It is August 1971. America is in the grip of an inflationary crisis the likes of which has not been seen since the era of The Great Depression. Owing to the declining value of the dollar, countries were scrambling to exchange their dollars for gold and gold began leaving American shores at unprecedented levels as a result. Unemployment and inflation both hover at around 6% and are rising. America’s situation was serious and deteriorating, immediate action needed to be taken so a confidential meeting at Camp David is arranged by President Richard Nixon. In attendance, among others, is President Nixon himself, Federal Reserve Chairman Arthur Burns, Treasury Secretary John Connally, Treasury Undersecretary and future Chairman of the Federal Reserve Paul Volcker and high ranking Nixon aides George Schultz and Peter Peterson. Further runs on the dollar could lead to economic catastrophe, the U.S. needed to combat inflation, reduce unemployment, improve their trade deficit, stabilise the dollar and, ultimately, rescue the U.S. economy. So on the 15th August 1971, on the strong advice of his cabinet, Nixon decided that the gold peg would be removed, abolishing the direct convertibility of the dollar into gold. And with that, the Bretton Woods system had come to an end and the fiat dollar was born. The fixed exchange rate mechanism was abolished and the U.S. was no longer responsible for having to secure overseas dollars with gold. The broader international community were not consulted about this decision. And this was the Nixon shock. By taking the action he did, it is no understatement to say that Richard Nixon effectively remade the world economy forever, which was in a pure fiat standard for the first time ever. This article explains the full implications of the Nixon shock and why it is such a significant moment in modern history, overlooked and misunderstood by so many despite the fact that the effects of it are still evident today.
Under the Bretton Woods agreement the dollar was pegged to gold at a fixed rate of $35 per troy ounce and nations could convert their dollars for gold when they wanted to but after the Nixon shock the gold peg had been discarded and nations could no longer exchange dollars for gold or other assets. As a result, the dollar became a floating, fiat currency. A fiat currency is a currency whose value is determined solely by the market, a currency that does not have a metallic base. Bretton Woods was finished and the fiat era had begun.
A final attempt to keep the Bretton Woods system alive occurred in late 1971, a meeting in Washington D.C. led to the Smithsonian Agreement whereby the United States agreed to devalue the dollar against gold by approximately 8.5% to $38 per ounce and other countries offered to revalue their currencies relative to the dollar. But despite these efforts, another run on the dollar occurred in 1973, creating yet more inflationary problems for America. The Smithsonian Agreement lasted 15 months before it was abandoned and the gold peg was finally done away with completely
The reason why Nixon didn’t enter into negotiations is that every time they attempted dialogue the markets would move, instability would increase, possibly leading to further runs on the dollar that the U.S. could ill afford.
Author Jeffrey E. Garten says in his book Three Days at Camp David that Nixon and Connolly wanted the dollar devalued against gold more substantially; perhaps to $50 a troy ounce or even $70, but others disagreed. It was actually George Schultz who proposed removing the peg and abolishing convertibility altogether. Paul Volcker wanted to raise interest rates in order to demonstrate to its allies that Washington was serious about addressing its balance of payments deficits. Nixon wanted to avoid raising interest rates because he feared it would increase unemployment and thus jeopardise his chances of re-election the following year.
The U.S. was afraid that further runs on the dollar would leave Washington exposed and at the mercy of the international community and they were not prepared to allow their gold stocks to be further depleted. In Connolly’s words “Anybody can topple us – anytime they want – we have left ourselves completely exposed”. Being the ones who took the decision to close the gold window allowed the U.S. to be seen to project power on the global stage by taking the lead. Devaluing the dollar further would have the opposite effect; a sign of defeat from a weak country that lacks confidence. When the British Treasury requested that $3 billion worth of dollar holdings be converted into gold that very much signalled the end of the line for Washington.
The Nixon shock is without a shadow of irrefutable doubt the single most significant event in the world economy in the post-Bretton Woods era. As a direct result of this decision the entire global economy was effectively remade forever. This is because it allowed for infinite expansion of the money supply and it also meant that all other currencies in the world were forced to become fiat as a result of Washington abandoning the gold peg. It can also be viewed as a significant extension of both American power and the central banking complex as well. Another important point is how the Nixon shock allowed for continuous, unrestrained warfare. In part two I will look at how it signalled the start of finance capitalism, ushering in the debt fuelled economy we have today, as well as the financialization of every sphere and facet of life. This is all a consequence of the Nixon shock. The birth of the fiat dollar was the birth of the modern world.
The Nixon shock is the final instalment of what I have come to term as the three stages of financial dominance for the United States, which fortified its economic empire across the world. The first being the 1913 Federal Reserve Act which saw the nation’s money supply moved into the hands of private interests; the second is the 1944 Bretton Woods conference where the dollar was installed as the World Reserve Currency, a position it has not vacated since the conference; the final stage is the Nixon shock whereby the gold link was abandoned and the currency was granted full elasticity, the fiat dollar was born and the world followed America’s lead into the fiat system of floating rates.
It is important to highlight that the fiat era really started before the announcement in 1971. America’s economic problems predate the decision in 1971 to close the gold window; Nixon’s decision was merely a decree, an announcement that formalised what had been taking place years, if not decades, earlier. America had been operating under defacto fiat conditions prior to the announcement: it had been running deficits since the 1950s and by 1959 it had an outright current account deficit. Under Kennedy and Johnson, spending was high but both presidents were reluctant to raise taxes.
A fiat currency is a currency whose value is determined by the market and by the trust and faith that all the concerned parties have in it. What is important to understand is that in a fiat system constraints are removed and money growth – by artificial means – is not held back by having a solid, metallic base but the problem is, as I will go on to show, neither is government borrowing and spending, commercial lending, and the creation of credit either. Gold and the corresponding commodity market around gold were constraining forces against excessive monetary inflation by national governments. John Maynard Keynes in his Treatise on Money (1930), said it best when he proclaimed that fiat money is “created and issued by the State, but is not convertible by law into anything other than itself, and has no fixed value in terms of an objective standard.” The relationship that money had to gold gives it value but with pure fiat money the only value money has is that which is imparted to it by the government.
The Nixon shock effectively meant that U.S. monetary policy no longer had any constraints. Though the U.S. had been deficit spending prior to 1971 they were still obligated to secure overseas dollars with gold but the act of removing the gold peg allowed for infinite expansion of the money supply without any obligations or restraints whatsoever. This was not possible prior to the Nixon shock because Washington always had one eye on the dollar to gold equilibrium; some monetary inflation was possible but excessive monetary policy (whereby they could just print all the units of currency it wanted) was limited by the amount of gold held by the central bank and America’s obligation to guarantee that dollars could be exchanged for gold on demand (as per the articles of the Bretton Woods accords). Removing the gold peg changed all that; henceforth, it allowed the U.S. government to pursue previously inconceivable, undisciplined fiscal policies of borrowing and spending, both at home and abroad, anchored by the expansionary monetary policy of the Federal Reserve, as well as allowing the United States to inflate away the existing balance of payments deficit that was the direct result of overspending in the past by previous administrations (Nixon’s included). However, there are consequences to such policies, as removing the metallic base of our money has invariably led to spiralling levels of debt, rising interest rates and volatile periods of high inflation. It has debased the currency and allowed the U.S. to effectively inflate away their debts all the while allowing for continuous, unrestrained warfare as well. All the consequences I cover in this article are in some way or other a result of the expansion of the money supply.
Under the gold standard interest rates remain stable but under a fiat system they normally go in one direction and that direction is up. 3.7 to 4 percent is the recommended interest rate (officially called the “federal funds rate”). From the graph below you can see interest rates grow steadily from 1960 onwards. President Lyndon Johnson didn’t want to raise interest rates because he feared it would harm his chances of re-election. Nixon also favoured lower interest rates but, eventually, rates would need to be raised in order to be brought in line with inflation.
You don’t need to be a scholar of political economy to realise that if interest rates are too high and these high rates persist for too long then they have a severely destabilising effect domestically and this is exactly what happened in the United States during this period. During this time, business investment slowed, productivity declined, and the nation’s trade deficit grew whilst many areas of America’s economy were overtaken by the likes of West Germany and Japan. This cycle would repeat again in 1980 when soaring interest rates led to rising unemployment, and recession.
High interest rates are a problem because they mean higher loan and mortgage repayments and that means less money in the economy being spent on goods and services, invariably leading to a recession and a contraction of the overall economy.
Interest rates mirror inflation. When inflation is high interest rates need to be higher in order to squeeze out inflation and bring it down to manageable levels. 2 percent is the target level of inflation but the U.S. crossed this threshold in 1966 and rates would not be stabilised until the mid-80s. Inflation tends to be stable under a gold standard but when the constraints of a metallic base are removed this leads to large swings in inflation that has devastating long-term effects.
The period known as the Great Inflation lasted from 1965 till 1982 and caused a great deal of economic hardship for the United States. Prior to the onset of the Great Inflation, the U.S. was running deficits throughout the 50s. Much of the inflation was caused by war, principally the Cold War and the Vietnam War whilst Lyndon Johnson’s Great Society programme also contributed enormously, as did the Space Race. Annual price rises from 1 percent in 1965 to 6 percent in 1969-70 set the scene for the double digit inflation of the 70s.
By 1974 inflation would be over 12 percent and unemployment was above 7 percent. But by the summer of 1980, inflation was near 14.5 percent, and unemployment was over 7.5 percent. So bad were America’s problems that it gave rise to a new phenomenon known as ‘stagflation’: rising unemployment and rising inflation together, for which leading economists at the time had no solution for. Yet more hardship would follow when, in 1980, in a desperate bid to overcome America’s inflationary woes, Fed Chairman Paul Volcker raised interest rates to 20 percent, leading to a 16 month long recession (the worst since the Great Depression) and record high levels of unemployment (see the graph below). Known as the Volcker shock, this demonstrates that once inflation has set in restoring monetary stability is a painful and difficult exercise. The period known as the Great Inflation would not be conquered until the early 80s.
The Nixon shock ushered in the age of runaway debt. It is no coincidence that the national debt skyrockets from this moment onwards, with the dollar now backed not by a hard asset but by the “full faith and credit” of the U.S. government. In the years since the gold window was closed, the lack of discipline in monetary and fiscal policy has only gotten worse and government spending has grown to astronomical levels as a result. Before 1971, there was a natural limit to how much money could be printed. New issuances were dependent on the amount of gold the country had in its possession. In 1960, federal debt was a little over half the size of the actual economy. Between the years of 1960 and 1971 the federal debt increased by 39 percent. But between 1971 and 1980 the debt increased by 128 percent (from $398 billion to $908 billion) and then from 1980 to 1990 by an incredible 256 percent (from $908 billion to $3.2 trillion). Today the national debt currently stands at $32 trillion with a debt to GDP ratio of 124%. The debt never goes away it just grows because under fiat rules the government does not have to resolve the growing deficits and the debt they produce – ever. Furthermore, Europe and Japan have followed the same trajectory as well.
Debasing the currency
The more units of currency in circulation the less each note is worth and the more the purchasing power of the currency is reduced. The absurdity of the current system was summed up by Forbes magazine, who said:
“So for now, we’re left with the current monetary system of unlimited money-printing, which in turn makes each U.S. dollar less valuable and each ounce of gold more valuable.”
Former presidential candidate and Texas Congressman Ron Paul said:
“Since the “Nixon shock” of 1971, the dollar’s value — and the average American’s living standard — has continuously declined, while income inequality and the size, scope, and cost of government have risen.”
Our currencies have been systematically debased, their purchasing power robbed and the chasm that this has left has been filled with a pernicious culture of credit and debt. We simply would not need to borrow as much as we do and rely on credit if our money retained its true value. It’s important to understand that this represents not just a transfer of wealth but also a transfer of power. The steady debasement of the dollar actually started in 1913 with the passing of the Federal Reserve Act by the Woodrow Wilson administration but the Nixon shock is a significant extension of this. Cartelizing the nation’s banking system and moving it into private hands has steadily robbed the U.S. dollar of its true value. Inflation erodes the purchasing power of fiat currencies and eventually they become worthless. From the graph below we can see that the dollar has lost 90% of its purchasing power since 1950, whilst the outbreak of war correlates strongly with a steep decline in the dollar’s value. The Joe Biden stimulus in 2020, a response to the COVID19 outbreak, added $3.5 trillion to the money supply (equal to 20% of all the dollars ever created).
A common rebuttal asserts that the source of these problems were the oil embargos of 1973 and 1979 which caused oil prices to skyrocket. However, this is largely mistaken; the fiscal policies that led to the Great Inflation predate both the embargos: Johnson’s Great Society social programmes, the Vietnam War, the Cold War, and the Space Race all happened a long time before OPEC decided to slash oil production and place an embargo on oil exports. True, the twin oil crises did indeed exasperate the economic problems but they weren’t the primary cause of them, far from it. The graph below shows there is no direct correlation between inflation and the oil shocks of the 70s. The start of the Great Inflation was in 1965, a long time before the 1973 oil embargo.
The full network effect of the Nixon shock meant that spiralling interest rates and inflation led to prolonged periods of volatility and instability that caused economic devastation for many, once inflationary problems set in they are very difficult to reverse. This was all caused by the reckless fiscal policies of the government and similarly irresponsible monetary policies by the Federal Reserve, enabled by the transition into a fiat system of floating currencies anchored by nothing but “faith and confidence” in the dollar. The global implications of such policies will be revisited again in part two of my series on the Nixon shock.
There was a brief moment where American hegemony was called into question and American empire was teetering on the brink of collapse but ultimately the Nixon shock would go on to increase U.S. power and strengthen America’s position in the world. Although the entire world was moved onto a pure fiat standard for the first time ever only the U.S. was allowed to engage in excessive levels of printing, borrowing and spending because ultimately only the United States can issue the World Reserve Currency freely, the U.S. dollar, the currency whose value only it can determine. This point was actually made by France’s finance minister and future president Valery Giscard d’Estaing at a meeting in Paris shortly after the announcement by Nixon: d’Estaing realised early on that the U.S. could engage in unrestrained fiscal and monetary policies as a result of the dollar’s central position in the world economy; it gave America an unassailable advantage over other countries who had to act with more restraint and discipline in monetary affairs. It also means that other countries have to constantly run a trade surplus in order to get the required amount of dollars for trade in global markets and for their foreign currency reserves as well. What d’Estaing was referring to and what is important to understand is that demand for the dollar and dollar denominated assets is built into the global economic system and as the years rolled on the overall network effect of the dollar would only increase as more and more trade would be conducted in dollars increasing its strength and liquidity and requiring countries to stockpile more and more dollars as a result. The dollar system is a self-reinforcing cycle, this is why the U.S. dollar is the backbone of the world economy and the foundation of the global American empire.
Removing the gold standard while the dollar was still the World Reserve Currency can be seen as a major power play by Washington on the grand chessboard of geopolitics as doing so strengthened America’s position across the world: from this point onwards, there was nothing constraining the U.S. from printing and spending all the dollars required to assemble the military infrastructure it needs to sustain the American empire; funding research and development into new weapons technology, building military bases abroad, providing subsidies to the military industrial complex, funding wars and so on. This is exactly what would happen as the decades rolled on as layer upon layer of the American empire was built on the back of the fiat dollar.
The relationship between war and the fiat system cannot be ignored. Under a gold standard governments can only pay for war either by raising taxes or by selling war bonds. If you actually have to part with physical gold to pay for bombs and munitions, to pay for soldiers’ salaries, to transport all the heavy machinery then you will quickly run out of gold and the capacity to wage war is greatly reduced. Likewise, if the war is not popular among the people then the citizenry will cease buying war bonds and the government will run out of funds. However, the fiat system enables countries to finance wars by printing and borrowing money and as a result spending on warfare is no longer constrained. The author David Graeber echoes this view in his book, Debt:
“Nixon floated the dollar in order to pay for the cost of a war [the Vietnam War] in which he ordered more than four million tons of explosives and incendiaries dropped on cities and villages across Indochina… the debt crisis was a direct result of the need to pay for the bombs, or, to be more precise, the vast military infrastructure needed to deliver them. This was what was causing such an enormous strain on U.S. gold reserves.”
Many feel that the closing of the gold window by Nixon ushered in the era of unrestrained, total warfare. The Cold War went on for almost half a century, the Vietnam War for approximately 20 years, the War in Afghanistan lasted over 20 years, the 2003 Iraq War lasted 9 years as well: this just wouldn’t be possible without having transitioned to the fiat system and abandoning the gold standard. At one stage, in 2011, America was actively involved in open warfare in Iraq, Afghanistan and Libya all at the same time, this is only possible because America can now finance wars by printing and borrowing trillions of dollars all in the safe knowledge that reserve currency status in a fiat system protects the U.S. dollar and its economy from the crippling effects of hyperinflation. Though some of these conflicts started before the Nixon shock, as I mentioned earlier transitioning to a fiat system absolves both past and future debt obligations.
Additionally, it should be pointed out that war practically bankrupted the major European powers in the 20th century: France and Great Britain had to borrow heavily during the two World Wars leading to the dissolution of their respective empires and a largely deferential role in world affairs thereafter. But the U.S. avoids this because of the fiat dollar and also because of the dollar’s World Reserve Currency status too. Such a privileged position was exemplified during the Afghanistan and Iraq wars when, at various stages, taxes actually went down.
It is also worth noting that within a few short years the petrodollar agreement was ratified between the United States and Saudi Arabia, it would soon be extended to all the other OPEC member states. The dollar was moved off gold and on to oil (‘black gold’ as it is sometimes referred to) by 1974 and this meant that countries would now need dollars to fund all future oil purchases from this moment onwards. What is also highly significant is that the treasury market sprang up alongside the petrodollar agreement and this led to U.S. debt securities effectively replacing gold as the number two asset. As F. William Engdahl says “this was a dollar exchange system, which, they reckoned, they could control unlike the old gold exchange system”.
In part two I will look at how the Nixon shock impacted the world; from the global crises that broke out to the growth of finance capitalism right through to the cultural implications of the decision.
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