The Nixon Shock

On Sunday evening, August 15, 1971, Richard Nixon appeared on national television to announce that the United States would immediately suspend the convertibility of the dollar to gold. The Bretton Woods system, which had organized the international monetary order for 27 years, effectively ended that night. Nixon's announcement was accompanied by a 90-day wage and price freeze, a 10% surcharge on imports, and what Nixon's Treasury Secretary John Connally made explicit in subsequent negotiations: the United States intended to restructure the international monetary order on terms more favorable to American interests.

The decision was not entirely voluntary. By 1971, US gold reserves had fallen to roughly $10 billion while dollar liabilities held abroad exceeded $40 billion. The arithmetic of convertibility at $35 per ounce was no longer sustainable -- anyone who tried to convert more than a fraction of outstanding dollars would exhaust the gold supply. Nixon was closing a window that was already effectively shut; he was simply being explicit about it.

The Smithsonian Agreement of December 1971 produced a new set of exchange rates -- the dollar devalued, other currencies revalued -- but these fixed rates collapsed within fourteen months. By 1973, the major currencies were floating against each other, their relative values determined by market forces rather than government agreement. The world had entered the era of managed floating exchange rates that persists today.

When the United States goes off gold, the rest of the world is put on the dollar standard whether they like it or not. There is simply no alternative reserve currency, and the world cannot function without a reserve currency.Adapted from Robert Triffin, testimony to Congress, 1960

The dollar's survival as the world's dominant reserve currency after the end of gold convertibility is one of the more remarkable facts about the postwar international order. With nothing backing the dollar except the authority and creditworthiness of the United States government, the currency maintained its reserve status because the alternatives were less attractive, because US financial markets were deeper and more liquid than any competitors, and because -- as would become clear within a few years -- the United States would find other mechanisms to underpin dollar demand.

The Nixon shock also had domestic consequences that were not immediately apparent. The shift to floating exchange rates removed the external constraint that the gold standard and fixed-rate system had imposed on US monetary and fiscal policy. The United States could now, in principle, run larger trade deficits and fiscal deficits than Bretton Woods had permitted. Whether this freedom would be used well or badly depended on the political choices that followed -- choices that, in the 1980s, would have profound consequences for American inequality.