TheNixon shock was the effect of a series of economic measures, includingwage andprice freezes, surcharges on imports, and the unilateral cancellation of the direct internationalconvertibility of theUnited States dollar to gold, taken by United States presidentRichard Nixon on 15 August 1971 in response to increasing inflation.[1][2]
Although Nixon's actions did not formally abolish the existingBretton Woods system of international financial exchange, the suspension of one of its key components effectively rendered the Bretton Woods system inoperative.[3] While Nixon publicly stated his intention to resume direct convertibility of the dollar after reforms to the Bretton Woods system had been implemented, all attempts at reform proved unsuccessful. By 1973, thefloating exchange rate regimede facto replaced the Bretton Woods system for otherglobal currencies.[4]
In 1944, representatives from 44 nations met inBretton 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".[5] It was not until 1958 that the Bretton Woods system became fully operational. Countries now settled their international accounts in dollars that could be converted to gold at afixed exchange rate of $35 per ounce, which was redeemable by theU.S. government. Thus, the United States was committed to backing every dollar overseas with gold, and other currencies were pegged to the dollar. For the first years afterWorld War II, the Bretton Woods system worked well. With theMarshall Plan, Japan and Europe were rebuilding from the war, and countries outside the U.S. wanted dollars to spend on American goods—cars, steel, machinery, and the like. Because the U.S. owned over half the world's official gold reserves—574 million ounces at the end of World War II—the system appeared secure.[6] From 1950 to 1969, as Germany and Japan recovered, the U.S. share of the world's economic output dropped significantly, from 35% to 27%. Furthermore, a negativebalance of payments, growingpublic debt incurred due to theVietnam War, andmonetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s.[6]
In France, the Bretton Woods system was called "America'sexorbitant privilege",[7] as it resulted in an "asymmetric financial system" where non-US citizens "see themselves supporting American living standards and subsidizing American multinationals". American economistBarry Eichengreen wrote: "It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one."[7] In February 1965, French presidentCharles de Gaulle announced his intention to exchange its U.S. dollar reserves for gold at the official exchange rate.[8] By 1966, non-U.S. central banks held $14 billion U.S. dollars, while the United States had only $13.2 billion in gold reserve. Of those reserves, only $3.2 billion was able to cover foreign holdings as the rest was covering domestic holdings.[9]
By 1971, themoney supply had increased by 10%.[10] In May 1971,West Germany left the Bretton Woods system, unwilling to sell furtherDeutsche Mark for dollars.[11] In the following three months, this move strengthened its economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark.[11] Other nations began to demand redemption of their dollars for gold. Switzerland redeemed $50 million in July.[11] France acquired $191 million in gold.[11] On August 5, 1971, theU.S. Congress released a report recommendingdevaluation of the dollar, in an effort to protect the dollar against "foreign price-gougers".[11] Also in August French PresidentGeorges Pompidou sent a battleship to New York City to remove France's gold deposits.[12] On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland left the Bretton Woods system.[11] The pressure began to intensify on the United States to leave Bretton Woods. On August 11, Britain requested $3 billion in gold be moved from Fort Knox to the Federal Reserve in New York.[12] By August 15, Nixon declared that there were only 10,000 metric tons of gold remaining, or less than half of the reserves the U.S. once held.[12]
At the time, the U.S. also had an unemployment rate of 6.1% (August 1971),[13][notes 1] as well as an inflation rate of 5.84% (1971).[14] To combat these problems, Nixon consultedFederal Reserve chairmanArthur Burns, incomingTreasury SecretaryJohn Connally, andPaul Volcker, then Undersecretary for International Monetary Affairs and future Federal Reserve Chairman. On the afternoon of Friday, August 13, 1971, Burns, Connally, and Volcker, along with twelve other high-ranking White House and Treasury advisors, met secretly with Nixon atCamp David. There was great debate about what Nixon should do but ultimately Nixon, relying heavily on the advice of the self-confident Connally, decided to break up Bretton Woods by announcing the following actions on August 15:[15][16][17]
Speaking on television on Sunday, August 15, when American financial markets were closed, Nixon said the following:
The third indispensable element in building the new prosperity is closely related to creating new jobs and halting inflation. We must protect the position of the American dollar as a pillar of monetary stability around the world. In the past 7 years, there has been an average of one international monetary crisis every year… I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States. Now, what is this action—which is very technical—what does it mean for you? Let me lay to rest thebugaboo of what is called devaluation. If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today. The effect of this action, in other words, will be to stabilize the dollar.[18]
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The Nixon shock has been widely considered to be a political success but an economic failure for bringing on the1973–1975 recession, thestagflation of the 1970s, and the instability of floating currencies.[citation needed]
Politically, Nixon's actions were a great success. The American public believed the government was rescuing them fromprice gougers and from a foreign-caused exchange crisis.[19][20] TheDow Jones Industrial Average rose 33 points the next day, its biggest daily gain ever at that point, andThe New York Times editorial read, "We unhesitatingly applaud the boldness with which the President has moved."[6][21]
By December 1971, the import surcharge was dropped as part of a generalrevaluation of theGroup of Ten (G-10) currencies, which under theSmithsonian Agreement were thereafter allowed 2.25% devaluations from the agreed exchange rate. According to Douglas Irwin inWorld Trade Review's report "The Nixon Shock After Forty Years: The Import Surcharge Revisited", for several months, U.S officials could not get other countries to agree to a formal revaluation of their currencies.[citation needed] In March 1973, the fixed exchange rate system became afloating exchange rate system.[22] The currency exchange rates no longer were governments' principal means of administeringmonetary policy.
Under the floating rate system, during the 1970s, the dollar plunged by a third. Further, the Nixon shock unleashed enormous speculation against the dollar. TheGerman Mark appreciated significantly after it was allowed to float in May 1971. It forced Japan's central bank to intervene significantly in theforeign exchange market to prevent theyen from increasing in value. Within two days, on August 16–17, 1971, Japan's central bank had to buy $1.3 billion to support the dollar and keep the yen at the old rate of ¥360 to the dollar. Japan's foreign exchange reserves rapidly increased: $2.7 billion (30%) a week later and $4 billion the following week. Still, this large-scale intervention by Japan's central bank could not prevent the depreciation of US dollar against the yen. France also was willing to allow the dollar to depreciate against thefranc but not allow the franc to appreciate against gold.[23] Even much later,Paul Volcker expressed regret over the abandonment of Bretton Woods. In 2011, Volcker said: "Nobody's in charge. The Europeans couldn't live with the uncertainty andmade their own currency and now that's in trouble."[6]
