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Nixon Shock

The Nixon Shock is a series of policy changes implemented by former president Nixon in 1971. It consisted of closing the gold window, a 10% surcharge on imports and a 90-day wage price freeze.[1] The American Presidency Project: “Address to the Nation Outlining a New Economic Policy: “The Challenge of Peace.”” Accessed March 18, 2022.

While these policy changes were a political success in the United States, they caused outrage among the international community. By closing the gold window, Nixon effectively ended the Bretton Woods system.

Table of Contents

Origins of the Nixon Shock

In 1944, global leaders drafted the Bretton Woods system. It consisted of a monetary system that pegged the US dollar to gold at a fixed exchange rate.[2] Federal Reserve History: “Creation of the Bretton Woods System” Accessed Feb. 22, 2022. All other currencies were pegged at adjustable exchange rates to the US dollar.

Before the Bretton Woods system, most of the world was on a gold standard. The traditional gold standard ended in 1914 with the outbreak of World War I.

In order to fund the war, many nations including Germany halted convertibility of paper money into gold.[3] Gross, Stephen: Confidence and Gold. German War Finance 1914-1918, in: Central European History 42 (2009), pp. 227ff. This meant these countries weren’t on the gold standard anymore and could print more paper money.

Portrait of Nixon taken right before the Nixon Shock
Portrait of Nixon taken in 1971

After World War I ended, returning to the gold standard proved challenging. There was more paper money in circulation than gold.

War nations also took on large war debts which they had to pay back. They could do this either by issuing more debt, taxation or by printing money. The result was an unstable international currency situation, including the German hyperinflation that led to the destruction of the Reichsmark.[4] Taylor, Frederick: The Downfall Of Money. Germany’s Hyperinflation And the Destruction Of The Middle Class (2014)

Great Depression

In 1929 the stock market crashed and the Great Depression took hold of the world. This put more pressure on nations that were already struggling during the inter-war period.

Given the restraints of the gold standard, the United States and other countries couldn’t arbitrarily expand the money supply.

The US dollar had to remain pegged to gold at a fixed exchange rate. This required keeping the currency backed by a certain amount of physical gold.

By 1933 many countries had already abandoned the gold standard and began devaluing their currencies against others.[5] Britannica. “The decline of gold” Accessed March. 1, 2022. They did this to counteract the deflation of the Great Depression. But it also allowed nations that devalued their currencies to gain advantages in international trade.

President Roosevelt took the United States off the gold standard in 1933 when he declared a nation-wide bank holiday and issued Executive Order 6102 which outlawed gold ownership.[6] The American Presidency Project. “Executive Order 6102—Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government” Accessed Feb. 24, 2022.

In 1937, when World War II began raging in Europe, most industrial nations, including the United States, took on large war debts. They inflated the money supply to fund the military. This led to further inflation.

Bretton Woods Agreement

In 1944, during the final days of the war, global leaders met in Bretton Woods to discuss and draft a new monetary system that pegged the US dollar to gold at a fixed exchange rate of $35 per ounce of gold.[7] Federal Reserve History: “Creation of the Bretton Woods System” Accessed Feb. 22, 2022.

All other countries that signed the Bretton Woods agreement pegged their local currencies to the US dollar at adjustable exchange rates.

This prevented the competitive devaluation of currencies that happened before and during the Great Depression.

And with the entire world officially off the gold standard, it needed a new monetary system that could provide stability. But the system only worked if the United States was able to maintain its gold peg of $35.

Problems Leading to the Nixon Shock

By 1966, the amount of dollars held by foreign nations exceeded the United States gold reserves. The United States was no longer able to honor its obligation to redeem US dollars into gold.

On top of this, the United States inflated the US dollar supply to fund the Vietnam War and pay for government programs. In order to deal with these issues and keep the US dollar pegged to gold at a fixed exchange rate of $35 per ounce, the US government took several steps. They consisted of capital controls, the establishment of a Gold Pool in Britain and putting moral pressure on countries, urging them not to convert US dollars into gold.

These measures were successful to some extent. But the gold peg of $35 per ounce couldn’t be maintained for prolonged periods of time.

The truth was that the United States had expanded the money supply beyond its gold reserves which meant the US dollar was overvalued compared to gold. The expansion of the money supply to fund the Vietnam war and government programs led to inflation.

Great Inflation

The Great Inflation is a period of heightened inflation that the United States experienced between 1965 to 1982.

The price inflation was caused by monetary inflation.

Or in other words, the expansion of the money supply led to more US dollars chasing the same number of goods and services, which bid up prices. In March 1989 inflation hit almost 15%.[8] Federal Reserve History: “The Great Inflation” Accessed March 18, 2022.

As trust in the US dollar faded, several central banks began withdrawing gold from the United States. In early August 1971, France sent a warship to New York with instructions to pick up gold in return for its US dollars.

Other countries demanded gold as well.

The United States gold reserves shrunk by over 50% during the Great Inflation, putting additional pressure on the already hard to maintain gold peg of $35 per ounce.

What happened can be described as a bank run on the United States. As nations that signed the Bretton Woods agreement realized the Untied States wasn’t able to keep its gold convertibility promise, they began demanding physical gold.

During the early days of the Bretton Woods agreement it was believed that the US dollar was as good as gold. This belief eroded quickly.

Nixon Shock

In order to prevent a full run on the United States gold reserves, president Nixon ordered Treasury Secretary John Connally to temporarily halt convertibility of us dollars into gold.

This was only one part of the Nixon Shock. Additionally to closing the gold window, Nixon imposed a 10% surcharge on imports and ordered a 90-day wage price freeze.[9] The American Presidency Project: “Address to the Nation Outlining a New Economic Policy: “The Challenge of Peace.”” Accessed March 18, 2022.

The first two policy changes aimed at stopping the gold drain out of the Untied States.

The wage freeze allowed masking inflation.

As the US dollar supply expanded, prices of wages increased, and implementing price controls allowed to temporarily suppress this increase.

Smithsonian Agreement

Nixon’s goal was to only temporarily halt redeemability of US dollars into gold while reforming the Bretton Woods agreement.

Although it wasn’t official, the Nixon Shock effectively ended the Bretton Woods system.

A new monetary system known as the Smithsonian agreement came to life. The Smithsonian agreement repriced gold at $38 per ounce.

This effectively meant devaluing the US dollar by 7.9%. The idea was to continue keeping the US dollar pegged to gold at $38 per ounce. Countries that signed the Smithsonian agreement would peg their currencies to the US dollar at adjustable exchange rates.

This reformed fixed exchange rate system stayed in place until 1973. Even before 1971, several countries had already abandoned the Bretton Woods system, including France and Switzerland.

Only 12 countries participated in the Smithsonian agreement compared to 44 in the Bretton Woods agreement.

As the Smithsonian agreement proved unfeasible, countries began adopting floating exchange rates throughout the 80s. From this point onward, all currencies became fiat currencies, backed only by the full faith and credit of the governments that issue them.

Nixon’s Address to the Nation

During a TV appearance on August 15, 1971, Nixon outlined his new policies to the nation. While it was a success domestically, it sent shock waves through the international community.[10] Office of the Historian: “Nixon and the End of the Bretton Woods System, 1971–1973” Accessed March 18, 2022.

Here is an excerpt of Nixon’s address to the nation:

In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy— and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators.

Nixon on “The Challenge of Peace”

Closing the Gold Window

Nixon then continued by closing the gold window, which effectively severed all ties to gold.

He said:

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 the bugaboo 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.

Nixon on “The Challenge of Peace”

These words changed the world forever. Despite attempts to re-peg the US dollar to gold under the Smithsosian Agreement, the world adopted floating exchange rates shortly after the Nixon Shock.

Nixon’s speech marked the beginning of a new monetary regime based on fiat currencies. From August 15th, 1971, the world was completely off the gold standard and all currency was backed by the faith and credit of the governments that issued them.

Despite this, the US dollar maintained its status as world-reserve currency in the decades to come.

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March 18, 2022