The end of the Dollar Standard

Forty years ago, on August 15 1971, President Nixon announced the end of the Bretton Woods monetary system. No central bank would be allowed any more to exchange part or whole of its dollar reserves for gold. Only a few central banks (among others the Banque de France) had made use of that possibility but the fact that the usual reserve currency (the US dollar) could be exchanged for gold (at the rate of 35 dollars an ounce of gold) meant that the global (Western) economic system rested on a solid guarantee, on an ultimate security. It had been the secret of the stability of the post-war economy. Whithout it, no "Trente Glorieuses" as the French call the thirty years of ecomic recovery and impressive growth which followed the end of the Second World War.

But at the end of the 1960's the amount of dollars circulating in the world was by far exceeding the amount of dollars of 1944, when the exchange rate of Bretton Woods had been fixed. The American market was by now largely importing manufactured goods from Western Europe or Japan; the financing of the nuclear arms race and of the Vietnam War meant an increasing public deficit; and the outflow of dollars necessary to the financing of the international economy was weakening the dollar further and contributed to the emergence of other strong currencies (the deutsche mark or the yen). The crisis of the dollar had been lasting for seven years already when Nixon was elected in 1968. And the most obvious answer to the American currency problem should have been the organisation of a new international conference leading to an adjustment of exchange rates. But Richard Nixon decided to take another path.

First, this was a question of prestige: how could the United States accept a devaluation of the US dollar? And this in favour of Germany and Japan, the two countries that had been crushed by American military forces in WW2 and then allowed to rebuild their manufacturing power through the generosity of the winner? Secondly it was a question of power. Since the United States held the international reserve currency why should they share this unique privilege with others? Any international conference on monetary matters, would have either led back to the Gold Standard as it had existed before the First World War or to the creation of an international currency unit, a "basket" made up of the strong currencies in the world; in either case the USA would have been recognized further as a "primus inter pares" but would not have been any more the unique world leader as under Franklin Delano Roosevelt.Thirdly, there was the Cold War. Washington was able to reject any challenge to its leadership in the name of the necessary unity of the Free World against Communism. Did any of the NATO or SEATO allies of the United States feel like giving up the American security shield (even De Gaulle's successors gave up his quest for French autonomy inside the Western alliance)?

These are the reasons behind President Nixon's announcement, on August 15 1971, that the United States would cease to guarantee the exchange rate of 35 dollars for an ounce of gold. At first sight it was a unilateral decision, a monetary "coup d'Etat". Instead of negotiating with their allies the United States had implemented John Connally's formula: " The US dollar is our currency and it is your problem".But it was soon clear that Washington's Allies would agree with President Nixon's decision. Visiting Washington in December 1971, President Pompidou of France gave up De Gaulle's fight for a fair international currency system; even if France had remained faithful to its tradition of monetary stability, it is hard to imagine how Germany or Japan, the vanquished powers of 1945, would have dared challenge the United States. And all other Western countries were scared of losing their protector against the Soviet military power.

The end of Bretton Woods was then the result of an international agreement, confirmed in December 1971 (through the so called Smithsonian agreement). It is very important to bear in mind that the international community of nations has to take together with the United States the responsibility for the tragic consequences of the destruction of Bretton Woods, which are becoming fully apparent forty years later. And the way out will have to be found through an international agreement.

The US dollar was from 1971 on accepted by all free nations as the unique reserve currency of the world while gold's monetary function was abolished. The dollar was never officially devaluated but this was the end of fixed exchange rates. From 1971 on American deficits steadily increased but they were accepted as a way of financing the global economy.

At first sight, Richard Nixon's decision had many positive consequences.

Still now most economists praise the fact that thanks to Bretton Wood's end the world economy got rid of the Gold Standard's last remnants. The main stream view about the Gold Standard has been very negative for decades: it has been denounced by Liberals and Conservative alike as a deflationist system, depriving the economic system of the amount of money it needs to secure a steady growth.

There is no room here to bring a more balanced view (see Husson/Palma, Le capitalisme malade de sa monnaie, Paris, 2009) as far as the pros and cons of the Gold Standard (of the 19th century) are concerned; let us just state that the consequences were ambiguous in the long term. The 1970's saw the peak but also the decline of the Welfare State: that decade's massive inflation, which was a direct consequence of Bretton Wood's demise, brought the end of Keynesianism and, in the 1980's, the delegitimation of any social public expenditure.

But let us come back to the apparently happy consequences of the fiat currencies' reign and of the Dollar Standard. In the 1980's the United States were able to bring the Soviet Union to its knees largely thanks to their capacity to finance the arms race apparently without restraint. Mikhail Gorbatchev was wise enough to give up the arms race in the middle of the 1980's at a time when the United States seemed able to invest as much as would be necessary to overcome the Communist military threat.

Of course the United States would have been unable to increase their defense effort under Reagan without international investors'massive buying of American T-Bonds. But who would not have been delighted at the fact that one of the most terrible dictatorships in world history collapsed peacefully, unable to sustain any further nuclear arms race. That the Cold War -and especially the Reagan years - had made the American economy hugely dependent on public defense expenditure to keep a dynamic of its own would become clear only at the beginning of the "New American Century".

Just after the collapse of the Soviet Union the Dollar Standard seemed to be the best monetary system ever. It let the globalization wave of the 1990's happen. This was the decade of free trade, of the new web-economy. A new economic giant was born, China, financing largely its growth through the purchase of US Treasury Bonds. That the American economy became even more dependent on foreign investment did not seem to be a problem as long as the United States remained apparently the most creative country in the world, the land of the Silicon Valey, of Microsoft, Apple and Google, of CalTech and Harvard; a place where there was no limit to free entrepreneurship and active individualism.

That the reality was more complex became clear in the following decade. The important thing about Irak was not that a bad guy (George W.Bush) had succeeded the cool guy Bill Clinton: but that it became clear clear that the American economy was financing its military system 50 million dollars an hour; or, better said, that international investors were keeping the American industrial-military complex thriving long after the Communist danger had disappeared. Were the global war against terror and the Irak conflict anything else than the quest for a substitute Cold War the American economy had become dependent (or even addict) on to maintain jobs in a more and more desindustrialized country? That China and other emerging countries had accelerated the desindustrialization process of the country became even more obvious and the question of protectionism came back in the 2008 presidential campaign.

What triggered the ultimate crisis of the dollar standard still more than the undecisive Afghanistan and Iraq wars was the collapse of the subprime system in 2007. What was seen as a relatively unexpected event was actually the last episode of the dollar crisis which Nixon's decision in August 1971had temporarily concealed.

The amount of dollars in circulation has been steadily increasing for the last four decades. It means that the real value of the dollar has been constantly decreasing. International investors, in order to compensate for the potential debasement of the dollar, have regularly reinvested their dollars into the US economy. Hence the successive bubbles since 1987: giant amounts of dollars have been put at the disposal of the private equity market, of the Net-economy, of the American housing market and every time a spectacular collapse of the market has followed. With every crash the reality became more obvious: the American currency was overvalued and its role as the single international reserve currency could be challenged.

The debt ceiling crisis of 2011 between the White House and the Congress is due to two factors: radical Republicans are slowly realizing that America's evergrowing indebtment is destroying the very substance of the country. President Obama on the other side is becoming increasingly aware that the international confidence in the Dollar Standard is weakening.

After 40 years the question is: was Richard Nixon's gamble worth it? If you have a look at the global economy it is easy to list all the problems created by the emergence of the dollar as the single world reserve currency: the permanent instability of the oil price since 1973, the Third World debt crisis in the 1980's, the permanent geographical instability of investments, the growing discrepancy between higher and lower incomes worldwide. All these questions would deserve a longer analysis but our point today is to make our readers aware of the global danger awaiting us.

For four decades the global economic system has been resting on an illusion: that America's deficits were not that bad because they were feeding the global growth. Fourty years after Nixon's monetary revolution the global economy is trapped: the reduction of American deficits could lead to a worldwide recession of unheard dimensions.

It would be childish to scapegoat the United States: exactly as all would have been concerned by an American default these days, all are concerned by the awaiting final collapse of the Dollar Standard. The Chinese and the Japanese own a huge amount of potentially worthless dollars; the euroland's crisis would be relatively easy to master without the international fear of a global systemic collapse. There is no other way out of the incoming catastrophe than an international currency conference. It has been suggested many times by China, Russia and France for the last two years. It is time to follow their advice and to act. And before a new stable international monetary system can emerge, the first emergency would be to create an International Currency Unit. A monetary basket made of US dollars, British pounds, euros,yens,yuans plus an amount of gold, in order to stabilize the international exchanges.

Some of my countrymen are currently tempted by what they call "deglobalization" ("démondialisation"). It would be a political mistake: because of its ancient and regular contribution to the strengthening of universal values, France cannot step down from history when the creation of a new global monetary standard is at stake. It would be a major economical mistake too: no part of the world will be able to resist on its own the collapse of the Dollar Standard. The only way out is a collective effort. The destruction forces are already underway. No major country can therefore withdraw from the global effort to recreate a sound monetary system. Certainly not France, the country of Jacques Rueff, one of the few economists who foresaw the disaster that the decision of August 1971 would lead us to.