When you hear Richard Nixon, you think of Watergate. The 37th President of the United States remained in the minds of the world as a power-obsessed cynic who wanted to wiretap the Democratic Party headquarters in the Watergate compound and was forced to resign on August 9, 1974 after a unprecedented impeachment. But Nixon was also a president who changed the world. He established diplomatic relations with the People’s Republic of China, but above all blew up the post-war monetary system.
Fifty years ago, on August 15, 1971, in a radio and television speech, Nixon unilaterally renounced the United States’ obligation to exchange dollars for gold. The dollar lost its function as an anchor for other currencies overnight. The rest of the world was absolutely unprepared for the speech, which is why it made history as the Nixon Shock. The shock has changed the way people perceive the market and the state in the world. In Europe, it sparked a dynamic which, decades later, would lead to monetary union and the euro.
The monetary system that had been in force until then had been decided by the victorious powers of World War II at a conference held from July 1 to 22, 1944 in the seaside resort of Bretton Woods in the US state from New Hampshire. The main participants were the head of the American delegation, Harry Dexter White (he would later be unmasked as a Soviet spy), and the British economist John Maynard Keynes. The two arrived at Bretton Woods with different concepts, with whites predominating – unsurprisingly given the economic strength of the United States.
White’s plan was for all currencies to be pegged to the dollar at a fixed rate. To compensate for this, the United States has committed to exchange its currency for gold at any time at a price of $ 35 per troy ounce. For comparison: Friday afternoon gold costs around $ 1,770. An International Monetary Fund (IMF) should help countries with payment difficulties.
The Bretton Woods system was initially incredibly successful after the war. The economy of the Western world has grown at an unprecedented rate in historical terms. World trade flourished, inflation remained under control and unemployment fell. In the 1960s, many believed that the “golden age of capitalism” had begun, as historian Harold James wrote.
Bretton Woods made the young Federal Republic an economic miracle exporter
The young Federal Republic of Germany has particularly benefited from Bretton Woods. Their economic miracle was due to the Minister of the Economy, Ludwig Erhard, but also to the Bretton Woods system. Stable exchange rates have allowed the Federal Republic to become an export powerhouse, although it has certainly helped that the D-Mark is sometimes grossly undervalued. Because the Germans exported much more than they imported, they were able to build up huge reserves of gold under Bretton Woods. Even today, Germany has the second largest gold reserves in the world after the United States. Gold bars total around 3,400 tonnes and are stored in the vaults of the Bundesbank in Frankfurt, the Federal Reserve Bank of New York and the Bank of England.
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Gold bars in the US Federal Reserve, registration dates from 1962.
For all of its success, however, the system had one flaw in weaving: a growing global economy needed more dollars. These additional dollars were less and less backed by gold and the US current account was in deficit. At one point, it must have led to a crisis of confidence. The problem was discovered early on by Belgian economist Robert Triffin, which is why it is still called the Triffin’s dilemma today. By the late 1960s, it became clear just how right Triffin was. Speculators attacked the dollar more and more aggressively and instead relied on the D-Mark. It couldn’t last long.
At least that was what a largely unknown economist in the US Treasury Department was convinced. His name was Paul Volcker and would later become famous as the head of the Federal Reserve (1979 to 1987) and adviser to President Barack Obama during the financial crisis (2009). In early 1969, however, he had just transitioned from a bank to the ministry as Secretary of State for Currency Crises. Volcker was actually close to the Democrats, but he joined the government after Republican Nixon came to power because he saw an opportunity to fight the devaluation of the currency in the United States. Inflation had now passed the five percent mark – not too much for what was to come in the 1970s, but worrisome at the end of the so far successful 1960s.
On behalf of Treasury Secretary John Connally – like Volcker a Democrat – he developed a concept meant to limit inflation and restore confidence. Nixon and Connally accepted the concept. It was then discussed and decided in complete secrecy at the US President’s country residence at Camp David. The conference began on the evening of August 13, 1971, a Friday, and ended the following Sunday morning. When Nixon announced the results on radio and television that night, 46 million Americans watched or listened.
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His speeches are documented in the Nixon Presidential Library. He sold the proclamation of the gold standard as a great liberation.
(Photo: Jae C. Hong / AP)
Nixon’s program consisted of three parts. First, the United States unilaterally untied the dollar’s peg from gold. Second, the government has declared a general price freeze for 90 days. And third, it imposed a ten percent import tariff to compensate for allegedly unfair exchange rates. The response to speech in America has always been positive. When the New York Stock Exchange opened on Monday, shares of Chrysler were up 15 percent, while those of Ford and General Motors were up 10 percent each.
The situation was a little different for American tourists overseas. They could sense how low their currency still held dear. Taxi drivers in Paris charged extra if they accepted dollars as a form of payment. A couple complained to the Wall Street Journal in Rome that they couldn’t even buy an ice cream cone with their dollars. Even German tourists to other European countries who had taken dollar travelers checks with them for security had to worry about their money for a few days.
Rhetorically, however, Nixon’s speech was brilliant. He sold the emergency measures as a blow: “The time has come for a new economic policy in the United States,” he said. “We need to create more and better jobs. We need to stop the rising cost of living, we need to protect the dollar from attacks by international currency speculators.” It was well received by voters. No one asked why the government and the central bank had not done the best thing to protect the dollar: raise interest rates and cut government spending. The response would have been awkward, as it would have triggered a recession and endangered Nixon’s re-election.
Indeed, the Nixon shock was a failure. After the 90-day price freeze, prices rose, as expected, all the more rapidly. The import tax did little to help the domestic industry, and the dollar crises did not end either. In December 1971, the industrialized countries again agreed on a reformed exchange rate system. The dollar has been devalued and the margins for exchange rate fluctuations have increased. But that Smithsonian deal, named after the Washington building it was decided in, only lasted a year. At the beginning of 1973 speculation against the dollar began again. On March 1, the Deutsche Bundesbank had to borrow no less than $ 1.7 billion to support the currency rate. Then there was a ‘confrontation’, as the Bundesbank-Magazin wrote in retrospect: Bundesbank Vice-President Otmar Emminger went to a cabinet meeting in Bonn to ask Federal Chancellor Willy Brandt to stop supporting the dollar. A day later, Brandt agreed, after which the Bundesbank stopped buying. It was the definitive end of Bretton Woods and the start of a new era.
The exchange rates of major currencies such as the dollar, the D-Mark, the franc or the yen were no longer politically fixed, but formed freely in the foreign exchange markets. The concept of flexible exchange rates originally came from economist Milton Friedman, who taught at the University of Chicago. Friedman and the monetarists close to him wanted the state to stay away not only from currency markets, but also from economic control in general. Instead, central banks should only ensure that the money supply grows in a controlled manner so that prices remain stable. Friedman was awarded the Nobel Prize for Economics in 1976. In 1973, the Bundesbank was the first central bank to adopt Friedman’s ideas and adopt a monetarist concept of money supply. No longer having to support the dollar, it could devote itself entirely to the fight against inflation. This increased the power and prestige of central bankers in Frankfurt.
The Nixon shock had another long-term consequence in Europe: Europeans united to fix exchange rates between themselves. It started in 1972 with the currency snake, in which members of the European Economic Community (EEC), Great Britain, Switzerland and a few others participated. The snake was followed in 1979 by the European economic system, which was supposed to create a unified economic space on the continent. The culmination of this development was the euro in 1998.