Most Americans will probably not recognize immediately the significance of August 15, 1971, in the history of global finance and international economics. Former Office of Management and Budget Director David Stockman, in his splendid book, The Great Deformation, cites this date as the beginning of an era of "fiat money." Bertrand Badré, the new CFO of the World Bank (and formerly the CFO at the French bank Société Générale), says that we are now at the close of a 42-year era that began on August 15, 1971.
So what happened on that late-summer day? It was a Sunday, and President Richard Nixon suspended convertability of the US dollar into gold, effectively ending the 25-year Bretton Woods era of fixed currency exchange rates against the US dollar. US gold reserves were facing enormous pressure due to balance of payment concerns, the Vietnam War debt and Great Society programs, and the ensuing monetary inflation. A growing number of countries began to redeem their dollar holdings for gold.
France sent a warship to New York harbor in early August 1971 with instructions to bring back its gold from the New York Federal Reserve Bank. It was, after all, French President Charles de Gaulle who remained consistently skeptical about the US dollar, saying at a press conference on February 4, 1965, that it was impossible for the dollar to be "an impartial and international trade medium . . . It is in fact a credit instrument reserved for one state only." (Cited in Benn Steil's The Battle of Bretton Woods. Princeton University Press, 2013.) After August 15, 1971, the value of the dollar floated against other major currencies, thereby relieving the pressure on the world's major reserve currency but also removing the earlier discipline to use that responsibility carefully.
I was in Europe during that period and had just finished a two-month internship with the Crédit Lyonnais bank's foreign-exchange division. Some ten days before I left the bank, my boss, who knew I planned to spend two weeks traveling around Europe before returning to college in the United States, told me that he was, for the first time, seeing unusual behavior in the foreign currency markets. He wasn't sure what was happening but suggested that I buy traveler's checks in Deutschemarks before beginning my travels. I was 20 years old, and he had 20 years of experience, so I followed his advice and converted my French francs and US traveler's checks into Deutschemarks a few days before August 15.
Nixon's decision created immediate uncertainty about the dollar's value, and I actually saw some currency exchanges refuse to accept US dollars for a few days. Fortunately, I breezed through with my Deutschemarks, but this experience left two lasting impressions. First, I'd actually seen people refuse to accept the Almighty Dollar. Second, I have for years believed that I experienced a watershed event but didn't appreciate its overall significance.
Stockman and Badré make clear the long-term consequences of Nixon's decision. On the positive side, freeing the dollar from the gold standard unleashed a 40-year period of leveraged debt finance that brought global prosperity and higher living standards for millions of people, accompanied, occasionally, by bouts of inflation and crashing asset bubbles. On the negative side, the United States was able to live beyond its means through annual budget and trade deficits, a growing national debt that now approaches $17 trillion, and Federal Reserve quantitative easing that enables the borrowing binge. Neither Stockman nor Badré is urging a return to the constraints of the gold standard -- constraints that would unduly restrict global trade. Nonetheless, they both believe strongly that we need a new system -- a new backstop -- that will discipline what has now become a profligate flood of dollars in our debt-driven global economy.
While the US dollar remains the global reserve currency, cracks in the edifice are now apparent. How much longer will countries like China and Japan finance our annual deficits? When the Federal Reserve's current policy of near 0 percent interest rates ends, how much will we have to spend out of current consumption to finance nearly $17 trillion of debt? Our current unfunded obligations, depending on whether you believe former US Comptroller General David Walker ($70 trillion) or Boston University's Larry Kotlikoff ($200 trillion), are clearly destabilizing and unsustainable. Nonetheless, our political leaders seem incapable of addressing the longer-term structural problems, and we lurch from one asset bubble to the next with only short-term fixes occasioned by a shutdown fight or another debt-ceiling deadline.
The Bretton Woods system imposed needed discipline. World currencies traded against a US dollar that, in turn, had a fixed price against gold of $35 an ounce. At issue now is whether current world leaders have the attention span, the depth, the policy experience, and the political courage to determine what the successor structure to Bretton Woods will look like. Some observers have pointed to the possibility of a new international reserve currency under the auspices of the International Monetary Fund. Countries such as China have already called for a weighted "market basket" of international currencies that would ultimately replace the US dollar. Whatever the new structure is, it is clear that such a structure is needed if we are to end the destabilizing tendencies of the last 40 years. One such destabilizing example is the buildup of global trade imbalances between the United States and China, which occasionally triggers spats between both countries. The United States claims that China is manipulating its currency, while the Chinese lecture the United States about the need to live within its means and address its own structural deficit.
During the last 42 years, the United States has enjoyed the privilege and the benefit of having the world's major reserve currency, but it has also behaved in a profligate manner that reflects a continuing addiction to debt. Former Federal Reserve Chairman William McChesney Martin used to say that the job of the Federal Reserve was to "take away the punchbowl just as the party gets going." With near zero interest rates for more than five years, the party is underway, but there will come a point in the not-so-distant future when the punchbowl disappears and everyone will be looking for what happens when it is time to sober up.
Charles Kolb is President of the French-American Foundation--United States in New York City. He served in the first Bush White House from 1990 - 1992 as Deputy Assistant to the President for Domestic Policy and at the Office of Management and Budget from 1983 - 1986. From 1997 until 2012 he was president of the Committee for Economic Development, a Washington, D.C.-based think tank. The views in this article are solely the author's.
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