On August 15, 1971, the last remains of what had been a magnificent monetary system died a terrible death, and the American academic, political, business, and media elites led the cheers. The Dow Jones Average jumped by more than 32 points the next day. A de facto national default was spun as a great liberation from a tyrannical financial arrangement that had plagued humanity for generations. A half century later the disinformation continues, as intellectual bankruptcy parallels the financial bankruptcy of that event.
I write, of course, of the decision by President Richard Nixon to officially close the “gold window,” through which the US government was obligated to sell its gold stores to foreign governments at $35 an ounce, which even then was a bargain. As Nixon’s regime encouraged the Federal Reserve System to inflate the dollar to pay for its bloated military and welfare spending, as had the Johnson and Kennedy regimes before him, it became apparent that the US dollar was quickly losing value. The United States was in rapid decline—and the dollar was falling with the nation’s prestige.
What happened? There are several accounts, and I will give the main ones, ending with the Austrian perspective. The first will be the Keynesian, the second the monetarist (Chicago school), the third the supply-side version, and the fourth from the Austrians. Before doing that, however, I will give a brief account of the events that began with the Bretton Woods Conference in 1944 and ended in national disgrace, an ignominy that even now the official American narrative refuses to recognize.
The Bretton Woods Conference didn’t occur in a vacuum. Just a month before, Allied troops had secured a beachhead in France and had begun to slowly push the German army eastward. Across the European continent, armies from the Soviet Union were slowly destroying the Axis forces from the other direction. In the Pacific, US bombers were beginning to lay waste to Japanese cities, and the Japanese armies were suffering defeat after defeat. Final victory for the USA and its allies would not come for another thirteen months, but even in July 1944, it was clear how the war would end.
The US State Department explains the stated purpose of the conference: to help reestablish trading relations in the postwar world:
The lessons taken by U.S. policymakers from the interwar period informed the institutions created at the conference. Officials such as President Franklin D. Roosevelt and Secretary of State Cordell Hull were adherents of the Wilsonian belief that free trade not only promoted international prosperity, but also international peace. The experience of the 1930s certainly suggested as much. The policies adopted by governments to combat the Great Depression—high tariff barriers, competitive currency devaluations, discriminatory trading blocs—had contributed to creating an unstable international environment without improving the economic situation. This experience led international leaders to conclude that economic cooperation was the only way to achieve both peace and prosperity, at home and abroad.
Some cynicism can be excused if one sees a disconnect between the high-minded rhetoric of the document and the actual policies of the Wilson and Roosevelt administrations that played a major role in creating the calamities from 1917 to the end of World War II. But then, it is a rare occurrence when government bombast and the truth intersect. Not surprisingly, Bretton Woods was an attempt by governments to deal with the previous disastrous results of intervention by imposing even more intervention.
In his classic What Has Government Done to Our Money, Murray N. Rothbard (who will figure heavily in my interpretation of the August 15 events) describes the Bretton Woods Agreement:
While the Bretton Woods system worked far better than the disaster of the 1930s, it worked only as another inflationary recrudescence of the gold-exchange standard of the 1920s and—like the 1920s—the system lived only on borrowed time.
The new system was essentially the gold-exchange standard of the 1920s but with the dollar rudely displacing the British pound as one of the “key currencies.” Now the dollar, valued at 1/35 of a gold ounce, was to be the only key currency. The other difference from the 1920s was that the dollar was no longer redeemable in gold to American citizens; instead, the 1930’s system was continued, with the dollar redeemable in gold only to foreign governments and their Central Banks. No private individuals, only governments, were to be allowed the privilege of redeeming dollars in the world gold currency. In the Bretton Woods system, the United States pyramided dollars (in paper money and in bank deposits) on top of gold, in which dollars could be redeemed by foreign governments; while all other governments held dollars as their basic reserve and pyramided their currency on top of dollars. (p. 99)
To put it another way, the Bretton Woods Agreement really was a scheme to give the appearance of “sound money” all the while ensuring that the sound money regime that existed prior to the outbreak of World War I would not be reinstituted. Furthermore, Henry Hazlitt, who then was writing editorials for the New York Times (how the mighty have fallen!), saw through everything and predicted that the new monetary arrangements would lead to disastrous consequences. He wrote:
The greatest single contribution the United States could make to world currency stability after the war is to announce its determination to stabilize its own currency. It will incidentally help us, of course, if other nations as well return to the gold standard. They will do it, however, only to the extent that they recognize that they are doing it not primarily as a favor to us but to themselves.
But Hazlitt knew that governments in 1944 were institutionally incapable of returning to sound money and that the elites in government, academe, and the media were hostile to anything but fiat money. Ultimately, Hazlitt and the NYT would part ways over his disagreements with the Keynesian economic views of the era. The NYT would continue to endorse monetary socialism and today features Paul Krugman, who has all but endorsed the money printing of modern monetary theory. In other words, Hazlitt predicted the demise of the Bretton Woods accord twenty-seven years before it officially collapsed.
As previously noted, the US dollar was set as the world’s “reserve” currency and it was set at $35 per ounce of gold, which meant that foreign governments and central banks could purchase US gold at that price if they wished to redeem their dollars on something other than dollar-denominated goods and assets. Rothbard points out that because the agreements set the currency exchange values at prewar levels, the dollar was undervalued and European currencies overvalued, thus increasing the demand for dollars.
(For reasons of length, I do not cover the Marshall Plan and how international monetary policies fit into trying to make it work. Suffice it to say the Marshall Plan has been given far too much credit for Europe’s postwar recovery. In many instances, it actually impeded recovery and it was only after the governments of Western European nations eased the economic controls set during Nazi occupations that Europe had a true economic recovery.)
The purposeful devaluing of the US dollar provided incentives for the Federal Reserve System to inflate the dollar, which it did in the postwar years and beyond (and is doing with a vengeance today). Because the law forbade Americans from buying and owning gold (with some exceptions for jewelry and official coin collections), the US government did not have to worry about its inflationary policies creating a domestic run on its gold reserves. That would not be the case overseas, however.
American economists and politicians embraced Keynesian theories that emphasized expansive government programs financed through deficit spending. The few dissenters such as economists Ludwig von Mises and F.A. Hayek were dismissed as “mossbacks” and “reactionaries,” as the American media, academic, and political establishments saw the New Economics as a gateway to easy prosperity.
European governments, and especially the French government led by Charles de Gaulle (who was advised by the classical gold-standard economist Jacques Rueff), by the 1960s began to purchase US gold in earnest. In the early postwar years, it made sense to hold officially undervalued dollars, but in less than two decades, the dollar had become hopelessly overvalued relative to most European currencies. Lyndon Johnson’s Vietnam war and his Great Society welfare programs had to be financed, and the government chose inflation. Buying US gold at what was a bargain price was a way that foreign governments could do an end run around a monetary exchange system that was becoming increasingly unbalanced.
In 1968, the US government tried to put together a stopgap measure to stop the gold hemorrhage. (Rothbard goes into the details of the measures, noting that they were doomed to fail because they were based upon faulty economic analysis.) By trying to sever the link between the US dollar and gold sold on the free market, the Johnson administration claimed that the new measures would force down the price of gold to less than $35 an ounce, making US stores an unattractive buy.
As any competent Austrian economist would predict, however, the runs on US gold did not diminish but rather intensified, and by the summer of 1971, the US economy was stagnant, prices were rising, and President Nixon on August 15 announced his “Phase One” economic plan of price controls and temporarily closing the gold window. Again, any competent economist would know that this move would end in failure, but the move initially was popular in the media and with the public. Gene Healy writes:
There was no national emergency in the summer of ’71: unemployment stood at 6 percent…. Yet, after Nixon’s announcement, the markets rallied, the press swooned, and, even though his speech pre‐empted the popular Western Bonanza, the people loved it, too—75 percent backed the plan in polls.
On the monetary side, the next step was the implementation in December of the Smithsonian Agreement, which raised the official price of US government gold to $38 an ounce and allowed some flexibility in the fixed exchange rates, but in the end, the combination of US inflation and economic stagnation on the home front would lead to the total collapse of fixed rates. By 1973, the dollar was hopelessly overvalued and ultimately the present system of floating exchange rates prevailed.
One of the most famous statements to come from this episode of “Nixon Shock” was the president’s statement to his advisers, “We are all Keynesians now.” It also was the most accurate statement anyone in the government would make. In one action, Nixon cut ties to gold, what J.M. Keynes had called “that barbarous relic.” The devaluation of the dollar would help exports, and Nixon saw government intervention as necessary to “balance power” between labor unions and corporations.
In fact, his Federal Reserve chairman, Arthur Burns, already had announced his fealty to Keynesian economics, and Nixon himself had surrendered any previous notions of free markets to Keynesian-inspired policies. The PBS Commanding Heights series reported:
[W]hatever the effects of the Vietnam War on the national consensus in the 1960s, confidence had risen in the ability of government to manage the economy and to reach out to solve big social problems through such programs as the War on Poverty. Nixon shared in these beliefs, at least in part. “Now I am a Keynesian,” he declared in January 1971—leaving his aides to draft replies to the angry letters that flowed into the White House from conservative supporters. He introduced a Keynesian “full employment” budget, which provided for deficit spending to reduce unemployment. A Republican congressman from Illinois told Nixon that he would reluctantly support the president’s budget, “but I’m going to have to burn up a lot of old speeches denouncing deficit spending.” To this Nixon replied, “I’m in the same boat.”
Whatever fiscal discipline Nixon had promised during his political campaign was out the window. Even if his enemies in the academic and political worlds (and they were legion) would always hate him, nonetheless he was giving them what they always had wanted: government control of the economy. Not surprisingly, while his policies were politically popular at the beginning, the 1970s ultimately became known for stagflation (simultaneous increases in unemployment and inflation—something Keynesians claimed was impossible), gasoline and natural gas shortages (due to price controls), and a general feeling of despair.
Democrats ultimately would drive Nixon from office three years later, but they endorsed his economic policies, and especially his penchant for price controls. President Jimmy Carter would push his wage-price “guidelines” in an unsuccessful attempt to bring down double-digit inflation, and when Senator Ted Kennedy ran for the Democratic nomination in 1980, he made price controls the centerpiece of his economic policies.
Ironically, Carter and the Democrats did embark on a supply-side venture of their own, deregulating the financial and transportation sectors and laying the groundwork to deregulate telecommunications. Thus, the party of the New Deal actually undid part of the legacy of Franklin Roosevelt—and actually provided a long-run boost to the economy, all the while being ignorant of their accomplishments.
While the group of economists that called themselves supply-siders raised important issues about how government intervention into the economy was causing stagflation and other economic ills, nonetheless their statements on Nixon’s actions were shortsighted. During the 1980 presidential campaign in which Ronald Reagan cast his lot with supply-side economics, Jack Kemp, who championed the supply-side policies in Congress, declared that Nixon’s error had been to go to floating exchange rates instead of holding to the fixed rates of the Bretton Woods accord.
Nixon’s actions, as dishonest as they were, did not occur in a vacuum. Holding to fixed exchanged rates and a (very) modified gold standard would have required the kind of fiscal and monetary discipline that had not existed in Washington since the Great Depression and certainly was not going to begin in August 1971. We should be clear: Nixon did not unilaterally destroy a productive arrangement. Nixon’s actions unwittingly exposed the bankruptcy of US government policies even though he would spin it as the US fending off an unjustified foreign attack on the dollar and on US gold supplies.
During the era of the international gold standard that fell apart in 1914, currency rates were fixed, but not against each other but rather to a measure of gold. Any attempts to game the system—as the US government did on a regular basis in the postwar years—would have quickly been detected, with gold outflows ultimately helping to counter cheating. Although the Bretton Woods accord was created to emulate the old gold standard with its fixed rates, it ultimately failed because governments are destructive. By summer’s end of 1914, the governments of Europe had gone to war and destroyed an international gold standard that took decades to build. In 1971, governments armed with Keynesian dogma laid waste to an economic system almost as surely as the Guns of August brought Western civilization to its knees.
When Nixon announced the imposition of wage and price controls, Milton Friedman of the University of Chicago loudly denounced them as an “utter failure.” However, as Rothbard wrote, Friedman was not unhappy to see the last ties of the dollar to gold broken. As an outspoken advocate of floating fiat exchange rates, Friedman for years had denounced gold ties to the dollar, as Rothbard explains:
Since the United States went completely off gold in August 1971 and established the Friedmanite fluctuating fiat system in March 1973, the United States and the world have suffered the most intense and most sustained bout of peacetime inflation in the history of the world. It should be clear by now that this is scarcely a coincidence. Before the dollar was cut loose from gold, Keynesians and Friedmanites, each in their own way devoted to fiat paper money, confidently predicted that when fiat money was established, the market price of gold would fall promptly to its nonmonetary level, then estimated at about $8 an ounce. In their scorn of gold, both groups maintained that it was the mighty dollar that was propping up the price of gold, and not vice versa. Since 1971, the market price of gold has never been below the old fixed price of $35 an ounce, and has almost always been enormously higher. (pp. 109–10)
In Friedman’s defense, the floating exchange rates didn’t cause the inflation of the 1970s. However, those floating rates imposed no financial discipline on the US government, and when things went south presidential administrations blamed foreign governments. When the dollar fell against European currencies in 1978, President Carter signed off on a scheme in which the Federal Reserve System underwrote a massive purchase of dollars in order to prop up the currency. Not surprisingly, the arrangement failed to strengthen the dollar over time.
While Keynesians and monetarists might look down on gold as money (or any monetary ties to gold), Austrians are not afraid to face the ridicule from elites. More than anyone else, however, Austrians such as Rothbard understood completely what was happening in 1971, and they were not fooled by the government’s various monetary tricks as were others. Rothbard writes:
All pro-paper economists, from Keynesians to Friedmanites, were now confident that gold would disappear from the international monetary system; cut off from its “support” by the dollar, these economists all confidently predicted, the free-market gold price would soon fall below $35 an ounce, and even down to the estimated “industrial” nonmonetary gold price of $10 an ounce. Instead, the free price of gold, never below $35, had been steadily above $35, and by early 1973 had climbed to around $125 an ounce, a figure that no pro-paper economist would have thought possible as recently as a year earlier.
Far from establishing a permanent new monetary system, the two-tier gold market only bought a few years of time; American inflation and deficits continued. Eurodollars accumulated rapidly, gold continued to flow outward, and the higher free-market price of gold simply revealed the accelerated loss of world confidence in the dollar. (pp. 104–05)
The American economy and the dollar rebounded during the 1980s in part because of lower tax rates and in part because of the deregulatory efforts instituted by the Carter administration. Unfortunately, the favorable economic conditions did not lead to fiscal soundness, but, instead, seemed to encourage even more reckless behavior in Washington. For the last twenty-two years, the economy has seen one financial bubble after another: first the tech bubble of the late 1990s, then the housing bubble that burst in 2008, and now a combination of housing and equities seems to be rising well out of synch with market fundamentals.
As they did in 1971, the elite economists of our day are the cheerleaders for fiscal foolishness. Lest one believe I am exaggerating, this is from a recent column by Paul Krugman in the New York Times, which lost its way editorially after the editorial leadership pushed out Henry Hazlitt. Endorsing the so-called Infrastructure Bill, Krugman writes:
Imagine, to use a round number, that the federal government were to go out right now and borrow $1 trillion—and that it were to do so without making any provisions for servicing the additional debt. That is, it wouldn’t raise any taxes or cut any spending to pay off the principal; it wouldn’t even do anything to cover interest payments, simply borrowing more money as interest came due.
Under these circumstances the debt would grow over time. But it wouldn’t grow very fast: The current interest rate on long-term U.S. debt is less than 1.2 percent, so after a decade the debt would have risen only about 13 percent.
And debt growth would be vastly outpaced by growth in the economy: The Congressional Budget Office projects a 50 percent rise in dollar G.D.P. over the next 10 years. Debt wouldn’t snowball; relative to the economy, it would melt.
So the fact that the infrastructure bill would, in practice, pay for public investment with borrowed money isn’t anything to worry about. If the investment is worth undertaking—and it is—we should just do it.
One can imagine that Krugman would have championed Nixon’s moves, from abrogating the Bretton Woods Agreement to imposing wage and price controls. To a Keynesian like Krugman and those that came before him, the economy works best when governments spend recklessly with no constraints.
Austrians know better. The collapse of the monetary order in 1971 reflected the massive dislocations and malinvestment of resources that ultimately turned the decade into one crisis after another, and the current economy is facing risks of even greater magnitude. Unfortunately, Keynesians rule the day, just as they did fifty years ago. As Charles-Maurice de Talleyrand wrote of the Bourbons in the years after the French Revolution, “They learned nothing, and they forgot nothing.” One can say the same for the Keynesians. A half century after The Crisis, Keynesians seem hellbent on creating new crises and printing money to “fix” them.