The Nixon Shock refers to the aftereffect of a set of economic policies announced by President Richard M. Nixon in 1971. Most notably, these policies led to the collapse of the Bretton Woods system of fixed exchange rates that had been in place since World War II.
Key Takeaways
- The Nixon Shock refers to an economic policy shift undertaken by President Nixon to prioritize job growth, lower inflation, and maintain exchange rate stability.
- It effectively led to the end of the U.S. dollar’s convertibility into gold.
- The Nixon Shock sparked the stagflation crisis of the 1970s resulting in a devalued U.S. dollar.
- It increasingly brought central banks into prominence, giving them more control over their national currencies and financial policies.
- The economic policy shift remains a subject of debate among economists regarding its long-term effects.
Understanding the Nixon Shock
The Nixon Shock followed President Nixon’s televised “New Economic Policy” address to the nation on August 15, 1971. Highlighting three main goals, Nixon announced:
- Lowering the unemployment rate
- Curbing inflation
- Protecting the U.S. dollar from international money speculators
Nixon envisioned tax cuts and a 90-day freeze on prices and wages as the best methods for boosting the job market and curbing inflation. He also advocated for suspending the dollar’s convertibility into gold to counter speculative pressures on the USD.
As an additional measure, Nixon suggested a 10% tax on all imports subject to duties. This levy was intended to encourage America’s main trading partners to increase the value of their currencies in relation to the dollar.
The Need for Change
The Bretton Woods system, established during a 1944 international conference in Bretton Woods, New Hampshire, fixed the value of foreign currencies to the U.S. dollar, which was convertible into gold. However, a global dollar surplus in the 1960s threatened the system. At that time, the U.S. lacked sufficient gold reserves to support the extensive international circulation of dollars, resulting in an overvalued dollar.
Attempts by the Kennedy and Johnson administrations to stabilize the dollar and reform international monetary policy largely failed. Anxiety grew in the foreign exchange market, triggering widespread speculation and selling of the dollar. Following repeated runs on the dollar, Nixon stepped in to chart a new economic course.
Nixon’s Speech
While Nixon’s address received enthusiastic support domestically, the international reaction was less favorable. Many saw his actions as a unilateral move. The Group of Ten (G-10) industrialized democracies responded with new exchange rates based on a devalued dollar, known as the Smithsonian Agreement. This plan took effect in December 1971 but eventually failed.
Starting in February 1973, persistent market pressures led to a devaluation of the USD and a wave of new exchange parities. By March, due to continued pressure, G-10 members decided that six European nations would tie their currencies together and collectively float them against the dollar. This effectively ended the fixed exchange rate system established by the Bretton Woods Agreement.
Aftereffects of Nixon Shock
Initially, Nixon’s economic policies were lauded as a political triumph. However, their long-term impacts remain contentious among scholars. The policies catalyzed 1970s stagflation and led to unstable floating currencies as the dollar drastically devalued throughout the decade. Over time, the USD faced numerous bouts of volatility, including a 34% loss in value from 1985 to 1995 and sharp declines between 2002 and mid-2011.
Nixon’s promise to avoid costly recessions also fell short, as the U.S. encountered severe economic downturns like the Great Recession of 2007-2009.
Advantages and Disadvantages
Advantages
Today’s world primarily uses free-floating, market-traded currencies, benefiting radical monetary policies like quantitative easing (QE). Central banks have more control over their national currencies and other financial variables such as interest rates and money supply.
Disadvantages
However, the Nixon Shock introduced uncertainties and led to a burgeoning financial market focused on hedging the new currency risks. The 2007-2008 financial crisis demonstrated that central bank control doesn’t guarantee protection against significant economic fluctuations.
Pros and Cons Summary
Advantages of Nixon Shock
- Government-backed money is generally more stable than commodity-based currency.
- Enhanced central bank flexibility helps protect against severe economic downturns.
- Actions to safeguard gold reserves, previously a source of economic instability, became unnecessary.
Disadvantages of Nixon Shock
- The 1970s stagflation resulted directly from these policies.
- Despite centralized control, severe recessions and USD volatility still persist.
- Gold constrained economic policies naturally, whereas post-Nixon, there was potential for increased manipulation.
What Was the Gold Standard and How Did It Work?
The gold standard tied a country’s currency value to a fixed quantity of gold. In practice, central banks ensured that local currency (paper money) was easily convertible into gold at a set price. Gold coins circulated alongside other metal coins and paper notes as legal tender.
When and Why Did Nixon End the Gold Standard?
President Nixon terminated the gold standard in 1971, chiefly to tackle the nation’s inflation problem and dissuade foreign governments from redeeming more USD for gold.
What Is Fiat Money?
Fiat money is government-issued currency backed by the government that issues it, rather than physical commodities like gold or silver.
What Would Happen If We Returned to the Gold Standard?
Some economists argue that reverting to the gold standard could destabilize prices, causing cycles of deflation and inflation and limiting government ability to manage financial crises.
The Bottom Line
The Nixon Shock marks the aftermath of President Richard Nixon’s August 1971 announced sweeping economic policy changes designed to better the U.S. financial position, prevent inflation, and cut unemployment. The impact of these changes continues to evoke divergent views among economists concerning their overall merits and long-term implications.
Related Terms: Fiat Money, Gold Standard, Stagflation, Quantitative Easing, International Monetary Fund.
References
- Richard Nixon Foundation. “The Challenge of Peace: President Nixon’s New Economic Policy”.
- Federal Reserve History. “Nixon Ends Convertibility of U.S. Dollars to Gold and Announces Wage/Price Controls”.
- Federal Reserve History. “Creation of the Bretton Woods System”.
- Office of the Historian. “Nixon and the End of the Bretton Woods System, 1971–1973”.
- Bloomberg. “Dollar Index Spot Chart”.
