The Nixon Shock of 1971

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Nixon changed the rules on a Sunday evening

At 9 p.m. on Sunday 15 August 1971, President Richard Nixon spoke to Americans on radio and television from the Oval Office. Inflation, the rate at which prices in general rise, had run at about 5 to 6 per cent a year in America in 1969 and 1970. Foreign governments held dollars that they could take to the US Treasury and swap for gold at a fixed price. By the end of the broadcast, the terms on which the world held dollars had changed.

The dollar was tied to gold, and other currencies to the dollar

Under the rules in force until 1971, each main currency had a fixed rate against the dollar, and the dollar had an official price in gold of $35 an ounce. A government holding dollars could ask the US Treasury for gold at that price.

The arrangement had been under strain for years before it ended. Nixon told his audience that for seven years there had been "an average of one international monetary crisis every year", and that speculators had spent recent weeks attacking the dollar. Whenever traders expected a fixed rate to change, they moved money out of the currency they thought would fall.

Dollars piled up abroad until America could not cover them

The President's Council of Economic Advisers later gave one reason the dollar was judged overvalued: between 1965 and 1969 American wages and prices had risen faster, for what workers produced, than in America's trading partners, making American goods harder to sell. America's trade surplus in 1970 was smaller than in the early and late 1960s, and in 1971 it turned into a deficit. Counting military commitments, aid and investment abroad as well as trade, more dollars went abroad each year than came back.

By 1971 the dollars held abroad far exceeded the gold and other reserve assets America held, which came to about $14.5 billion. Holders who expected the dollar to be devalued had a reason to ask for gold before others did. From January to mid-August 1971 the Treasury paid out more than $3 billion of reserve assets, about 40 per cent of it in early August.

Camp David agreed a package, and the gold window split the advisers

On Friday 13 August 1971 Nixon took his economic advisers to Camp David, the presidential retreat in Maryland, and ordered that nothing leak before an announcement. Paul Volcker, who would later chair the Federal Reserve, opened with that day's losses of gold. The Treasury Secretary, John Connally, proposed one package: close the "gold window", the Treasury's promise to swap dollars for gold; tax imports; change taxes; and freeze wages and prices. Arthur Burns, chair of the Federal Reserve, backed most of it but argued hard against closing the window.

The same speech froze wages and prices and taxed imports

The same speech cut taxes and federal spending, and alongside closing the gold window it made two more moves. Nixon ordered "a freeze on all prices and wages throughout the United States for a period of 90 days", and put a temporary tax of 10 per cent on goods imported into the United States. He said the import tax would end when what he called unfair exchange rates were put right.

The freeze ran until 13 November 1971 and covered rents and salaries as well as prices and wages. The order forbade charging prices or paying wages above their levels before the freeze, and breaking it wilfully was punishable by a fine. Congress had given the President the power to do this a year earlier, in the Economic Stabilization Act of 1970.

Controls ran in four phases, and Britain used the same tool

The freeze was the first of four phases of control. Phase II, from November 1971 to January 1973, replaced the freeze with controls run by a Pay Board and a Price Commission. In 1973 the controls became mostly voluntary, with a second price freeze that summer, and the last phase ended on 30 April 1974.

America was not the only country to freeze pay and prices. In July 1966 the British government called for a standstill on wages and salaries for six months, and on prices. In November 1972 it went further and brought in a legal standstill on increases in pay, prices, rents and dividends. Whether controls like these changed where prices ended up is a question for later in this series.

The fixed rates agreed in December 1971 gave way by March 1973

Closing the gold window was meant to force new fixed rates, not to end them. In December 1971 the Group of Ten countries met at the Smithsonian Institution in Washington and agreed a new set. The official price of gold was agreed to rise to $38 an ounce, so a dollar would be worth less gold, and the Japanese yen was raised in value by 16.88 per cent against the dollar.

Traders were not convinced the new rates would last. In June 1972 Britain let the pound float. On 12 February 1973 a second devaluation of the dollar was announced, and the yen was allowed to float. On 1 March European central banks had to take in more than $3.6 billion, and Europe's currency markets closed. When they reopened on 19 March, the main currencies floated: the market, not a government promise, set their price.

Floating rates moved far more than the fixed ones had

In the first half of 1971 the yen barely moved against the dollar, because the rate was fixed. The chart runs through the decade, past each break. A floating rate moves whenever buyers and sellers change their view of a currency, so the line steps down at each break and then swings.

For a Japanese exporter or an American importer, the exchange rate stopped being a fixed number and became a price to watch every day.

A decade of high inflation followed

The end of fixed rates opened the period this series follows, the Great Inflation. The price of oil jumped twice: during the Arab oil embargo of 1973 and 1974, and again after the revolution in Iran in 1979. American inflation reached double figures in 1974, and again in each year from 1979 to 1981.

In August 1979 the same Paul Volcker became chair of the Federal Reserve, and interest rates rose sharply over the following months. By 1983 American inflation had fallen a long way. Economists still argue about the cause. Some put most weight on bad luck, the oil price shocks; others on bad policy, central banks that let money and credit grow too fast. Whether the end of fixed exchange rates helped cause the inflation is part of the same argument.

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