EDITOR NOTE: Fifty years ago this week, Richard Nixon took to American television to announce he was closing the gold window due to economic conditions eerily similar to today. Inflation, the budget deficit, and the trade deficit were skyrocketing, and the U.S. was entangled in an unwinnable conflict halfway around the globe. “Nixon’s closing of the gold window marked the end of a commodity-based monetary order and the beginning of a new world of fiat currencies,” said Princeton historian Harold James. He also says that today, “We are moving toward another new monetary order, based on information.” This sounds good in theory, but growing government involvement in crypto and China’s entry into the space is worrisome. Just because the dollar prevailed during the last monetary reset 50 years ago doesn’t mean it will be the same story today.
After Richard Nixon scrapped Bretton Woods, the U.S. currency’s exorbitant privilege only grew — because the U.S. embraced innovation, not regulation.
It was Sunday night on Aug. 15, 1971, and many Americans were watching television — the most popular show that evening being the Western series “Bonanza.” (Older readers will recall that it chronicled the adventures of the Cartwright family — Ben, his three sons and their Chinese cook — on their Ponderosa Ranch in Nevada.) At 9 p.m. Eastern time, the Cartwrights and their rivals on the other two networks were interrupted by the somewhat less popular figure of President Richard Nixon.
The word “bonanza,” according to the Oxford English Dictionary, was introduced into American English in the 1880s to describe a highly productive or profitable mine, such as the silver mines of the Comstock Lode in Cartwright country. Ironically, Nixon was disrupting Sunday evening to tell Americans that the days of precious metal were over. The link between the U.S. dollar and gold — a link that dated back to the country’s adoption of the gold standard nearly a century before — was to be severed. The age of fiat money — that is, of currency backed by nothing more than the credibility of the U.S. Treasury — had dawned.
Not that Nixon put it like that. It’s worth watching a clip of his address to remind yourself just how terrible the production values of U.S. politics used to be. Nixon looks as if he is addressing the nation from a passport photo booth, a nasty blue curtain all but matching his equally nasty blue suit and tie. There were no teleprompters then, so he constantly looks down at his script. You would not know from his flat delivery how many hours he and his advisers and speechwriters had devoted to this historic text.Americans by now were used to presidential addresses about Vietnam. It was less usual to have a lecture on the economy on a Sunday night. However, as Jeffrey E. Garten explains in his gripping account of the speech’s origins and consequences, “Three Days at Camp David,” the announcement had to go out before financial markets opened on Monday. In his own charmless way, Nixon was dropping a bombshell.
“The time has come,” Nixon declared, “for a new economic policy for the United States. Its targets are unemployment, inflation and international speculation.” There followed a succession of presidential pledges, in ascending order of radicalism: to introduce tax breaks to encourage investment; to repeal the excise tax on automobiles (but only U.S.-made ones); to bring forward planned income tax deductions (though with offsetting spending cuts); to impose a 90-day “freeze” on all prices and wages; and — the bombshell — “to suspend temporarily the convertibility of the dollar into gold.” Finally, Nixon announced a 10% tax on all imports — in a word, a tariff.
For foreign leaders, finance ministers and central bankers, this was stunning. Not only would the U.S. dollar cease to be convertible into gold; the U.S. was apparently turning away from the free trade it had embraced at the end of World War II and reverting to protectionism — though this proved to be just a threat to get the Europeans and Japanese to accept the dollar devaluation. In the words of Henry Brandon, the chief Washington correspondent of the London Sunday Times, this was the “moment of the formal dethronement of the Almighty Dollar.”
Except that it wasn’t.
From the distance of half a century, the most surprising thing about what the Japanese called “the Nixon shock” was precisely that it did not mark the end of the era of dollar dominance. On the contrary, the U.S. currency has only grown more important — its privilege even more exorbitant — since Nixon severed its link to gold.
There is an important lesson here for every commentator who is tempted to speculate about the dollar’s demise (and I have done it myself more than once). My old friend Steve Roach, the former chairman of Morgan Stanley Asia, made the standard case in January. Since then, the dollar has essentially flatlined, according to the trade-weighted indices produced by the Bank for International Settlements.
The arguments for a dollar crisis back in 1971 are familiar to modern ears. Inflation was rising. The budget deficit was worrisome. The trade deficit was growing. And Asian and European competitors were eroding U.S. economic leadership. Nixon’s economic bombshell needs to be seen in the broader context. He and his national security adviser, Henry Kissinger, were struggling to extricate the U.S. from an unpopular war in Vietnam. They were in the midst of a bold attempt to deal directly with China’s communist government in the hope of putting pressure on the North Vietnamese and their Soviet backers.
You might say that Joe Biden confronts a somewhat similar landscape (for Vietnam, read Afghanistan) except that the deficits of 2021 make the deficits of 1971 look trifling. The federal deficit in Nixon’s first term peaked at 2.1% of GDP. In the words of a July 21 Congressional Budget Office report, “At 13.4% of GDP, the deficit in 2021 would be the second largest since 1945, exceeded only by the 14.9 percent shortfall recorded last year.” And that doesn’t include the $1 trillion infrastructure bill that the Senate just passed, which the CBO thinks would widen the budget deficit by another $256 billion over 10 years. Nor does it include the $3.5 trillion antipoverty and climate package that the Senate majority leader, Chuck Schumer, would also like to enact this year.
As for the trade deficit, you have to squint to see one in 1971. It was a negligible $1.4 billion — true, the first trade deficit since 1893, but still tiny in a $1.2 trillion economy. The overall current account deficit at the time of the Nixon shock was 0.2% of GDP. Today it’s 3.5%.
As Garten tells the story, 15 white guys (as I said, the 1970s were different) repaired to Camp David and thrashed out Nixon’s new economic policy. The Texan force of political nature that was Treasury Secretary John Connally got most of what he wanted: in particular, “to screw the foreigners before they screw us.”
The losers were Paul Volcker, then a Treasury undersecretary, and the other financial technocrats who had hoped to re-engineer the Bretton Woods system — with the International Monetary Fund’s special drawing rights (a synthetic reserve currency) taking the place of gold. Yet Connally was playing the part of a wrecking ball, as Kissinger pointed out when he came to understand what was being cooked up. (He was on his way to Paris during that fateful weekend, for secret peace negotiations with the North Vietnamese.)
“I will be perfectly frank with you,” Connally candidly told reporters after Nixon’s TV address. “None of us know for certain what will occur.” Politically, it delivered the boost to the administration’s popularity Connally and Nixon had anticipated. But the collateral damage to American foreign policy — as Asian and European markets and currencies went haywire — took many months to repair. Not until the Smithsonian Agreement in late December were new exchange rate arrangements in place, whereby everyone else accepted the reality of dollar devaluation.
Read more at Bloomberg