finally rescuing the American public from price-gougers, and from a foreign-caused exchange crisis. By December 1971, the import surcharge was dropped, as part of a general revaluation of the major currencies, which thereafter were allowed 2.25% devaluations from the agreed exchange rate. By 1976, the world’s major currencies were floating — in other words, the currency exchange rates no longer were governments’ principal means of administering monetary policy.

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