Nixon Shock
Encyclopedia
The Nixon Shock was a series of economic measures taken by U.S. President Richard Nixon
in 1971 including unilaterally cancelling the direct convertibility of the United States dollar
to gold
that essentially ended the existing Bretton Woods system
of international financial exchange.
and increased domestic spending accelerated inflation, the U.S. was running a balance-of-payments
deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, because foreign arbitrage
of the U.S. dollar caused governmental gold coverage of the paper dollar to decline from 55% to 22%. That, in the view of neoclassical economics
and the Austrian School
, represented the point where holders of the U.S. dollar lost faith in the U.S. government's ability to cut its budget and trade deficits.
By 1971, the money supply had increased by 10%. In the first six months of 1971, $22 billion in assets left the U.S. In May 1971, inflation-wary West Germany
was the first member country to unilaterally leave the Bretton Woods system
— unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, West Germany's move strengthened their economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark.
Due to the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America's "promise to pay" – that is, the redemption of their dollars for gold. Switzerland
redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and 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. Still, on August 9, 1971, as the dollar dropped in value against European currencies, Switzerland unilaterally withdrew the Swiss franc
from the Bretton Woods system
.
rate of 5.84%, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, "closed the gold window", ending convertibility between US dollars and gold. The President and fifteen advisers made that decision without consulting the members of the international monetary system, so the international community informally named it the Nixon shock. Given the importance of the announcement — and its impact upon foreign currencies — presidential advisers recalled that they spent more time deciding when to publicly announce the controversial plan than they spent creating the plan. Nixon was advised that the practical decision was to make an announcement before the stock market
s opened on Monday (and just when Asian markets also were opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular and raised the public's spirit. The President was credited with finally rescuing the American public from price-gougers
, and from a foreign-caused exchange crisis.
By December 1971, the import surcharge was dropped, as part of a general revaluation of the major currencies, which thereafter were allowed 2.25% devaluations from the agreed exchange rate. By March 1976, the world’s major currencies were floating
— in other words, the currency exchange rates no longer were governments' principal means of administering monetary policy
.
summarizes the post-Nixon Shock era as follows:
is supported by followers of the Austrian School
, largely because they object to the role of the government in issuing fiat currency through central bank
s. A number of gold standard advocates also call for a mandated end to fractional reserve banking.
Richard Nixon
Richard Milhous Nixon was the 37th President of the United States, serving from 1969 to 1974. The only president to resign the office, Nixon had previously served as a US representative and senator from California and as the 36th Vice President of the United States from 1953 to 1961 under...
in 1971 including unilaterally cancelling the direct convertibility of the United States dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
to gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
that essentially ended the existing Bretton Woods system
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
of international financial exchange.
Background
By the early 1970s, as the costs of the Vietnam WarVietnam War
The Vietnam War was a Cold War-era military conflict that occurred in Vietnam, Laos, and Cambodia from 1 November 1955 to the fall of Saigon on 30 April 1975. This war followed the First Indochina War and was fought between North Vietnam, supported by its communist allies, and the government of...
and increased domestic spending accelerated inflation, the U.S. was running a balance-of-payments
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, because foreign arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
of the U.S. dollar caused governmental gold coverage of the paper dollar to decline from 55% to 22%. That, in the view of neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
and the Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
, represented the point where holders of the U.S. dollar lost faith in the U.S. government's ability to cut its budget and trade deficits.
By 1971, the money supply had increased by 10%. In the first six months of 1971, $22 billion in assets left the U.S. In May 1971, inflation-wary West Germany
West Germany
West Germany is the common English, but not official, name for the Federal Republic of Germany or FRG in the period between its creation in May 1949 to German reunification on 3 October 1990....
was the first member country to unilaterally leave the Bretton Woods system
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
— unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, West Germany's move strengthened their economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark.
Due to the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America's "promise to pay" – that is, the redemption of their dollars for gold. Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On August 5, 1971, Congress released a report recommending devaluation
Devaluation
Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged....
of the dollar, in an effort to protect the dollar against foreign price-gougers. Still, on August 9, 1971, as the dollar dropped in value against European currencies, Switzerland unilaterally withdrew the Swiss franc
Swiss franc
The franc is the currency and legal tender of Switzerland and Liechtenstein; it is also legal tender in the Italian exclave Campione d'Italia. Although not formally legal tender in the German exclave Büsingen , it is in wide daily use there...
from the Bretton Woods system
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
.
The Shock
To stabilize the economy and combat the 1970 inflationInflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
rate of 5.84%, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, "closed the gold window", ending convertibility between US dollars and gold. The President and fifteen advisers made that decision without consulting the members of the international monetary system, so the international community informally named it the Nixon shock. Given the importance of the announcement — and its impact upon foreign currencies — presidential advisers recalled that they spent more time deciding when to publicly announce the controversial plan than they spent creating the plan. Nixon was advised that the practical decision was to make an announcement before the stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
s opened on Monday (and just when Asian markets also were opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular and raised the public's spirit. The President was credited with finally rescuing the American public from price-gougers
Price gouging
Price gouging is a pejorative term referring to a situation in which a seller prices goods or commodities much higher than is considered reasonable or fair. In precise, legal usage, it is the name of a crime that applies in some of the United States during civil emergencies...
, and from a foreign-caused exchange crisis.
By December 1971, the import surcharge was dropped, as part of a general revaluation of the major currencies, which thereafter were allowed 2.25% devaluations from the agreed exchange rate. By March 1976, the world’s major currencies were floating
Floating exchange rate
A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency....
— in other words, the currency exchange rates no longer were governments' principal means of administering monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
.
Later ramifications
Nobel-prize winning American economist Paul KrugmanPaul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
summarizes the post-Nixon Shock era as follows:
Criticism
The return to a gold standardGold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
is supported by followers of the Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
, largely because they object to the role of the government in issuing fiat currency through central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
s. A number of gold standard advocates also call for a mandated end to fractional reserve banking.
See also
- The Death of MoneyThe Death of MoneyThe Death of Money is a 1993 book by Joel Kurtzman, a former editor of Harvard Business Review. Kurtzman uses the "death of money" to refer to a change in the economic nature of money in the United States following Richard Nixon's removal of US dollar from the gold standard , informally referred...
- Triffin dilemmaTriffin dilemmaThe Triffin dilemma is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives...
- Bretton Woods systemBretton Woods systemThe Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
- Dollar hegemonyDollar hegemonyDollar hegemony is the hypothesized monetary hegemony of the US dollar in the global economy. Henry C.K. Liu popularized the term in the article "Dollar Hegemony has to go" in Asia Times, April 11, 2002...
External links
- Stemming Inflation: the Office of Emergency Preparedness and the 90-day freeze: A comprehensive history of the management of the 90-day wage-price freeze, undertaken by the Office of Emergency Preparedness and the newly established Cost of Living Council.
- The Economy at Mid-1972: A testimony of the Council of Economic Advisers before the Joint Economic Committee on economic developments since President Nixon's New Economic Policy was adopted on August 15, 1971