Exactly 50 years ago today, on August 16, 1971, the world awakened to find the international financial and trading system in place when went to bed, gone. The previous evening, at 9 PM on the East Coast, when the markets were closed, President Richard Nixon destroyed the system that had been set up in Bretton Woods some 27 years earlier. That, writes William Greider in his history of the Federal Reserve System, “was the precise date on which America’s singular dominance of the world’s economy ended.” Whether the President, an avid football plan we are told by Nicholas Evan Sarantakes’ in his study, Fan in Chief: Richard Nixon and American Sports, 1969-1974, preceded his announcement by watching the New England Patriots defeat the New York Giants in a pre-season game, we do not know.
The institutions that were born in Bretton Woods – the International Monetary Fund and the World Bank – remain, and have morphed into giant, highly paid bureaucracies. But the underpinning of the system, America’s readiness to buy gold from other countries at a fixed price of $35 per ounce, the rate set by FDR in 1934, was no more. The dollar link to gold, and other currencies’ link to the dollar were no more. Foreign governments and central bankers woke up on August 16 to find they could no longer convert their dollar holdings to gold at a fixed price. What those dollars would prove to be worth would be subject to market forces and arduous negotiations.
In the jargon of the day, Nixon had slammed shut America’s gold window. As Jeffrey Garten details in Three Days at Camp David, only Nixon’s closest advisor-experts were consulted at secret meetings held at Camp David, the Presidential rural retreat. Congress had no advance warning. The media had not been briefed.
In a sense Nixon merely read the last rites over what John Maynard Keynes in 1923 called “already a barbarous relic”. Dollars had been pouring out of the US to finance the post-war recoveries of Europe and Japan, the war in Vietnam, and America’s trade deficits. The supply of gold had not kept pace. America simply did not have enough gold to honour its commitments: $40 billion dollars in foreign hands backed by $10 billion in gold reserves. Holders of dollars were increasingly worried.
On August 12, in what Nixon’s team saw as an et tu, Brute? move, Britain asked the Fed to insure part of its dollar reserves – thought mistakenly to be a $3 billion tranche – against a change in the value of the dollar. All the President’s men concluded that if they did not move there would be the equivalent of a run on the bank, with America forced to renege on its global commitment. Down slammed the gold window three days later.
It was not only the shortage of gold that drove Nixon to pull “a central plank out of the edifice of international finance and of the regime of international trade that depended on it,” as Garten puts it. He was contemplating his 1972 presidential election run with the dollar so highly valued that American exports were being priced out of foreign markets. Growth was sluggish. Tightening fiscal and/or monetary policy to tamp down the 5.4% inflation rate would slow the economy, drive up the 6% unemployment rate and might even trigger a recession. Stagflation does not generate the sort of background music any politician would like to hear as he hits the campaign trail, and Nixon was a particularly insecure President.
Nixon decided to contain inflation that might follow a certain, and desired, devaluation of the dollar, unmoored from gold, by imposing a 90-day wage-price freeze. There is an irony here. Democrats had passed a bill authorizing the President to freeze wages and prices in the hope that by not doing so Nixon would hand them a stick with which to pummel them. Tricky Dick proved trickier than the Democrats.
The freeze would buy time to negotiate a new relationship between the dollar and other currencies. The outflow of dollars would be reduced by a new 10 per cent duty on imports and by persuading other countries to pick up part of the cost of containing the Russian threat to European democracies.
A devaluation of the dollar of about 8%-10% was initially agreed, but by March 1973 the G-10 gave up the ghost of Bretton Woods, and acknowledged what Benn Steil describes in The Battle Of Bretton Woods as “the end of nearly two year of tortuous efforts to re-establish a world of fixed exchange parities.” Nixon beat George McGovern handily, and shortly after the election revoked the price/wage freeze, which had become increasingly unpopular and administratively unworkable.
With the dollar unmoored from gold, Nixon’s Secretary of the Treasury, John Connally, proclaimed to finance ministers meeting in Rome, “The dollar is our currency, but it’s your problem.” And so it remains. The dollar might be a fiat currency, potentially not worth the paper on which it is printed, but it dominates global trade, and shifts in the value of the dollar have spillover effects on trading partners’ economic policies.
And many worries of the gold era remain. America’s trade deficits continue to soar. Truly free trade remains an item for textbooks. Equitable burden-sharing in NATO remains elusive as Germany refuses to pay its agreed share. Bouts of inflation continue to bedevil the American economy, including the Great Inflation of 1965-1982, during which inflation rose from a 1 per cent annual rate in 1964 to 14 per cent in 1980.
In 2005 the late Allan Meltzer, the most authoritative analyst of Fed policy, published his magisterial history of the central bank. In it, he recorded the policy errors that led to the Great Inflation. “The Federal Reserve staff and several of its members denied for several years that inflation had either begun or increased … in effect claiming that the rise in the price level resulted from one-time, transitory changes …”. Today, those “transitory increases” are running at annual rate of more than 5%. Producer prices have spurted 6.2% over last year, meaning more grief in the pipeline for consumers, whose wage increases on average have not kept price with rising prices.
Americans now rank inflation as their number one problem. The Fed says inflation is transitory. Professor Meltzer’s volumes gather dust on shelves in the Fed library.