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Anniversary: How Nixon the Keynesian Destroyed the Monetary Regime of Keynes
It was 42 years ago today, on a Sunday, that President Richard Nixon went on television and announced to the American people that he was closing the gold window the next day and imposing full-scale price and wage controls on the American economy. He signed an executive order. Congress had nothing to say about it, and therefore said nothing.
The third indispensable element in building the new prosperity is closely related to creating new jobs and halting inflation. We must protect the position of the American dollar as a pillar of monetary stability around the world.
In the past 7 years, there has been an average of one international monetary crisis every year...
I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.
Now, what is this action -- which is very technical -- what does it mean for you?
Let me lay to rest the bugaboo of what is called devaluation.
If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.
The effect of this action, in other words, will be to stabilize the dollar.
So, it would stabilize the dollar. This, from the man who told the media in November 1962, after his defeat for Governor of California, "You won't have Dick Nixon to kick around any more." If you want to see the decline of the dollar since 1971, click here.
Nixon unilaterally abolished the monetary agreement established in 1944 at Bretton Woods, New Hampshire. At that meeting, the United States, Great Britain, and other Western nations established a new monetary order. It would be supported by the United States Treasury. The United States Treasury would guarantee that any central bank or foreign government could buy gold from the Treasury at a price of $35 per ounce.
The goal of the Treasury was simple: to get foreign governments to hold Treasury debt instead of gold. Because Treasury debt was supposedly as good as gold, foreign governments and central banks could hold Treasury debt instead of holding gold. This enabled the United States government to run fiscal deficits, and foreign governments and central banks financed a portion of this debt. They did so by creating their own domestic currencies out of nothing, and then using these currencies to buy U.S. dollar-denominated debt, meaning U.S. Treasury debt. It was a nice arrangement. Foreign governments and foreign central banks gained an interest rate return on holding treasury debt, which they could not get by holding gold. Yet the dollars that they were being promised by the Treasury were supposedly as good as gold.
On August 15, 1971, Richard Nixon declared for all the world to hear that the dollar was not as good as gold. From that day forth, foreign governments and central banks could no longer get gold from the Treasury at a fixed price of $35 an ounce. Nixon broke the promise, and thereby opened the possibility of extensive monetary inflation by the Federal Reserve. From that point on, the Federal Reserve did not have to worry about the possibility that the price of gold would rise in private markets, and that central banks would find it profitable to buy Treasury gold at $35, and put it in their own vaults.
This had nothing to do with Americans. Americans could not legally own gold bullion in 1971. That did not become legal until January 1, 1975. So, the focus was on the foreign value of the dollar in relation to gold. That value had fallen, and so there was a run on the Treasury. Foreign central banks were demanding gold at $35 an ounce, which was why the price was being kept at this low rate. They could get the gold at $35 an ounce from the Treasury. But, in August 1971, it became clear to the Treasury secretary that this could not go on much longer. If the drain of gold reserves continued, within a few years, there would be no gold remaining at the Federal Reserve Bank of New York. Actually, the gold would have been there, but it would have been allocated to different owners. The United States government would have lost ownership.
It was this decision that made it possible for Arthur Burns and the Federal Reserve to expand the money supply rapidly, in order to overcome the Nixon recession. That recession was the worst one since the end of World War II. The federal government ran back-to-back deficits of $25 billion a year. In 1970 and 1971, this was considered a gigantic failure on the part of the federal government. Nobody had heard of such deficits ever since the end of World War II. How times have changed.
The Federal Reserve did inflate, and by 1975, Gerald Ford was so concerned about this that he inaugurated a new public relations scheme called "Whip Inflation Now," or WIN. But by the time that plan was inaugurated, the Ford administration was facing a major recession. All concerns about price inflation disappeared. The Federal Reserve expanded the monetary base. Only in the fall of 1979 did Federal Reserve Chairman Paul Volcker decide that this must not go on any longer. He stabilized the monetary base, or least came close to it. That created the Carter recession of 1980, followed by the Reagan recession of 1981 and 1982.
It was Nixon's decision that persuaded Ron Paul to run for Congress. He had been aware of the government's monetary policies relating to central banks run on American gold, but he decided that it would escalate. It did.
From 1971 until 2007, the main negative sanction facing the United States government in the field of economic policy was the threat of an increase in the rate of interest on the 10-year Treasury bond. This led to a memorable confrontation between the newly inaugurated Bill Clinton and his economic advisers. James Surowiecki described the incident in 1999.
Hard as it may be to believe right now, the most important thing Bill Clinton ever said was not "I did not have sexual relations with that woman." Although that statement did have the virtue (from the perspective of memorability) of being, well, a bald-faced lie, there's nothing especially profound about it. Consider, by contrast, the passage from Bob Woodward's The Agenda in which Clinton asks the rhetorical question "You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of [*******] bond traders?"
Now, that's poetry. And for a time, that moment when Clinton realized that the U.S. bond market had effective veto power over all of his economic plans took on the force of a primal scene. Bond traders, with Fed chair Alan Greenspan as their honorary leader, were understood as controlling the secret levers of the economy. If they didn't like what they saw in Washington, or in the housing market, they'd stamp on the brakes, sending interest rates soaring and making unemployment lines longer. Keeping the bond market happy was, it seemed, a president's first priority.
Ever since 2008, the threat of rising bond rates has been minimized by the recession. Investors are desperate for any positive rate of return. So, they buy the debt of the United States government at low rates of interest. A year ago, this rate was well under 2%. It has jumped since then, but it is still extremely low.
Richard Nixon made a lot of bad decisions, but this one was his worst. This one has had long-term consequences far beyond anything he ever imagined.
We are now trapped by the Federal Reserve, which buys $1 trillion worth of government debt every year. If it stops, we will get into another major recession. So far, there are few signs the Federal Reserve is going to stop.
From 1965 until 1971, foreign governments and central banks could put pressure on the Federal Reserve to stop its expansion of money. All the government or the central bank had to do was order gold at $35 an ounce. That leverage ceased 42 years ago.
When foreign governments and central banks could no longer put pressure on, only the bond traders could. These days, not even they can do it. So, the deficit keeps rising, and the Federal Reserve's balance sheet keeps rising. We are riding on the back of the monetary tiger.