In the face of mounting balance-of-payments deficits, President Richard M. Nixon suspended the gold standard and issued wage and price controls.
During the Great Depression in the 1930’s and the political unrest and tumult generated by World War II, foreign exchange rates were uncertain and highly unstable. The leading nations of the world, with the exception of Soviet Russia, met in July, 1944, at Bretton Woods, New Hampshire, to address the problems of foreign exchange. An agreement intended to stabilize international exchange was reached. This agreement, known as the Bretton Woods Agreement, established international standards for official foreign exchange. By this agreement, the U.S. dollar became the key currency for international exchange.
The dollar was a dominant world currency utilized as a standard for trade between many countries and as a reserve to “back” the currencies of many underdeveloped countries. The underdeveloped countries in Africa, Asia, Europe, and Latin America were anxious for American capital in order to expand their industrial development, while capitalists in the industrially developed nations, who were reluctant to risk ventures in foreign currencies, were seeking the stability of an international order. It was largely expected that the dollar would emerge as the international currency.
The major accomplishment of the Bretton Woods Conference was to define parities of currencies for international exchange and finance. These parities were defined not only in terms of gold but also simultaneously in terms of the American dollar, pegged at the equivalent of one thirty-fifth ounce of gold per dollar. Official changes in the parity value of any currency were permissible under the agreement as a method of dealing with a disequilibrium in a nation’s balance of payments. The World Bank
A series of events and building pressures led to the collapse of the Bretton Woods Agreement and to international monetary reform. By the 1950’s and through the 1960’s, the European community experienced balance-of-payments surpluses, while the U.S. balance of payments ran an average deficit of $1.5 billion per year. This chronic deficit situation for the United States was not alarming in view of the large amounts of dollars involved in foreign exchange. Even to the more pessimistic critics, the role of the dollar as a worldwide reserve currency for a growing world economy appeared successful.
By 1965, however, the U.S. balance-of-payments deficit began to increase, and the increases in the deficit quickly escalated. It was apparent that the American foreign exchange deficit was a major problem. In early 1971, a large movement of funds from the United States to Europe began to create difficulties in maintaining parity between the dollar and other currencies. In March and April of 1971, overt speculation in foreign exchange markets became newsworthy to the extent that by May 4, 1971, the German Federal Bank (Deutsche Bundesbank) had absorbed a capital inflow of one billion dollars in one day and, after forty minutes of trading on May 5, had absorbed another billion dollars and then suspended support of the American dollar. By July, 1971, the reserves deficit of the United States had soared to more than eleven billion dollars and the official U.S. gold stock had fallen to nearly ten billion dollars. A congressional subcommittee called for a general realignment of exchange rates, and President Nixon responded on Sunday, August 15, by announcing a major new program—his Economic Stabilization Program—that included a ninety-day freeze on wages and prices, new tax measures, a temporary surcharge on imports, and the suspension of the conversion of dollars into gold. This action ended the twenty-seven-year formal role of the U.S. dollar as the world reserve currency and devalued it.
Many factors contributed to the United States’ balance-of-payments problem and the eventual demise of the Bretton Woods Agreement. American military expenditures and generous aid programs continued after World War II. Expensive Cold War
In addition, increasing productivity in other countries brought about significant problems for the United States’ balance of payments. Remarkable increases in productivity in Western European countries and Japan dramatically changed the position of the United States in world trade. These countries were increasingly able to produce for themselves and to rely less on goods from the United States. With increasing productivity, these countries were able to compete effectively with the United States in international markets and even to capture significant shares of markets within the United States. The Western European countries were most anxious to advocate changes in the international monetary order, with Karl Schiller, West Germany’s economics minister, among the most articulate and outspoken advocates of establishing floating exchange rates.
The development of the European Common Market strengthened the competitive position of the European economies and presented the opportunity for a more unified front in the international financial scene. Pierre-Paul Schweitzer, director of the International Monetary Fund, was a leading spokesman for the European communities and encouraged a continuation of the convertibility of dollars into gold. The increasing productivity in European economies was creating attractive opportunities for American investors, and the European community did not favor any additional impediments to this important flow of capital.
Domestic inflation in the United States and a growing lack of trust in the dollar were also contributing factors to the balance-of-payments problem. In the early 1960’s, the European economies were rapidly approaching full employment. European wage and other money costs were rising at a faster pace than those in the United States. As the sluggish American economy approached full employment in the mid-1960’s, however, this situation changed to the point that money costs in the United States grew at rates comparable to those in the European economies. The financial advantages were obliterated and the chronic deficits in the balance of payments became alarmingly apparent. A general apprehension that the U.S. dollar would depreciate in value relative to other currencies became prevalent. Many individuals and governments attempted to liquidate holdings of U.S. dollars in favor of gold, thereby contributing to an escalated “gold drain” for the United States in the late 1960’s.
Generally, a country may attempt to adjust to a persistent balance-of-payments deficit through internal deflation, through a devaluation in its exchange rate, or through restrictive controls on trade, investment, and exchange. The United States had instituted a series of programs throughout the 1960’s that attempted to control investment abroad. In 1963, the interest equalization tax attempted to reduce the flow of dollars to foreign countries. In 1965, the voluntary restraint program was designed to limit direct investments abroad. In 1968, mandatory investment controls were instituted by the U.S. government. “Swap agreements” were made between the Federal Reserve system and the central banks of Europe, and bonds were issued by the U.S. Treasury that were payable in dollars or in a specific foreign currency. These programs were not successful in reducing the balance-of-payments deficit, but they did lessen the drain of gold from the United States and affected the speculation on the dollar in international exchange markets.
By mid-1971, the U.S. deficit had become more acute. In one week, more than four billion dollars moved into foreign reserves in spite of the view that the dollar was overvalued and would be depreciated. Arthur Burns, chair of the Federal Reserve Board, reported to the Joint Economic Committee on the failure to deal with domestic inflation and the deficit in payments, recommending stringent action. As a result, Nixon made his August 15 announcement of the suspension of gold convertibility of dollars as part of the Economic Stabilization Program to deal with inflation and the chronic deficit of payments.
By this action, the order established by the Bretton Woods Agreement was ended. Nixon’s move, in effect a devaluation of the dollar, was officially confirmed in the international Smithsonian Agreement
Despite the preliminary support occasioned by this agreement, exchange markets found great difficulty in achieving stability. Devaluation had been expected to help reverse the deficit but did not consistently do so. Internationally, the floating exchange rates bogged down trade for a number of months; world currency became more stable as the focus shifted from gold and the dollar to other currencies. Domestically, wage and price controls promised short-term success, but in the long term such controls bent to pressures for wage and price increases, and the problems of unemployment and inflation returned.
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American Enterprise Institute for Public Policy Research. International Monetary Problems. Washington, D.C.: Author, 1972. Proceedings of a conference that considered the issues of international monetary reform. -
Matusow, Allen J. Nixon’s Economy: Booms, Busts, Dollars, and Votes. Lawrence: University Press of Kansas, 1998. A thorough and well-researched account of the Nixon administration’s failed economic policies. Discusses topics such as wage-and-price controls, dollar devaluation, and demise of the gold standard. -
Miller, Robert LeRoy, and Raburn M. Williams. The New Economics of Richard Nixon: Freezes, Floats, and Fiscal Policy. San Francisco: Canfield Press, 1972. A critical analysis of Nixon’s program, with appendixes printing Nixon’s August 15 announcement and executive orders. -
Mundell, Robert A., and Alexander K. Swoboda, eds. Monetary Problems of the International Economy. Chicago: University of Chicago Press, 1969. Collected essays from a conference that brought together experts in the field of international finance to debate the theoretical issues surrounding monetary reform. -
Sobel, Lester A., ed. Inflation and the Nixon Administration. 2 vols. New York: Facts On File, 1974-1975. Presents major economic events in chronological order, allowing the reader to review facts with minimal interpretation by the editors. -
Solomon, Robert. The International Monetary System, 1945-1976: An Insider’s View. New York: Harper & Row, 1977. Provides insights into the international financial situation through the author’s association with the Federal Reserve and through interviews with key participants. -
Triffin, Robert. Our International Monetary System: Yesterday, Today, and Tomorrow. New York: Random House, 1968. Provides historical background to the forces affecting the international monetary system. -
Weber, Arnold Robert. In Pursuit of Price Stability: The Wage-Price Freeze of 1971. Washington, D.C.: Brookings Institution, 1973. An explanation of why and how the freeze was implemented from the point of view of an administrator of the program.
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