August 15, 2014
In April of last year, Arizona became the second U.S. state after Utah to make gold and silver legal currency in the state (alongside existing U.S. currency issued by the federal government). Supporters of the law cited to a lack of confidence in the international monetary system as the impetus for the change. These proponents would further support pegging the value of the U.S. dollar to the value of gold to restore their confidence in the international monetary system.
Once upon a time, U.S. currency was attached to the value of gold, with the most recent system of which, known as the Bretton Woods agreement, being established during July of 1944.
Under this arrangement, developed by a number of countries to mitigate the economic fallout from World War II, the U.S. would fix the value of its currency to gold ($35 an ounce), and the rest of the nations would base their currency on the value of the U.S. dollar.
Obviously, since there is currently a movement for a return to gold-based currency, Bretton Woods is no longer in effect. It was effectively ended by President Richard Nixon 43 years ago today, when he announced his “New Economic Policy,” which is more commonly known as the “Nixon shock.”
The announcement was known as a “shock” because it was largely unexpected, especially by the international community, who had no knowledge of the planning or execution of the decision before Nixon’s announcement thereof.
In addition to suspending the convertibility of the dollar into gold or other reserve assets, such that foreign governments could no longer exchange their dollars for gold, Nixon also instituted a 90-day freeze on prices and wages – the first time in U.S. history that the government froze prices and wages outside of wartime. Nixon took these steps to offset any inflation that resulted from these actions.
Finally, Nixon also imposed an import surcharge of 10% to encourage the U.S.’s major trading partners to increase the value of their currencies and lower their trade barriers so that more U.S. imports were allowed.
What prompted such “shocking” action from Nixon? The demise of Bretton Woods was actually a long time coming.
By the 1960s, heavy U.S. spending on foreign aid, military, and foreign investment created a surplus of U.S. dollars to the point that the government did not have sufficient gold reserves to cover the number of dollars in worldwide circulation. The system was facing collapse.
Nixon’s two immediate predecessors, Presidents John F. Kennedy and Lyndon B. Johnson, both attempted to remedy the problem while still maintaining the gold standard through programs such as restrictions on foreign lending and international monetary reform; however, nothing was successful, causing international speculators to believe that the U.S. government would soon devalue the U.S. dollar (i.e. increasing the price of an ounce of gold in U.S. dollars), which, in turn, led to occasional runs on the dollar. Incidentally, it was such a run that finally led to Nixon’s decision to end the gold standard.
Despite some worries that the switch to a floating currency would cause worldwide economic instability, the system has largely remained stable these past 43 years.
Whether that continues to be the case remains to be seen, but if the current system is ever headed for collapse, hopefully we will have sufficient warning signs as there were in the 1960s to prevent a worldwide economic collapse, as the “Nixon shock” did.