Today marks 45 years since US President Richard Nixon ended the redemption of dollars for gold. Called “closing the gold window,” this action signaled the end of the world’s last gold standard — the Bretton Woods system.
Designed to avoid the pitfalls of the Classic Gold Standard, its fatal flaw was using a single nation’s currency (the US dollar) as the official international reserve currency. It could be said that Bretton Woods was killed by the US government’s lack of political will and enormous deficit spending.
The Bretton Woods international monetary system was devised in 1944, at a New Hampshire meeting of the 44 Allied nations of World War II. In its simplest terms, the agreement defined one US dollar as worth 1/35th ounce of gold ($35/oz), with other currencies pegged to the value of the dollar.
The US dollar was chosen to replace gold as the new international reserve currency, as the US had most of the world’s gold reserves as well as the largest economy. War-ravaged nations in Europe and Asia desperately needed food, clothing, and other essential goods. The only place to get them was the US, and the only way to pay for them was gold or US dollars.
The actual goal of Bretton Woods was to encourage international economic cooperation, instead of protectionism and “currency wars” that some believed help set the stage for the outbreak of World War II.
Bretton Woods Dollar Pegs
All signatory nations* worked to keep their currency at an agreed-upon ratio (peg) to the US dollar, give or take 1%. This required everyone to periodically intervene in their domestic currency markets to preserve that ratio. The 1949 dollar peg for some major currencies were:
Belgian Franc: 50 to the dollar
French Franc: 272.21 to the dollar
Dutch Gulden: 3.8 to the dollar
German Deutsche Mark: 4.2 to the dollar
Italian Lire: 625 to the dollar
Japanese Yen: 360 to the dollar
The British pound retained its greater relative value to the dollar. It took $2.80 to equal one pound sterling.
A Flexible Gold Standard
Bretton Woods made the US dollar a de facto substitute for gold. It also removed one of the hurdles of the classic gold standard; the physical scarcity of gold for many nations, compared to the United States and British Empire. Under Bretton Woods, the US dollar was literally “as good as gold,” and was much easier for other nations to acquire through normal trade than physical gold was. In fact, all member nations of Bretton Woods pledged to use the US dollar in international settlements.
It was nice (especially for the US) as long as it lasted.
In return for other nations using dollars to settle their international trade, the US was supposed to manage the dollar supply to keep the value of gold at $35 USD per ounce. This was fairly easy in the immediate post-war years, as the only thing more in demand than gold was US dollars. War-torn nations struggled to get dollars or gold to pay off debts and import necessities, since their economies were in ruins. The US began expanding its money supply, as it gave billions of dollars in foreign aid to Europe under the Marshall Plan. This money came right back to the US to pay for exports, meaning fewer dollars in the hands of foreign central banks. Fewer foreign-held dollars meant fewer dollars that could be presented to the Federal Reserve for redemption in gold.
By the 1950s, much of Western Europe was back to pre-war economic activity, or greater. The US had spent heavily in the Korean War, to stop the spread of Communism in Asia. To counter the Soviet threat to Europe, billions more dollars were spent in a military and nuclear build-up. In 1958, Europe had recovered enough to finally implement Bretton Woods’ dollar pegs and mutual currency exchanges. The dollar still held its position as the world’s reserve currency, but the world was awash in dollars. Central banks in Europe and elsewhere began thinking that they would rather hold gold.
The Spirit Is Willing…
A famous saying that can be traced back to the Bible is, “The spirit is willing, but the flesh is weak.” The temptation to force the rest of the world to deal with America’s inflation was eventually too great for the US government to resist. The US had spent (and given away) billions of dollars to counter Soviet influence in the 1950s and 60s. This led to there being more foreign-held dollars than there was gold in Fort Knox.
The first crisis under Bretton Woods was the global run on gold in 1960. On October 20, gold in London shot up to $40 an ounce, throwing the stability of the US dollar into doubt. As a result, the London Gold Pool was created the next day. The central banks of the US, Great Britain, France, West Germany, Switzerland, the Netherlands, Belgium and Italy agreed to jointly defend the $35/oz peg of the dollar to gold. This suppressed speculation in the gold market for a while, but by the spring of 1968, the scheme collapsed. Seven central banks, including the US, promised to keep their gold off the open market, and only use it to settle international trade.
Gold redemption increased through the 60s, and US gold reserves began shrinking dramatically. The US was no longer the world’s #1 exporter, and its balance of trade was flowing outward. It was becoming harder to defend the $35 an ounce gold price that the Bretton Woods system was built upon, with so many dollars circulating overseas.
It was at this point that two events that were to change US history occurred: the Vietnam War, and the “Great Society” welfare programs under President Lyndon Johnson.
The End of Bretton Woods
The logical action for the US would have been to reduce the number of dollars circulating overseas. To do this, it would have to stop running huge deficits. This was impossible for US politicians to consider. The nation had to stop Communism in Vietnam, fund the explosive expansion of the welfare state of the Great Society, and had to beat the Russians to the Moon.
All of this deficit spending not only caused inflation to rise in the US, but it forced the other nations in the Bretton Woods system to devalue their own currencies, whether they needed to or not. Eventually, nations decided to opt out of the dollar peg, and began cashing in dollars for gold. One vocal opponent of the dollar hegemony was French president Charles de Gaulle. Beginning in 1958, he instructed the French central bank to accelerate conversion of dollars into gold. In 1965, French warships brought a total of $150 million worth of gold from New York back to France.
Redemptions of dollars for gold snowballed. The United States went from holding 70% of the world’s gold in 1947, to only 16% by 1970. Gold bullion had to be airlifted from Fort Knox to New York to honor these redemption requests. As the US reeled from stagflation and faith in the dollar plummeted, on August 15, 1971 President Richard Nixon pulled the plug.
The Nixon Shocks
Financial officials in the Nixon Administration believed that the only way to rein in inflation was to raise interest rates. This would lead to higher unemployment for a public that was already discontented over a stagnant economy and rising prices. It would be political suicide. On Friday the 13th of August, 1971, Nixon called together his top financial advisors to Camp David to determine what had to be done to stop inflation from running amok. Among those present was Secretary of the Treasury John Connally, Federal Reserve Chairman Arthur Burns, and Undersecretary for International Monetary Affairs Paul Volcker.
The night of August 15, 1971 saw the death of Bretton Woods, and the birth of global fiat currency: President Nixon addressed the nation on TV, announcing that the US would stop redeeming dollars for gold, effective immediately. He also announced a 90-day freeze on both wages and prices, the first time price controls had been implemented outside of wartime. A 10% import surcharge was also announced, to give US industry some relief from cheaper imports.
*The original 44 nations who signed on to Bretton Woods were:
Australia, Belgium, Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica, Cuba, Czechoslovakia, Dominican Republic, Ecuador, Egypt, El Salvador, Ethiopia, France, Greece, Guatemala, Haiti, Honduras, Iceland, India, Iran, Iraq, Liberia, Luxembourg, Mexico, Netherlands, New Zealand, Nicaragua, Norway, Panama, Paraguay, Peru, Philippines, Poland, South Africa, Soviet Union, United Kingdom, United States, Uruguay, Venezuela, Yugoslavia.
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