Dollar’s Dominance Faces Threat
50 Years After Nixon Ended the Gold Standard, Dollar’s Dominance Faces Threat
By Randall W. Forsyth Updated Aug. 14, 2021
President Richard Nixon announcing the severing of links between the dollar and gold as part of a broad economic plan on Aug. 15, 1971.
Fifty years ago this Sunday, President Richard Nixon announced a bold economic plan, including the severing of the U.S. dollar’s ties to gold. Since then, the world’s monetary system has consisted of (mostly) freely floating currencies. The dollar nonetheless remains the primary legal tender used internationally for trade, finance, and as a store of value, which has conferred upon the U.S. enormous advantages. Whether that will continue for the next half-century is far from certain.
The Bretton Woods system, in effect back then, reflected America’s economic pre-eminence after World War II. Currency exchange rates were fixed, relative to the dollar, which, in turn, was exchangeable for gold at a fixed $35 an ounce.
The idea was to avoid the currency instability and competitive devaluations of the 1930s, but with greater flexibility than allowed under the classical gold standard, which most economists agreed had helped trigger and spread the Great Depression.
But the Bretton Woods regime led to a trilemma: Countries couldn’t simultaneously have fixed exchange rates, free capital flows, and independent fiscal and monetary policies. They could choose only two of the three. A fixed exchange rate essentially meant adjusting economies to a nation’s currency, requiring restrictive policies when inflation rose or trade accounts went into deficit.
Nixon chafed at those constraints, especially as he looked ahead to the 1972 elections. “What mattered most to his reelection prospects was national economic growth and especially lower rates of unemployment,” says Yale School of Management dean emeritus Jeffrey E. Garten in Three Days at Camp David, his new book on the momentous events of a half-century ago.
The dollar had come under a series of attacks that would have required tight fiscal and monetary policies, the sort Nixon thought had cost him the 1960 election against John F. Kennedy. Instead, Garten notes, ahead of the 1972 presidential vote, Nixon ran ever-bigger budget deficits while relentlessly pressuring Arthur Burns, then the Federal Reserve chairman, to lower interest rates. To suppress inflation, he imposed wage and price controls.
By March 1973, what had been supposed to be a relatively limited realignment of exchange rates gave way to freely floating currencies, the system under which the world has operated ever since. Since then, the dollar has gone through various phases, beginning with pronounced weakness during the 1970s.
The inflation of that decade was largely a result of the explosion in energy prices that, to a major extent, reflected oil-producing countries’ refusal to be paid with ever-depreciating paper dollars. Later, under President Jimmy Carter, who was elected in 1976, the Treasury initially favored a cheaper dollar to reduce the U.S. trade gap.
In the 1980s, the dollar turned superstrong, a result of the huge rise in U.S. interest rates by the Federal Reserve, led by Paul Volcker, to quash inflation, combined with the pro-growth policies of President Ronald Reagan, which made America a magnet for global investment. That gave way to the Plaza Accord in 1985 to lower the dollar’s value and permit expansionary policies around the globe.
A subsequent agreement to stabilize exchange rates unraveled in October 1987, when the stock market crashed as Washington let it be known that it would rather let the buck fall than have rates rise further. And throughout much of the early 1990s, the dollar reverted to its levels of the 1970s.
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