On August 15, 1971, US President Richard Nixon changed the world capitalist economic order. What happened that day is the starting point of any understanding of the desperate crisis striking at the heart of the system in Europe and the United States.
At a stroke, Nixon cancelled the convertibility of the dollar into gold which had underwritten world credit and financed the post-World War Two reconstruction in Western Europe and Japan as well as the Cold War and the arms race. His decision tore up the Bretton Woods agreement which the Western world’s finance meetings had solemnly signed in 1944 to restabilise capitalism and prime it with a torrent of gold-backed credit.
Under Bretton Woods, the American “greenback” was officially recognised as the world’s dominant currency and became the currency of global trade. It was given a fixed exchange rate and made convertible with gold at US$35 an ounce. Every other world currency was then tied to this official rate of exchange and two instruments were established to monitor the new order, the International Monetary Fund and the World Bank. With gold guaranteeing their “value”, US dollars were printed like Monopoly money and Wall Street arranged astronomical lines of credit to finance the post-war boom.
Nixon’s dramatic announcement forced the closure of every currency market in the world as bankers and money lenders tried to second guess its consequences. Nixon’s measures were a thinly veiled declaration of war on America’s economic competitors: his devaluation of the dollar was a huge boost to US exports, the 10 per cent surcharge on all imports was an implicit act of trade war and the ban on sales of US gold from Fort Knox to foreign central banks raised the spectre of Fortress America.
The administration’s accompanying domestic measures were just as brutal: an immediate 90-day wage freeze, a cut of 5 per cent in the public service, massive cuts in government spending and tax concessions to business to stimulate investment. The old Republican Party nostrum of non-interference in the workings of the free market went out the window.
What forced Nixon’s hand was the gathering economic clouds over Washington and Wall Street. America’s post-war role as the world’s policeman came with a massive price ticket. Huge military spending had been consumed in the Korean war and now it was costing ten times that amount in Vietnam. The balance of payments deficit was at an all-time high as US private overseas investment grew at a phenomenal rate and gold reserves were being steadily depleted. Furious that Western Europe and other allies were not prepared to share the burden of fighting his hopelessly conceived war against communism in Vietnam, Nixon unilaterally decided to share America’s pain with the rest of the capitalist world.
The clapped-out British economy was particularly vulnerable to Nixon’s draconian measures and the Brit-despising president knew it. He was furious that Edward Heath’s Conservative Government and the previous Labour Government of Harold Wilson had refused point-blank to commit British troops to Vietnam. London’s attitude to Vietnam was a rare piece of bipartisanship in foreign policy: both major parties wanted to inflict some payback on Washington for refusing to support Britain during the abortive 1956 military attack on Egypt during the Suez Crisis and they saw no political or economic dividend in fighting in the jungles of Vietnam where the French had come to such grief a decade earlier.
Re-reading the coverage of Nixon’s August measures is to be struck by the depth of panic in the money markets, the aimless dithering of politicians and the smug stupidity of economists and commentators. Brought up on the inflationary theories of John Maynard Keynes, most pundits thought that capitalism would “restabilise” and that the ending of gold-dollar convertibility would be absorbed as business returned to normal. There was little recognition that the very foundation of the post-war capitalist world order was the existence of the US dollar as a stable currency backed by gold. When its gold backing was ended, the dollar became a mere promisory note, a piece of paper in a long line of endless credit. The political classes, all now self-styled Keynesians, vulgarized his theories and began printing dollars at an alarming rate to finance prosperity and investment. It was like trying to put out the fire by throwing buckets of petrol on the flames.
The dangerous absurdity of the economic measures which began to flourish among Western governments was accompanied by an even greater piece of nonsense. Politicians and establishment economists began to denounce the Marxist analysis of gold as a measurement of value within the currency system and announced that gold could and would be “demonitised”. Central banks around the world sold off their bullion stocks raising whatever cash they could to stabilize national budgets while new-fangled instruments, such as Special Drawing Rights (SDRs), were pulled out of the hate to “replace” gold as a backing for national currencies. A few years later the Bank of International Settlements pronounced that “gold is dead”, and braced itself for the brave new world of unregulated currency speculation and floating currencies whose “value” had shifted into the hands of money market speculators.
If the media and academia were hopelessly sanguine about Nixon’s measures, Whitehall’s mandarins certainly weren’t. A top secret briefing note prepared for Heath on the eve of his visit to Bermuda to meet Nixon late in 1971 captured the flavour of the times:
“The sources of strain in Anglo-American and European-American relations have increased in number and seriousness in 1971. With visits to Peking and Moscow due in his election year, and with the free world in disorder over the dollar crisis, he (Nixon) cannot appear to ignore his allies.
“These tensions have arisen from inadequate consultation as well as from conflicts of interest. Procedurally, the fault has been mainly with the Americans. Dr (Henry) Kissinger’s methods, and latterly Mr (John) Connally’s (Treasury Secretary), have shaken confidence both within the administration and abroad. Many Americans think that Europe has been slow to realise the scale and admit the urgency of the United States balance of payments problem. In particular, they complain that Europe has failed to react to Mr Nixon’s message of August 15 in a manner which meets America’s urgent needs.
“We cannot sit back and wait for our relations with the US to improve. The complexity of the period we are entering demands urgent action to ensure that transatlantic relations are restored to the closeness which we regard as essential if we are to cope with the difficulties that lie ahead.
“The President is in an irritable mood and may be difficult to handle. He is feeling bruised, lonely and misunderstood. He is uneasily aware that his policies and style of government have caused strains between the US and her friends and allies. The old ease and closeness of Anglo-American inter-communication have been lost. Our first task is to restore them. It would not help to apportion blame.”
The briefing note concluded with this advice: “The Prime Minister will also wish to emphasise that 1972 will be a crucial year for us. Our balance of payments is sound (!) and the Government’s economic policies are beginning to yield results (!!). But the safety margin between success and failure is narrow.”
The Foreign Office-compiled note showed Heath and his advisers were searching for a diplomatic way of patching up what they saw as a testy failure of communications. In fact, they were dealing with breakdown of the post-war order fashioned at Bretton Woods. Heath’s response was to rush Britain into the Common Market in the vain hope that the UK economy would be shielded by the critical mass of the unified West European market. Secondly, he and his Chancellor Tony Barber attempted a “dash for growth” through reflation. By mid-1972 almost £1 billion fled the country in a matter of days and the big banks were obliged to put up interest rates by one per cent. Most of the reserves of the Bank of England, it turned out, were held not in gold but in dollars. OPEC oil-producers felt robbed by receiving payment in US dollars so they decided to double and then treble the price of their black gold to maintain the purchasing power of their vast dollar accounts.
Much of today’s world economic catastrophe can be traced to the Nixon measures 40 years ago but memories in the financial world fade faster than in most walks of life. One feature of the current crisis which would put a smile on the face of the old German philosopher and that is the astronomical rise in the price of gold. Recently it hit US$1600 an ounce: so much for gold being a fuddy-duddy thing of the past.