Fifty Years Without Gold

Fifty years ago, on Sunday evening, August 15, 1971, after crisis meetings with close advisers at Camp David, President Richard Nixon announced an historic decision in his “Address to the Nation Outlining a New Economic Policy.” It was by then clear that the United States might not have enough gold to meet its international commitment to redeem dollars. It was experiencing “the start of a run on the dollar.” Paul Volcker, then with the Treasury Department, reported to the President on gold losses. “Dollar dumping accelerated. France sent a battleship to take home French gold from the New York Fed’s vaults.” The French not unreasonably believed that the special status of the dollar gave it an “exorbitant privilege,” making it “monumentally over-privileged.” Already in the 1960s, French President Charles de Gaulle had ordered the Bank of France to increase the amount of payments in gold from the United States.

Said Nixon to the nation, “The speculators have been waging an all-out war on the American dollar,” and that to “protect the dollar from the attacks of the international money speculators” would take “bold action.” “Accordingly,” he announced, “I have directed [Treasury] Secretary Connolly to suspend temporarily the convertibility of the dollar into gold.” The suspension of course turned out to be permanent. Today everybody considers it normal and almost nobody even imagines the slightest possibility of reversing it.

Nixon had thereby put the economic and financial world into a new era. By his decision to “close the gold window” and have the American government renege on its Bretton Woods commitment to redeem dollars for gold for foreign governments, he fundamentally changed the international monetary system. In this new system, still the system of today, the whole world always runs on pure fiat currencies, none of which is redeemable in gold or anything else, except more paper currency or more accounting entries. Instead of having fixed exchange rates, or “parities,” with respect to each other, the exchange rates among currencies can constantly change according to the international market and the interventions and manipulations of central banks. The central banks are free to print as much of their own money as they and the government of which they are a part like.

This was a very big change and highly controversial at the time. The Bretton Woods agreement was a jewel of the post-World War II economic order, negotiated in 1944 and overwhelmingly voted in by the Congress and signed into law by President Truman in 1945. Its central idea was that all currencies were linked by fixed exchange rates to the dollar and the dollar was permanently linked to gold. Now that was over. Sic transit gloria.

Economist Benn Steil nicely summed up the global transition:  “The Bretton Woods monetary system was finished. Though the bond between money and gold had been fraying for nearly sixty years, it had throughout most of the world and two and a half millennia of history been one that had only been severed as a temporary expedient in times of crisis. This time was different. The dollar was, in essence, the last ship moored to gold, with all the rest of the world’s currencies on board, and the United States was cutting the anchor and sailing off for good.” It was sailing, we might say, from a Newtonian into an Einsteinian monetary world, from a fixed frame of reference into many frames of reference moving with respect to each other. Nobody knew how it would turn out.

Fifty years later, we are completely used to this post-Bretton Woods monetary world. We take a pure fiat money system entirely for granted as the normal state of things. In this sense, in this country and around the world, we are all Nixonians now.

How very different our prevailing monetary system is from the ideas of Bretton Woods. The principal U.S. designer of the Bretton Woods system, Harry Dexter White insisted, strange to our ears, that “the United States dollar and gold are synonymous.” Moreover, he opined that “there is no likelihood that . . . the United States will, at any time, be faced with the difficulty of buying and selling gold at a fixed price.”

This was a truly bad forecast. It may have been arguable in 1944, but by the 1960s, let alone 1971, it was obviously false. (White’s misjudgment here was exceeded by his bad judgment in being, in addition to an officer of the U.S. Treasury, a spy for the Soviet Union.)

A better forecast was made by Nixon’s Treasury Secretary, John Connally. Meeting with the President two weeks before the August 15, 1971 announcement, he said, “We may never go back to it [convertibility]. I suspect we never will.”  He’s been right so far for fifty years.

In the early years of the Nixonian system, Friedrich Hayek wrote: “A very intelligent and wholly independent national or international monetary authority might do better than an international gold standard. . . . But I see not the slightest hope that any government, or any institution subject to political pressure, will ever be able to act in such a manner.”

Running low on gold and facing the inability to meet its Bretton Woods obligations, the American government had to do something. Instead of cutting off gold redemption, it could have devalued the dollar in terms of gold. A decade before, British Prime Minister Harold Macmillan had suggested to President John Kennedy that the already-apparent problems could be addressed if the dollar were devalued to $70 per ounce of gold, from the official $35. Whether you have enough gold or not depends on the price. But announcing a formal devaluation was politically very unattractive and no one could really know what the right number was going forward. Today, after fifty years of inflation, it takes about $1,800 to buy an ounce of gold, which is a 98% devaluation of the dollar relative to the old $35 an ounce.

How shall we judge the momentous Nixon decision? Was it good to break the fetters of the “barbarous relic” of gold and voyage into uncharted seas of central bank discretion? Most economists say definitely yes. At the time, the public response to Nixon’s speech was very positive. The stock market went up strongly.

But wasn’t it dangerous to remove the discipline Bretton Woods provided against wanton money creation and inflationary credit expansion? The end of Bretton Woods was followed by the international Great Inflation of the 1970s, and later by our times in which central banks, including the Federal Reserve, with a clear conscience, commit themselves to perpetual inflation instead of stable prices, and promise to depreciate the value of the currency they issue. They speak of “price stability,” but mean by that a stable rate of everlasting inflation. As we observe the renewed unstable and very high rate of inflation of 2021, we may reasonably ask whether discretionary central banks can ever know what they are really doing. Personally, I doubt it.

In the early years of the Nixonian system, Friedrich Hayek wrote: “A very intelligent and wholly independent national or international monetary authority might do better than an international gold standard….But I see not the slightest hope that any government, or any institution subject to political pressure, will ever be able to act in such a manner.” Central banks, including the Federal Reserve, are indeed subject to political pressure and depend on political support. Politicians, Hayek added, are governed by the “modified Keynesian maxim that in the long run we are all out of office.” If Hayek is watching today from economic Valhalla as the Federal Reserve buys hundreds of billions of dollars of mortgages, and thus stokes the housing market’s runaway price inflation, he will be murmuring, “As I said.”

The distinguished economist and scholar of financial crises, Robert Aliber, pointedly observed that the Nixonian system of pure fiat money and floating exchange rates has been marked by a recurring series of financial crises around the world. Such crises erupted in the 1970s, 1980s, 1990s, 2000s, and 2010s. The fiat currency system was born to solve the 1971 crisis, but it certainly cannot be given a gold medal for financial stability since then. Aliber wrote to me recently: “I used to think that the failure to ‘save Lehman’ was the biggest mistake that the U.S. Treasury ever made, now I realize 1971 was the bigger mistake.”

Professor Guido Hülsmann, speaking in 2021, described the results of the end of Bretton Woods in these colorful terms: “All central banks were suddenly free to print and lend as many dollars and pounds and francs and marks as they wished. . . . Nixon’s decision led to an explosion of debt public and private; to an unprecedented boom of real estate and financial markets;…to a mind-boggling redistribution of incomes and wealth in favor of governments and the financial sector;…and to a pathetic dependence of the so-called financial industry on every whim of the central banks.”

As always in economics, you cannot run the history twice. What would have happened had there been a different decision in 1971, and whether it would have been better or worse than it has been under the Nixonian system, is a matter for pure speculation. Another speculation, good for our humility, is to wonder what we ourselves would usefully have said or done, had we been at Camp David among the counselors of the President, or even been the President, in that crucial August of fifty years ago.

The Bretton Woods system had developed by then a severe, and as it turned out, fatal problem. Our Nixonian system is seriously imperfect. But given the deep, fundamental uncertainty of the economic and financial future at all times; the inescapable limitations of human minds, even the best of them; and the inevitable politics that shape government behavior, including central bank behavior, we are not likely ever to achieve an ideal international monetary system. We are well-advised not to entertain either foolish hopes or foolish faith in central banks.

In any case, there is no denying that August 15, 1971 was a fateful date.