The 50th Anniversary of Nixon's Closing of the Gold Window
He also announced that he was placing comprehensive price and wage controls on the American economy, which he said would be a temporary measure. After 90 days, a price control board would consider exemptions. Those price controls remained in force until January 12, 1973. The government extended the controls in healthcare products, food, and construction. Most of the system of controls came to an end in March 1974.
He did all this by Executive Order #11615. Congress had not discussed it.
This was the most comprehensive assault on American liberty by means of an executive order since 1 AM on March 6, 1933, when Franklin Roosevelt announced the criminalization of gold ownership by Americans and the closing of all banks.
This executive order began a decade of stagflation. There was low economic growth, and there was also the most rapid peacetime price inflation in American history.
One sector of the economy remained under the controls: energy. Oil and natural gas prices were still controlled by the government. This created a tremendous opportunity for the international cartel known as OPEC: the Organization of Petroleum Exporting Countries. In 1973, the international price of oil went from about $5 a barrel in 1973 to $12 a barrel in 1975. The result of the controls was long lines of cars in front of gasoline stations. Price controls create shortages.
I KNEW THIS WAS COMING
I had no doubt in early August 1971 that there would be a major dollar crisis within a month or two. Too many foreign governments were demanding payment in gold. I knew this would not last. The government would devalue the dollar.
When reporters asked Secretary of the Treasury John Connolly whether there was any possibility that the United States government would stop exchanging gold for dollars, he denied this emphatically. That was when I knew that it was going to happen, and would probably happen soon.
A friend of mine was going on a trip to Japan. I asked him to buy two items for me: an Asahi Pentax 35mm camera and a Seiko wristwatch. He was able to get both of them for me, which he brought back. He told me of his experience in buying the wristwatch. He had asked to see the watch, and the salesperson handed it to him. At that point, someone came up to the salesperson and said something in his ear. The salesperson said that he could no longer sell the wristwatch for dollars. My friend complained. The salesperson agreed to let him buy it, but only because he had actually picked up the watch.
A friend of mine had gone to Great Britain for vacation that month. He was an old-time Democrat liberal. I told him that as soon as he got off the plane, he should exchange his American Express travelers checks in dollars for travelers checks in British pounds. My friend, who was an Anglophile, did what I said. That saved his vacation. All across Great Britain, restaurants and hotels stopped accepting dollars.
When he got back, he asked me how I knew this was going to happen. My answer: I understood Gresham's Law. This is known as "bad money drives good money out of circulation." That summary is conceptually incorrect. In a free market, good money drives bad money out of circulation. This is Gresham's Law: "Currency that is artificially overvalued by the government drives out of circulation currency that is undervalued by the government." But that was too technical for my Democrat friend. It was way too technical for Richard Nixon.
INITIAL PUBLIC SUPPORT
The public loved this initially. A PBS special, Commanding Heights, reported:
Nixon's speech -- despite the preemption of Bonanza -- was a great hit. The public felt that the government was coming to its defense against the price gougers. The international speculators had been dealt a deadly blow. During the next evening's newscasts, 90 percent of the coverage was devoted to Nixon's new policy. The coverage was favorable. And the Dow Jones Industrial Average registered a 32.9-point gain -- the largest one-day increase up to then.
I joined the senior staff of the Foundation for Economic Education in early September. FEE's president, Leonard E. Read, was upset by the price controls. He resented the intrusion of the government into the system of free market pricing. But what really upset him was the fact that the controls were supported by the National Association of Manufacturers. The controls were also supported by the national Chamber of Commerce. Read had for years been a senior executive with the Chamber of Commerce. He knew the head of the organization. That man told him what a great idea the controls were.
As the controls began to affect the supply of goods and services, public opinion began to change. There was resentment against the shortages. Most people did not understand why there were shortages -- the controls -- but they did not like the effects.
Internationally, Nixon's decision regarding the end of the gold exchange standard had the opposite effect. He abolished the fixed exchange rate between gold and dollars and the fixed rates between the dollar and foreign currencies. He allowed floating exchange rates -- market pricing. This allowed the dollar to continue as the preferred international currency. The value of the dollar fell substantially in weeks, especially in relation to the Swiss franc, but it continued to serve as a medium of exchange. Gresham's Law did not affect the availability of dollars at market prices. People who had held dollars instead of foreign currencies lost a lot of their wealth, but the international currency system did not freeze up the way that the domestic economy froze up under the controls.
MONETARY INFLATION
America in 1971 was coming out of the recession of December 1969 to November 1970. The federal government had run back-to-back deficits of $25 billion: 1970 and 1971. In those days, that large a deficit was unprecedented in peacetime.
Nixon by then was a Keynesian, and had said so publicly the previous January. So was Arthur Burns, the Chairman of the Federal Reserve's Board of Governors. The FED was facing a problem. There was an escalating run on the Treasury's gold. The FED would be unable to expand the money supply for as long as the run on the gold continued. The more money that the Federal Reserve and the banking system created, the more that foreign governments and foreign central banks would demand gold at $35 an ounce. Gold was a fabulous bargain at $35 an ounce. So, the Federal Reserve's hands were tied.
Because Nixon closed the gold window, the Federal Reserve could continue to expand the money supply. In retrospect, the increase is barely visible.
This was not enough. A second recession hit in November 1973. It ended during Gerald Ford's term: March 1975.
Prices continued to rise. Early in his presidency, Ford announced a truly silly program called Whip Inflation Now, or WIN. Any American who sent in an idea to the White House on how to get prices to stop rising was sent a little metal WIN button. The recession took over as Ford's number-one economic concern, yet inflation was not whipped.
Keynesian theory at the time taught that there is a trade-off between price inflation and unemployment. In a recession, Keynesians taught, the national government had to spend more money, and the central bank had to expand the money supply. That would drive up prices, but it supposedly would reduce unemployment. The problem of the 1970's was this: the FED kept expanding the money supply, prices kept rising, but unemployment did not go away. The two recessions of the 1970's indicated that the Keynesian belief in the trade-off between price inflation and unemployment is conceptually flawed.
UNSHACKLING THE FED
Because foreign governments and central banks could no longer demand payment in gold at $35 an ounce or at any price, the gold remained on the books of the Federal Reserve at $35. In 1973, it was increased to an imaginary price of $42.22. But there was no threat to the Federal Reserve from foreign governments and central banks any longer. The Federal Reserve could expand the money supply, and no one could come to the Treasury to demand gold at a fixed price or any price.
This meant that the central bank could expand the money supply without legal restriction. All it had to do was buy the debt of the United States government. There is always plenty of that available. The borrowing increases, and no one expects to be paid. Everybody expects the debt of every national government to be rolled over without end.
The result has been a vast expansion of the on-budget federal debt. There has also been a comparable increase in the money supply, especially since 2009. The two go up together like a pair of drunks staggering home from a night on the town.
Had Nixon not closed the gold window, the United States government would have faced the problem of running out of gold. The solution to that for well over a century and a half was simple: stop creating fiat money. In other words, the central bank would have to stop funding the government's debt. That would have brought back a recession, but it would have solved the problem of the escalating on-budget debt. Nixon thought only in terms of the short term. (When Nixon thought "short term," he did not have in mind his own presidency.)
CONCLUSION
The closing of the gold window was the sixth pillar of America's welfare-warfare state. I have discussed all six here: https://www.garynorth.com/public/22584.cfm.
We have seen no reversal of either the warfare state or the welfare state. Both have been funded by the power of taxation, the ability to borrow from the private sector because of the power of taxation, and the expansion of the monetary supply by the Federal Reserve. The federal deficit continues to grow at rates undreamed of in 1971. So does the money supply.
It is clear where this is going to end: a great default. The federal government will be unable to deliver on its promises because it is going to run out of money at today's interest rates. It will not be able to borrow what it needs to continue to expand the welfare-warfare state.
Nixon kicked the can of both the welfare state and the warfare state on August 15, 1971. His successors have continued to kick that can. But the growth of the off-budget liabilities of Social Security and Medicare continues to expand more rapidly than the productivity of the American economy, and also at rates vastly exceeding the ability of future politicians to fulfill the promises to the American voters.
It would have been nice if Nixon had stopped kicking the can. It would have been a much smaller on-budget can today if he had. But, ultimately, Social Security and Medicare expenditures would still have been sufficient to overcome all monetary restraint that any post-Johnson administration could have adopted, other than cutting the promised benefits. Medicare is the 800-lb gorilla. Social Security is his 600-lb mate. She is pregnant.
"The wicked borroweth, and payeth not again: but the righteous sheweth mercy, and giveth" (Psalm 37:21).