The End of Bretton Woods
The public attack on the Bretton Woods system of a dominant dollar anchored to gold began even before the 1967 devaluation of sterling. In February 1965, President Charles de Gaulle of France gave an incendiary speech in which he claimed that the dollar was finished as the lead currency in the international monetary system. He called for a return to the classical gold standard, which he described as “an indisputable monetary base, and one that does not bear the mark of any particular country. In truth, one does not see how one could really have any standard criterion other than gold.” France backed up the words with action. In January 1965, France converted $150 million of dollar reserves into gold and announced plans to convert another $150 million soon. Spain followed France and converted $60 million of its own dollar reserves into gold. Using the price of gold in June 2011 rather than the $35 per ounce price in 1965, these redemptions were worth approximately $12.8 billion by France and $2.6 billion by Spain and at the time represented significant drains on U.S. gold reserves. De Gaulle helpfully offered to send the French navy to the United States to ferry the gold back to France.
These redemptions of dollars for gold came at a time when United States businesses were buying up European companies and expanding operations in Europe with grossly overvalued dollars, something De Gaulle referred to as “expropriation.” De Gaulle felt that if the United States had to operate with gold rather than paper money, this predatory behavior would be forced to a halt. However, there was fierce resistance to a pure gold standard in the late 1960s—as in the 1930s, it would have necessitated a devaluation of dollars and other currencies against gold. The biggest beneficiaries of a rise in the dollar price of gold would have been the major gold-producing nations, including the repugnant apartheid regime in South Africa and the hostile communist regime in the USSR. These geopolitical considerations helped to tamp down the enthusiasm for a new version of the classical gold standard.
Despite the scathing criticisms coming from France, the United States did have one staunch ally in the Gold Pool—Germany. This was crucial, because Germany had persistent trade surpluses and was accumulating gold both from the IMF as part of operations to support sterling and through its participation as an occasional buyer in the Gold Pool itself. If Germany were suddenly to demand gold in exchange for its dollar reserve balances, a dollar crisis much worse than the sterling crisis would result. However, Germany secretly assured the United States it would not dump dollars for gold, as revealed in a letter from Karl Blessing, president of the Deutsche Bundesbank, the German central bank, to William McChesney Martin, the chairman of the Board of Governors of the Federal Reserve. Dated March 30, 1967, the “Blessing Letter” provided:
Dear Mr. Martin,
There occasionally has been some concern . . . that . . . expenditures resulting from the presence of American troops in Germany [could] lead to United States losses of gold….
You are, of course, well aware of the fact that the Bundesbank over the past few years has not converted any . . . dollars . . . into gold….
You may be assured that also in the future the Bundesbank intends to continue this policy and to play its full part in contributing to international monetary cooperation.
It was extremely comforting for the United States to have this secret assurance from Germany. In return, the United States would continue to bear the costs of defending Germany from the Soviet troops and tanks stationed in the woods immediately surrounding Berlin and throughout Eastern Europe.
Germany, however, was not the only party with potential gold claims on the dollar, and in the immediate aftermath of the 1967 sterling devaluation the United States had to sell over eight hundred metric tons of gold at artificially low prices to maintain the dollar-gold parity. In June 1967, just one year after withdrawing from NATO’s military command, France withdrew from the Gold Pool as well. The other members continued operations, but it was a lost cause: claims on gold by overseas dollar holders had become an epidemic. By March 1968, the gold outflow from the pool was running at the rate of thirty metric tons per hour.
The London gold market was closed temporarily on March 15, 1968, to halt the outflow, and remained closed for two weeks, an eerie echo of the 1933 U.S. bank holiday. A few days after the closure, the U.S. Congress repealed the requirement for a gold reserve to back the U.S. currency; this freed the U.S. gold supply to be available for sale at the $35 price if needed. This was all to no avail. By the end of March 1968, the London Gold Pool had collapsed. Thereafter, gold was considered to move in a two-tier system, with a market price determined in London and an international payments price under Bretton Woods at the old price of $35 per ounce. The resulting “gold window” referred to the ability of countries to redeem dollars for gold at the $35 price and sell the gold on the open market for $40 or more.
The two-tier system caused speculative pressures to be directed to the open market while the $35 price remained available only to central banks. However, the U.S. allies reached a new, informal agreement not to take advantage of the gold window by acquiring gold at the cheaper official price. The combination of the end of the Gold Pool, the creation of two-tier system and some short-term austerity measures put in place by the United States and United Kingdom helped to stabilize the international monetary system in late 1968 and 1969, yet the dénouement of Bretton Woods was clearly in sight.
On November 29, 1968, not long after the collapse of the London Gold Pool, Time reported that among the problems of the monetary system was that “the volume of world trade is rising far more quickly than the global supply of gold.” Statements like this illustrate one of the great misunderstandings about the role of gold. It is misguided to say that there is not enough gold to support world trade, because quantity is never the issue; rather, the issue is one of price. If there was inadequate gold at $35 per ounce, the same amount of gold would easily support world trade at $100 per ounce or higher. The problem Time was really alluding to was that the price of gold was artificially low at $35 per ounce, a point on which the magazine was correct. If the price of gold was too low, the problem was not a shortage of gold but an excess of paper money in relation to gold. This excess money was reflected in rising inflation in the United States, the United Kingdom and France.
In 1969, the IMF took up the “gold shortage” cause and created a new form of international reserve asset called the special drawing right, or SDR. The SDR was manufactured out of thin air by the IMF without tangible backing and allocated among members in accordance with their IMF quotas. It was promptly dubbed “paper gold” because it represented an asset that could be used to offset balance of payments deficits in the same manner as gold or reserve currencies.
The creation of the SDR was a little-understood novelty at the time. There were several small issuances in 1970–1972 and another issuance in response to the oil price shock and global inflation in 1981. Thereafter, the issuance of SDRs came to a halt for almost thirty years. It was only in 2009, in the depths of a depression that had begun in 2007, that another, much larger amount of SDRs were printed and handed out to members. Still, the original issuance of SDRs in 1970 was a reflection of how badly unbalanced the supply of paper money had become in relation to gold and of the desperation with which the United States and others clung to the gold parity of $35 per ounce long after that price had become infeasible.
The entire period of 1967 to 1971 is best characterized as one of confusion and uncertainty in international monetary affairs. The devaluation of sterling in 1967 had been somewhat of a shock even though the instability in sterling had been diagnosed by central bankers years before. But the following years were marked by a succession of devaluations, revaluations, inflation, SDRs, the collapse of the Gold Pool, currency swaps, IMF loans, a two-tiered gold price and other ad hoc solutions. At the same time, the leading economies of the world were undergoing internal strains in the form of student riots, labor protests, antiwar protests, sexual revolution, the Prague Spring, the Cultural Revolution and the continuing rise of the counterculture. All of this was layered onto rapid technological change summed up in the ubiquity of computers, the fear of thermonuclear war and plain awe at landing a man on the moon. The whole world seemed at once to be on a wobbly foundation in a way not seen perhaps since 1938.
Yet through all of this, one thing seemed safe. The value of the U.S. dollar remained fixed at one thirty-fifth of an ounce of pure gold and the United States seemed prepared to defend this value despite the vast increase in the supply of dollars and the fact that convertibility was limited to a small number of foreign central banks bound to honor a gentleman’s agreement not to press too hard for conversion. Then suddenly this last anchor snapped too.
On Sunday, August 15, 1971, President Richard Nixon preempted the most popular show in America, Bonanza, to present a live television announcement of what he called his New Economic Policy, consisting of immediate wage and price controls, a 10 percent surtax on imports and the closing of the gold window. Henceforth, the dollar would no longer be convertible into gold by foreign central banks; the conversion privilege for all other holders had been ended years before. Nixon wrapped his actions in the American flag, going so far as to say, “I am determined that the American dollar must never again be a hostage in the hands of international speculators.” Of course, it was U.S. deficits and monetary ease, not speculators, that had brought the dollar to this pass, but, as with FDR, Nixon was not deterred by the facts. The last vestige of the 1944 Bretton Woods gold standard and the 1922 Genoa Conference gold exchange standard was now gone.
Nixon’s New Economic Policy was immensely popular. Press coverage was overwhelmingly favorable, and on the first trading day after the speech the Dow Jones Industrial Average had its largest one-day point gain in its history up until then. The announcement has been referred to ever since as the Nixon Shock. The policy was conceived in secret and announced unilaterally without consultation with the IMF or other major participants in Bretton Woods. The substance of the policy itself should not have been a shock to U.S. trading partners—de facto devaluation of the dollar against gold, which was what the New Economic Policy amounted to, was a long time coming, and the pressure on the dollar had accelerated in the weeks leading to the speech. Switzerland had redeemed dollar paper for over forty metric tons of gold as late as July 1971. French redemptions of dollars for gold had enabled France to become a gold power, ranking behind only the United States and Germany, and it remains so today.
What most shocked Europeans and the Japanese about the New Economic Policy was not the devaluation of the dollar, but the 10 percent surtax on all goods imported into the United States. Abandoning the gold standard, by itself, did not immediately change the relative values of currencies—sterling, the franc, and the yen all had their established parities with the dollar, and the German mark and Canadian dollar had already been floated by the time of Nixon’s speech. But what Nixon really wanted was for the dollar to devalue immediately against all the major currencies and, better yet, to float down thereafter so that the dollar could indulge in continual devaluation in the foreign exchange markets. However, that would take time and negotiations to formalize, and Nixon did not want to wait. His 10 percent surtax had the same immediate economic impact as a 10 percent devaluation. The surtax was like a gun to the head of U.S. trading partners. Nixon would rescind the surtax once he got the devaluations he sought, and the task of negotiating those devaluations was delegated to his flamboyant Treasury secretary, John Connally of Texas.
International response to the 1971 Nixon gambit was not long in arriving. By late August, Japan had announced that it would allow the yen to float freely against the dollar. To no one’s surprise, the yen immediately rose 7 percent against the dollar. Combined with the 10 percent surtax, this amounted to a 17 percent increase in the U.S. dollar price of Japanese imports to the United States, which was welcome news to U.S. car and steel producers. Switzerland created “negative interest rates,” in the form of fees charged on Swiss franc bank deposits, to discourage capital inflows and help prop up the dollar.
In late September, the council of the General Agreement on Tariffs and Trade (GATT) met to consider whether the U.S. import surtax was a violation of free trade rules. There was no justification for the surtax and U.S. deputy undersecretary of state Nathaniel Samuels made almost no effort to defend it, other than to suggest that the surtax would be lifted when the U.S. balance of payments improved. Under the GATT rules, retaliation would likely have been justified. However, the U.S. trading partners had no stomach for a trade war. Memories of the 1930s were still too fresh and the role of the United States as a superpower balance to the Soviet Union and military protector of Japan and Western Europe was too important to risk a major confrontation over trade. Japan and Western Europe would simply have to suffer a weaker dollar; the question was to what extent and on whose terms.
An international conference in London was organized under the auspices of the so-called Group of Ten, or G10, in late September. These were the wealthiest nations in the world at the time, which importantly included Switzerland, even though it was not then an IMF member. Connally put on a performance worthy of his Texas pedigree. He told the delegates that the United States demanded an immediate $13 billion swing in its trade balance, from a $5 billion deficit to an $8 billion surplus, and that this demand was nonnegotiable. He then refused to engage in discussions about how this might be achieved; he told the delegates it was up to them to formulate a plan, and upon his review he would let them know whether they had been successful. The nine other members of the G10 were left to mutter among themselves about Connally’s arrogance and to think about what kind of swing in the U.S. trade balance they might be willing to orchestrate.
Two weeks later, in early October, the key players met again in Washington at the annual meeting of the IMF. Little progress had been made since the London conference, but the implications of Nixon’s 10 percent surtax were beginning to sink in. The Canadian trade minister, Jean-Luc Pépin, estimated that the surtax would destroy ninety thousand Canadian jobs in its first year. Some dollar devaluation had already taken place on the foreign exchange markets, where more countries had begun to float their currencies against the dollar and where immediate gains of 3 percent to 9 percent had occurred in various currencies. But Nixon and Connally were seeking total devaluation more in the 12 percent to 15 percent range, along with some assurance that those levels would stick and not be reversed by the markets. The IMF, not surprisingly given its research-dominated staff, began vetting a number of technical solutions. These included wider trading “bands” within which currencies could fluctuate before requesting formal devaluation, and possibly the expanded use of SDRs and the creation of a world central bank. These debates were irrelevant to Connally. He wanted an immediate response to the immediate problem and would use the blunt instrument of the surtax to force the issue for as long as it took. However, he did soften his views slightly at the IMF meeting by indicating that the surtax might be lifted if the U.S. trade balance moved in the right direction even if its ultimate goals had not yet been achieved.
There was one other issue on which the United States seemed willing to show some flexibility and on which the Europeans were quite focused. While the United States had announced it would no longer redeem dollars for gold, it had not officially changed the dollar-gold parity; it still regarded the dollar as worth one thirty-fifth of an ounce of gold, even in its nonconvertible state. An increase in the price of gold would be just as much of a devaluation of the dollar as an upward revaluation of the other currencies. This was symbolically important to the Europeans and would be seen by them as a defeat for the United States in the currency war despite U.S. indifference. The Germans and French would also benefit because they held large gold hoards and an increase in the dollar price of gold would mean an increase in the dollar value of their gold reserves.
Nixon and Connally did not really seem to care; having closed the gold window, the price of gold seemed somewhat irrelevant, and devaluation by whatever method was all just a means to an end. By the end of the IMF meeting, it seemed that some combination of continued upward revaluation of most currencies against the dollar on foreign exchange markets, some flexibility on timing of trade deficit reduction by the United States and a U.S. willingness to explicitly raise the dollar price of gold might form the basis of a lasting currency realignment consistent with Nixon’s goals.
By early December, the endgame had begun with another G10 meeting, convened at the ornate Palazzo Corsini in Rome. This time, Connally was ready to deal. He proposed an average revaluation of foreign currencies of 11 percent and a devaluation of the dollar against gold of 10 percent. The combination of the two meant an effective increase of over 20 percent in the dollar price of foreign exports into the United States. In exchange, the United States would drop the 10 percent surtax.
The Europeans and Japanese were in shock: a total swing of perhaps 12 percent to 15 percent might have been acceptable, but 20 percent was too much to bear all at once. Moreover, the members of G10 began to position themselves against one another. A 20 percent swing against the dollar would be one thing if all countries did it at once, but if, for example, the UK revalued only 15 percent while Germany did the full 20 percent, then Germany would be disadvantaged against the UK and the United States. France wanted to limit the size of the dollar devaluation against gold so that more of the adjustment would be pushed onto a German revaluation in which France would not fully participate. And so it went.
By now the negotiations were almost nonstop. A few days after the Rome meeting, President Nixon met one-on-one with President Georges Pompidou of France in the Azores, where Pompidou pressed the case for an increase in the dollar price of gold as part of a package deal. Nixon conducted the negotiations in a sleep-deprived state because he had stayed up most of the night to follow a Washington Redskins football game in local time. In the end, Nixon agreed to the French demands and Pompidou returned to France a hero for having humbled the Americans in the delicate matter of the dollar and gold. Still, Nixon did not leave empty-handed, because Pompidou agreed to push for significant reductions in the stiff tariffs on U.S. imports imposed by the European Common Market.
The tentative agreements reached at Palazzo Corsini and in the Azores were ratified two weeks later by the G10 in a meeting held in the historic red castle of the Smithsonian Institution, adjacent to the National Mall in Washington, D.C. The venue gave its name to the resulting Smithsonian Agreement. The dollar was devalued about 9 percent against gold, and the major currencies were revalued upward between 3 percent and 8 percent against the dollar—a total adjustment of between 11 percent and 17 percent, depending on the currency. Important exceptions were England and France, which did not revalue but still went up about 9 percent relative to the dollar because of the devaluation against gold. The Japanese suffered the largest total adjustment, 17 percent—even more than the Germans—but they drew the least sympathy from Connally since their economy was growing at over 5 percent per year. The signatories agreed to maintain these new parities in a trading band of 2.25 percent up or down—a 4.5 percent band in total—and the United States agreed to remove the despised 10 percent import surtax; it had served its purpose. No provision for a return to the convertible gold standard was made, although technically gold had not yet been abandoned. As one writer observed, “Instead of refusing to sell gold for $35 an ounce, the Treasury will simply refuse to sell . . . for $38 an ounce.”
The Smithsonian Agreement, like the Nixon Shock four months earlier, was extremely popular in the United States and led to a significant rally in stocks as investors contemplated higher dollar profits in steel, autos, aircraft, movies and other sectors that would benefit from either increased exports or fewer imports, or both. Presidential aide Peter G. Peterson estimated that the dollar devaluation would create at least five hundred thousand new jobs over the next two years.
Unfortunately, these euphoric expectations were soon crushed. Less than two years later, the United States found itself in its worst recession since World War II, with collapsing GDP, skyrocketing unemployment, an oil crisis, a crashing stock market and runaway inflation. The lesson that a nation cannot devalue its way to prosperity eluded Nixon, Connally, Peterson and the stock market in late 1971 as it had their predecessors during the Great Depression. It seemed a hard lesson to learn.
As with the grand international monetary conferences of the 1920s and 1930s, the benefits of the Smithsonian Agreement, such as they were, proved short-lived. Sterling devalued again on June 23, 1972, this time in the form of a float instead of adherence to the Smithsonian parities. The pound immediately fell 6 percent and was down 10 percent by the end of 1972. There was also great concern about the contagion effect of the sterling devaluation on the Italian lira. Nixon’s chief of staff briefed him on this new European monetary crisis. Nixon’s immortal response, captured on tape, was: “I don’t care. Nothing we can do about it I don’t give a shit about the lira.”
On June 29, 1972, Germany imposed capital controls in an attempt to halt the panic buying of the mark. By July 3, both the Swiss franc and the Canadian dollar had joined the float. What had started as a sterling devaluation had turned into a rout of the dollar as investors sought the relative safety of German marks and Swiss francs. In June 1972, John Connally resigned as Treasury secretary, so the new secretary, George P. Shultz, was thrown into this developing dollar crisis almost immediately upon taking office. With the help of Paul Volcker, also at Treasury, and Fed chairman Arthur Burns, Shultz was able to activate swap lines, which are basically short-term currency lending facilities, between the Fed and the European central banks, and started intervening in markets to tame the dollar panic. By now, all of the “bands,” “dirty floats,” “crawling pegs” and other devices invented to maintain some semblance of the Bretton Woods system had failed. There was nothing left for it but to move all of the major currencies to a floating rate system. Finally, in 1973, the IMF declared the Bretton Woods system dead, officially ended the role of gold in international finance and left currency values to fluctuate against one another at whatever level governments or the markets desired. One currency era had ended and another had now begun, but the currency war was far from over.
The age of floating exchange rates, beginning in 1973, combined with the demise of the dollar link to gold put a temporary end to the devaluation dramas that had occupied international monetary affairs since the 1920s. No longer would central bankers and finance ministries anguish over breaking a parity or abandoning gold. Now markets moved currencies up or down on a daily basis as they saw fit. Governments did intervene in markets from time to time to offset what they saw as excesses or disorderly conditions, but this was usually of limited and temporary effect.
