The Nixon Shock
On August 15, 1971, 40 years ago today, President Richard Nixon completed his plan for the United States to break from the gold standard by ending convertibility of the United States dollar into gold by foreign investors. This was part of a series of economic measures taken by Nixon in 1971 that were known as the "Nixon Shock".
By the early 1970s, the costs of the Vietnam War and increased domestic spending accelerated inflation in the U.S. The nation was running it's first trade deficit of the 20th century. Economists and holders of the U.S. dollar lost faith in the government's ability to cut its budget and trade deficits. In the first six months of 1971, $22 billion in assets left the U.S. and in May 1971, West Germany was the first economic power to unilaterally break from the Breton Woods system, an economic protocol in which nations tied their currency to the US dollar. West Germany was unwilling to devalue the Deutsche Mark in order to prop up the dollar. As a result, West Germany's move strengthened their economy, while the dollar dropped in value against the Deutsche Mark.
Due to the excess of printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America's promise to redeem their dollars for gold. Switzerland redeemed $50 million worth of paper dollars for gold in July. France 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. On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland followed West Germany and withdrew the Swiss franc from the Breton Woods system.
To stabilize the economy and combat inflation, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, ending the system of convertibility between US dollars and gold. The President made that decision without consulting the members of the international monetary system, so the international community informally named it the Nixon shock. 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). Nixon's actions proved very popular with the American public. The president was credited with finally rescuing the nation from price-gougers, and from a foreign-caused exchange crisis.
Economist Paul Krugman summarized the reaction to the Nixon Shock 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, the costs of the Vietnam War and increased domestic spending accelerated inflation in the U.S. The nation was running it's first trade deficit of the 20th century. Economists and holders of the U.S. dollar lost faith in the government's ability to cut its budget and trade deficits. In the first six months of 1971, $22 billion in assets left the U.S. and in May 1971, West Germany was the first economic power to unilaterally break from the Breton Woods system, an economic protocol in which nations tied their currency to the US dollar. West Germany was unwilling to devalue the Deutsche Mark in order to prop up the dollar. As a result, West Germany's move strengthened their economy, while the dollar dropped in value against the Deutsche Mark.
Due to the excess of printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America's promise to redeem their dollars for gold. Switzerland redeemed $50 million worth of paper dollars for gold in July. France 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. On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland followed West Germany and withdrew the Swiss franc from the Breton Woods system.
To stabilize the economy and combat inflation, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, ending the system of convertibility between US dollars and gold. The President made that decision without consulting the members of the international monetary system, so the international community informally named it the Nixon shock. 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). Nixon's actions proved very popular with the American public. The president was credited with finally rescuing the nation from price-gougers, and from a foreign-caused exchange crisis.
Economist Paul Krugman summarized the reaction to the Nixon Shock 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."