The Nixon shock was the effect of a series of economic measures, including wage and price freezes, surcharges on imports, and the unilateral cancellation of the direct international convertibility of the United States dollar to gold, taken by United States president Richard Nixon on August 15, 1971, in response to increasing inflation and threats of a currency crisis. Although Nixon's actions did not formally abolish the existing Bretton Woods system of international financial exchange, the suspension of one of its key components effectively rendered the Bretton Woods system inoperative. 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, effectively converting the U.S. dollar into a fiat currency. By 1973, the floating exchange rate regime de facto replaced the Bretton Woods system for other global currencies.
Background
Bretton Woods system
In 1944, representatives from 44 nations met in Bretton 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". The Bretton Woods system became fully operational by 1958. Under the system, countries settled their international accounts in United States dollars, which could be converted to gold at a fixed exchange rate of $35 per ounce, which was redeemable by the U.S. government. Thus, the United States was committed to backing every U.S. dollar overseas with gold, and other currencies were pegged to the dollar. For the first years after World War II, the Bretton Woods system worked well. Under the Marshall Plan, Japan and Europe were rebuilding from the war, and demand for American goods and dollars were high, and 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. However, as Germany and Japan recovered from 1950 to 1969, the U.S. share of global economic output dropped from 35% to 27%. Furthermore, a negative balance of payments, growing public debt incurred to fund U.S. involvement in the Vietnam War, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s.
Criticism and decline In France, Minister of Finance Valéry Giscard d'Estaing criticized the Bretton Woods system as "America's exorbitant privilege", as it permitted the United States to avoid a currency crisis and resulted, in the words of American economist Barry Eichengreen, in an "asymmetric financial system" where non-U.S. citizens "see themselves supporting American living standards and subsidizing American multinationals."
"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." In February 1965, French president Charles de Gaulle announced his intention to redeem U.S. dollar reserves for gold at the official exchange rate. By 1966, non-U.S. central banks held $14 billion in U.S. dollars, while the United States had only $13.2 billion in gold reserves, of which only $3.2 billion was available to cover foreign holdings. In March 1968, the London Gold Pool collapsed. In May 1971, West Germany left the Bretton Woods system, unwilling to sell further Deutschmarks for U.S. dollars. In the following three months, the U.S. dollar dropped 7.5% against the Deutschmark, and other nations began to demand redemption of their U.S. dollars for gold. On August 5, 1971, the United States Congress released a report recommending devaluation of the dollar in an effort to protect their currency against "foreign price-gougers". Also in August, French president Georges Pompidou sent a ship to New York City to retrieve French gold deposits. On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland left the Bretton Woods system. Pressure intensified on the United States to leave the Bretton Woods system. On August 11, Britain requested $3 billion in gold be moved from Fort Knox to the Federal Reserve in New York. As Paul Volcker, then Undersecretary of the United States Department of the Treasury for Monetary Affairs, later put it:
"If the British, who had founded the system with us, and who had fought so hard to defend their own currency, were going to take gold for their dollars, it was clear the game was indeed over." By August 15, there were only 10,000 metric tonnes (= 352740000 ounces) of gold remaining in the U.S. reserves, less than half of their peak amount. At the time, the U.S. also had a monthly unemployment rate of 6.1%, as well as an annual inflation rate of 5.84%.
American policy response
To combat these problems, Nixon consulted Federal Reserve chairman Arthur F. Burns, Treasury Secretary John Connally, and Paul Volcker. On the afternoon of Friday, August 13, 1971, Nixon, Burns, Connally, Volcker, and twelve other high-ranking White House and Treasury advisors met secretly at Camp David to discuss policy solutions to the growing crisis. Nixon, relying heavily on the advice of Connally, ultimately decided to abandon the Bretton Woods system by announcing the following actions on August 15:
Nixon directed Connally to suspend the convertibility of the dollar into gold or other reserve assets (with certain exceptions), such that foreign governments could no longer exchange their dollars for gold, thereby ending the Bretton Woods system. Nixon issued Executive Order 11615 (pursuant to the Economic Stabilization Act of 1970), imposing a 90-day freeze on wages and prices. Nixon instituted a 10 percent import surcharge in anticipation of the expected fluctuation in exchange rates. On Sunday, August 15, when American financial markets were closed, Nixon explained the policy agenda in a national address:
This was the first time the U.S. government had enacted wage and price controls since the Korean War.
Impact and aftermath
The Nixon shock has been widely considered to be a political success but an economic failure for bringing on the 1973–1975 recession, the stagflation of the 1970s, and the instability of floating currencies.
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