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What didn't change in August 1971 was just as important as what did...
"LET ME lay to rest the bugaboo of what is called
devaluation," Richard Nixon told the American people on August 15 1971.
The
37th President had just announced the US would "temporarily"
close the gold window – ending the convertibility of Dollars into gold that had been a
cornerstone of the postwar Bretton Woods system, writes Ben Traynor at BullionVault.
What
didn't change in 1971, though, was every bit as important as what did.
Because the Dollar remained the world's reserve currency – a
"privilege" that, four decades on, looks increasingly like a curse.
When
he made his address, Nixon was keen to allay fears he was undermining the
Dollar's value by cutting the link to gold – especially given the
apocalyptic warnings (both in the press and inside the White House) of how
disastrous such a move would be.
His
pitch? "If you want to buy a foreign car or take a trip abroad, market
conditions may cause your Dollar to buy slightly less. But if you are among
the overwhelming majority of Americans who buy American-made products in
America, your Dollar will be worth just as much tomorrow as it is today. The
effect of this action, in other words, will be to stabilize the Dollar."
Any
British viewers that day would have found it eerily reminiscent of prime
minister Harold Wilson's "Pound in your Pocket" speech four years earlier.
Nothing would change besides the entire monetary structure. And now, back to
your scheduled programming with Bonanza (the popular TV show Nixon had
delayed in order to drop his bombshell).
Here
in 2011, it's now been 40 years since the "temporary" suspension of
Dollar convertibility. Has the Dollar been "stabilized"? Clearly
not. But what's worth noting is how much faster the Dollar's domestic
purchasing power has fallen in the last four decades – freed from gold – than it
did in the 40 years before Nixon's announcement.
Between
August 1931 and August 1971, the consumer price index – as
measured by the Bureau of Labor Statistics – went up by 170%. Since
1971, the CPI has risen 453%.
Of
course, Nixon tried to spin his economic reforms – the gold window
closure was accompanied by a wage and price freeze and a 10% import tariff
– as necessary for "building the new prosperity". The logic
was clear. A devalued Dollar, aided by the import tax, would increase
America's international competitiveness, while wage and price controls would
prevent these policies feeding through into higher inflation.
That,
at least, was the plan. As we know, it didn't turn out too well on the
inflation front. But higher rates of inflation aren't the only phenomenon
we've seen since the early 1970s. The irony is,
Nixon hoped to solve another problem by closing the gold window – the
US trade deficit.
"The
United States has always been, and will continue to be, a forward-looking and
trustworthy trading partner," he reassured the world on that fateful
August evening. Within a minute, Tricky Dicky
announced the 10% tax on imports.
Nixon
hoped to improve America's trade balance. Indeed, that was one rationale
behind devaluing the Dollar by de-pegging it from gold. But it didn't work:
The
United States has not run a trade surplus since 1974. It has consistently
imported more goods and services than it has exported. Most countries cannot
do this for long. They need the revenues from exports to pay for imports.
The
US is different, because it issues the world's only reserve currency, which
is used to settle most international trade. France's finance minister under
president Charles de Gaulle, Valéry Giscard D'Estaing, described this
in the mid-1960s as America's "exorbitant privilege" – it
allowed the US to fund its trade gap by the creation of new Dollars, in which
its imports are still denominated.
With
gold convertible
for Dollar bills, this "privilege" risked emptying the United
States' huge stockpile of monetary metal. But freed from that gold obligation
in 1971, isn't the privilege actually still a curse today?
The
US was in a tricky position throughout the Bretton Woods era. Its problem was
summed up by what became known as the Triffin
Dilemma, after Belgian economist Robert Triffin.
Because as the global economy expanded, he explained, more and more Dollar
liquidity was needed to oil the wheels of international trade. And the US was
the sole issuer of Dollars. So the only way the rest of the world could
obtain Dollars was by exporting more to America than it imported – all
but ensuring the US would run a trade deficit.
Of
course, the US could seek to match its exports to its imports – but
that risked a seize-up of global trade if foreigners could not get hold of
sufficient Dollars to settle their trading with other, non-US parties.
That
was one part of the Triffin Dilemma. The other
concerned the link to gold,
fixed at $35 an ounce. As more and more Dollars entered the system, so the
ratio of Dollars to gold increased, putting upwards pressure on the Dollar Gold Price.
The
London Gold Pool – whereby central banks clubbed together to keep Gold
Prices down by co-ordinated gold sales – was set up in 1961 to
address this problem. However, the system fell apart after France pulled out
– De Gaulle preferring to swap his Dollars for gold rather than vice
versa.
The
open market Gold Price rose, accelerating the drain on US gold
reserves, as arbitrageurs realized they could swap $35 for an ounce of US
government gold and sell it for more elsewhere.
The
fixed exchange regime of Bretton Woods, resting as it did on a $35 an ounce Gold Price,
was unsustainable in a world of ever-increasing Dollar liquidity. Nixon had
three choices – close the gold window, risk setting off a global
deflationary spiral, or give away the United States' remaining stockpile of
metal. He closed the window.
The
Dollar, however, remained the world's reserve currency. This meant the US was
now in a position – both at home and abroad – to really go to
town exploiting D'Estaing's exorbitant privilege. And looking back over the
last 40 years, it looks like that's exactly what successive administrations
did.
We
hear a lot today about "imbalances" in the global economy. One of
the biggest imbalances is that the monetary unit of international trade is
issued by a single nation. Gold was giving a strong signal of this
disequilibrium half a century ago. Nixon, however, either misread the signals
or willfully ignored them. Instead he blamed the Dollar's travails on
"international money speculators".
By
doing so, he pushed the world onto a whole new monetary system, one whose
ultimate backing is the "Full Faith and Credit" of the United
States government – and nothing more. It's a worrying irony that a
system resting on such "faith and credit" was mid-wifed by the man responsible for Watergate.
Ben Traynor
You
can receive
your first gram of Gold free by opening an account with Bullion Vault : Click here.
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