The Nixon Shock And The End of Gold Convertibility

the-nixon-shock

Bloomberg Businessweek : The Nixon Shock

See how many of the following excerpts mirror what we see in the global financial turmoil today:

– out-of-control deficits

– over issuance of currencies

– countries propping up the dollar to benefit their exports

– expanding the money supply to solve the problem

– exporting inflation to other countries

– blaming other countries of being currency manipulators/speculators for problems caused by their own fiscal indiscipline

We are repeating history…

Notable excerpts:

Inflation had disturbing international implications because, in the system known as Bretton Woods that had prevailed since the end of World War II, the U.S. was committed to backing every dollar overseas with gold. Thus, foreign countries had the right to exchange their greenbacks at the rate of $35 per ounce. The other currencies were fixed to the dollar, and the dollar—the sun in the monetary sky—was pegged to gold.

…from 1950 to 1969, as Germany and Japan recovered, the U.S. share of the world’s economic output fell decisively, from 35 percent to 27 percent. Other nations had less need for dollars and more for deutsche marks, yen, and francs. Also, U.S. spending on Vietnam and domestic programs flooded the world with dollars. Bit by bit, America’s allies began to ask for gold.

America’s balance of payments deficit in 1969 had reached $7 billionsmall by today’s standards but scary then. This meant more dollars accumulating in London, Bonn, and Tokyo. Volcker pressed the Europeans to revalue their currencies; if Americans had to pay more for French wine, fewer dollars would pile up overseas. Germany modestly revalued; others refused. The Europeans, as well as Japan, were caught in a trap: They were reluctant to hold dollars, but unwilling to give up their dependence on exporting goods to America.

money supply was the single key tool at the Fed’s disposal. Friedman viewed money in terms of supply and demand: If the Fed printed more dollars, then money would be worth less and goods would cost more, i.e. inflation.

Rampant domestic inflation was mirrored, franc for franc, in markets overseas. Foreign governments intervened to buy dollars to shore up America’s currency (and their export trade).

Meanwhile, America’s gold stock had dwindled to $10 billion, half its 1960 level. The gold standard now existed only in name, for foreign banks held far more dollars than the U.S. held gold. This left the U.S. vulnerable to a run.

Volcker, as well as Shultz, wanted to close the gold window. Burns was vehemently opposed. Severing the gold link would turn money into … paper.

The plan, presented by Connally, had three key points. First, America would stop converting dollars to gold. Second, to combat the potential inflationary effects, wages and prices would be frozen for 90 days. And third, the U.S. would impose an import surcharge of 10 percent.

Connally brilliantly packaged the program not as America abandoning its commitment to the gold standard but as America taking charge. He turned the dollar’s collapse, which could have appeared shameful, into a moment of hubris.

Addressing the nation on Sunday, Nixon blamed currency speculators and “unfair” exchange rates rather than U.S. monetary policy.

The gold window stayed shut. More devaluations followed, and by 1973, currencies were freely floating.

Floating currencies unleashed a new world of risk and instability. For the first time, investors could bet on the direction of interest rates or the Swiss franc. New financial instruments, new speculative tools, proliferated.

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2 thoughts on “The Nixon Shock And The End of Gold Convertibility

  1. Pingback: Rise of Gold Prices From 1968 To 2013 | livinginabubbleblog

  2. Pingback: Ex-French President Charles de Gaulle Predicted a US Monetary Crisis in 1965 | livinginabubbleblog

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