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Forty years
ago, US dollar holders knew what their currency was worth. They could swap it
for gold
at $35 an ounce. Then along came President Richard Nixon.
BullionVault
has taken a trip to the archives, and looked at the days leading up to the
last great US 'default' – when Nixon ended the convertibility of
dollars to gold in 1971.
Tuesday, Aug. 3, 1971 –
Treasury secretary John Connally yesterday urged US banks not to follow the
Bank of Michigan, the Financial Times reported, after the small bank
raised its key lending rate from 6% to 6.5%.
Instead, US banks should look
to "hold prime rate down", said Connally, adding that,
"Further unjustified increases in interest rates, already historically
high, might well jeopardize the strength of business recovery."
Faced with recession, the Federal Reserve had
slashed its key interest rate to a 7-year low of
3.7% at the start of the year. But after slipping negative, real US interest
rates – allowing for the rate of inflation – had turned higher.
That meant tighter credit for US households and business. But what looked
(only a little) like strong money at home was doing nothing to support the
dollar, or reduce volatility, on the foreign exchanges.
Dollars continued to pour out
of Washington into foreign-reserve accounts overseas. So also on the Monday,
Germany's Bundesbank had set a 6% trading band on the Deutsche Mark versus
the dollar, selling the US currency at DM3.46 even as Deutsche Bank analysts
forecast a rise in the Dollar to the previous parity of DM3.66.
Currency confusion was hitting
commodities too, where the Financial Times said firm cocoa prices were
"even attributed to dollar weakness" by traders – as if weak
money could possibly wind up in high prices. Rubber had meantime fallen to
its lowest price since 1949. While sugar prices had turned higher in early
August, they'd been falling all year with "no scarcity" reported.
Closer to
home for FT readers, and thanks to that ongoing flood of dollars out
of Washington, the United Kingdom was meantime enjoying its fastest
foreign-reserves growth in five years, with gold and foreign-exchange reserves
reaching $3.8 billion – a 20-year high (if you allowed for the effect
of devaluation) – thanks to higher-still interest rates attracting
foreign capital.
Moreover, new capital controls
on British money, plus import tariffs, meant that food-price inflation in the
UK, which had forced retail prices over 10% higher from summer 1970,
"would soon abate" claimed the Financial Times. Such
policies worked, apparently. Just the kind of policies US President Nixon had
campaigned against – and abolished – during his first campaign
for the White House.
Thursday, Aug. 5, 1971 –
"Nixon softens attitudes to prices and incomes policy," announced
the FT, reporting from Washington on Wednesday that "President
Nixon startled everyone this morning [with an] impromptu press
conference."
Nixon "declared an 'open
mind'...a far cry from the obduracy shown...for the previous two and a half
years." But would domestic price caps and wage controls help the dollar
recover? "Pressure on dollar follows French currency curbs" said
the FT's front-page, reporting how Paris had banned its commercial
banks from growing their overseas debts in either francs or foreign currency.
France had also bought $50
million in gold from the US Treasury that Wednesday, delivering it to the
International Monetary Fund as part-payment of the $609m still owing from the
franc devaluation of 1969. France had now taken $250m in gold off the United
States in the "last few months." Its foreign-exchange reserves had
swollen by some $500m.
"The
effects of the moves spilled over into the gold market," said the FT,
"always a center of attention at times of currency upheaval." Gold traded in London had hit a
two-year high of $42.50 per ounce.
The United States Treasury
still obliged itself to swap gold for $35 per ounce, but only to its major
central bank counterparts, all of whom had promised not to demand metal for
paper.
Monday, Aug. 9, 1971 –
Alongside the round-up of IRA supporters in Ulster and a trades-union strike
over rising Metro fares in Paris, "US Treasury rejects a call for
devaluation" said the Financial Times, quoting a weekend
statement from Nixon's Treasury spokesmen, after the Reuss subcommittee in
Congress had called for the United States to follow Britain and France in
formally cutting its currency's exchange rate.
"That the Treasury felt
obliged to issue a formal 'denial' statement to the conclusions (not
unanimous) of a dim and more or less powerless Congressional subcommittee is
proof of the altered condition of the dollar.
"This
will be in evidence this week, when the US gold stock will drop to just over
$10,000 million, the lowest point since the early 1930s...There has naturally
been a revival of the traditional theory that when the gold stock hit
$10,000m, the US would simply close the gold window.
"There is no evidence
that the Nixon Administration plans such action."
Washington was busy in foreign
exchange, however, buying $862m worth of Belgian Francs and Dutch guilders
from the IMF to better suit their governments' preference for guaranteed
credits at the central-banks' central bank. Reports of French gold buying
continued, with the FT noting the "orthodox position" that
Paris would only take gold to pay off its IMF debts, rather than build its
own central-bank gold hoard. "[But] some commentators here [in Paris]
openly suggest it should do so and thus increase pressure on the Americans to
put their own house in order."
Three-month US Treasury bills
fell, pushing interest rates in the open market up to 5.37%.
Tuesday, Aug. 10, 1971 –
"Pressure on dollar – new d-mark peak" announced the FT's
headline writer, never dreaming that one day a cut-and-paste function would
enable him to repeat such disasters at the click of a button.
"The dollar crisis
intensified yesterday," said the paper, "with strong speculative
pressure once again centered on the d-mark and the Swiss franc." Gold
had hit highest price since the collapse of the London Gold Pool – the
ill-fated cartel in which the US, Germany, UK and France sold gold into the
open market, trying to suppress its price near the official peg of $35 per
ounce – in March 1968.
"Confusion in
N.York," the Financial Times went on inside, noting that although
"the Nixon Administration maintained its customary silence on the
difficulties of the dollar", what the paper called "well-founded
rumors" said the New York Fed would make an announcement concerning its
Dollar swap-line agreements with other central banks. Because after heavy use
throughout 1970, "a number of foreign Governments were no longer
prepared to accumulate dollars, with the Fed's assistance, in order to pay
off their international indebtedness," according to an un-named New York
Fed official.
What to do amid the confusion?
Switzerland banned what the FT called "speculative flows"
into the safe-haven Swiss franc – itself "already revalued to a
new fixed parity". The Swiss National Bank would now only take US
dollars deposited against corresponding deposits of Swiss francs on
"blocked accounts". The UK Government meantime continued
implementing official controls and tariffs on imports, while business chiefs'
lobby the Confederation of British Industry that day called on some 200
companies not to raise their prices by more than 5% for the next 12 months.
But in Washington?
"Problems of a parity change," explained John Graham, US editor for
the FT, meant that even doubling the official price of gold to $70 per
ounce might leave foreign-exchange rates untouched, creating no net
depreciation for US exporters, nor a devaluation in all those dollars piled
up overseas.
There was another solution for
Nixon's White House, however – "more ingenious and less
improbable...The gold content of the dollar is guaranteed only because the US
Treasury accepted an option in the late 1940s to buy and sell gold at $35 an
ounce," Graham told his readers. "The acceptance of this offer is
contained in a letter" from the then Treasury Secretary, clearly as keen
to support America's historic gold hoard as to support the post-War
fixed-exchange system agreed at Bretton Woods in 1944. Down in the detail,
and alongside all those governments not obliged to buy or sell gold, the
Treasury had to hold the dollar inside a 1% parity band. Because "The
[International Monetary Fund] rules that a country has an obligation
regarding exchange stability, and that a country whose authorities 'in fact freely
buy and sell gold within the limits prescribed' is fulfilling that
obligation.
"[But]
the US does not 'in fact freely' buy and sell gold, except in a narrow
technical sense. It is true that no monetary authority which has insisted on buying gold [from the US] has ever been
refused, but pressure of all sorts has been applied to reduce the likelihood
of such insistence."
Ergo, said Graham, revealing
what seemed a little-known solution, the US could disoblige itself of the
gold clause, but still stick within the Bretton Woods' rules by moving solely
to currency-to-currency parities instead.
Friday, Aug., 13, 1971 –
The headline writer said it all once more: "Dollar under pressure again...US
seeking study of wider currency bands...Gold active."
Reports in Germany said
Thursday that the Bundesbank wouldn't let the deutsche mark rise above 3.33
to the dollar – "a revaluation of virtually 10%" from the
agreed fixed-exchange rate parity. Indeed, for the first time since the
deutsche mark had been floated off its Dollar-parity in mid-May, the
Bundesbank had bought "a noticeable amount of spot dollars, reliably
reported at $39m" in the open market.
"This
helped to steady the market," said the FT, but "Gold
again attracted attention in fairly active dealings. The metal ended the day
at $43.30, a rise of 40c on the previous day."
Over in Washington, Nixon's
Treasury secretary – John Connally – had on Thursday asked the
IMF board "to study seriously the possibility of widening the official
bands around currency parities. A 3% margin has been suggested."
Currency traders weren't waiting for the politicians and central bankers to
agree, however, and "The New York foreign exchange market went wild
again this morning," said one of the Financial Times' US
correspondents.
"The only thing that
hasn't moved is the pound," the FT quoted a dealer at a major
bank, who described the session as "crazy".
"Although key European
currencies rose sharply in value against the Dollar, there was no sign the
New York Federal Bank, acting as the agent of the US government, had
intervened in the market." But Washington was intervening at the
political level, however, and with good reason.
"US warns Japan to speed
removal of trade barriers," said the FT – pointing to what
one historian, writing 35 years later, noted as a plain but little-recognized
fact of the 1971 dollar crisis: "Japan had [already] replaced Western
Europe as the target of America's economic complaints." Its go-go
economy was hoovering up foreign exchange so fast, the yen's fixed parity
rates couldn't hold. Tokyo added $4 billion to its reserves inside two weeks
that month, trying to maintain the ¥360-Dollar rate. But by the end of
August, Tokyo caved in. Another FT article that Friday reckoned there
was "No hidden magic in Japanese management" techniques. But its
export boom continued regardless, and the Nixon White House saw trade tariffs
as the culprit.
In contrast to the turmoil
elsewhere, "France reacts calmly to US currency margins bid" the FT
went on elsewhere. Because "The rounds of anti-speculative measures
taken last week has had the effect of putting France a little outside the
mainstream of the monetary crisis, as was the authorities'
intention...Dealings in foreign currencies have remained restricted to bona
fide commercial transactions." Exchange controls worked was the lesson,
or so the US was to claim that coming Sunday.
And the stock market?
"Dow jumps 12.6 with volume up 4.5m" reported the FT.
Whatever chaos was hitting the Dollar, equity buyers must have judged it good
news for risk.
Saturday, Aug. 14, 1971
– "Dollar ends week still under pressure...From Switzerland came
confirmation of the moves agreed with the banks to control hot money
flows...100% minimum reserves...In Frankfurt the dollar again reached new
lows...The gold market, however, was fairly quiet after a nervous start
[with] a fall of 25c on the day."
"The $ under pressure"
added a headline on page 12, just after the FT's weekly How to Spend
It pages, aimed then as now at City bankers looking for fine wines and
watches. "No one doubts that the objective must be to produce a more
realistic exchange relationship between the dollar and America's chief
economic partners," said the editorial piece below. "Either the
dollar changes its relationship to gold or all the strong currencies float or
revalue upwards against the dollar. But for the present both routes are barred."
Raising
the Dollar gold price
"has always been resisted [by the US] on the grounds that it is a
haphazard way of increasing world liquidity, that it would reward America's
enemies (particularly the Russians) and penalize her friends." With
pressure eased by the post-Gold Pool two-tier market – one private, one
for central banks – and as the Congressional sub-committee had said,
why not let gold float a little – say 10 or 15%...? It needn't cause
"massive disruption to the international system.
"But the chances of the
US administration submitting to this blow to its prestige in a pre-election
year is so remote as to be virtually non-existent."
Adrian Ash
Head of
Research
Bullionvault.com
You can Receive your first gram of Gold free by opening an
account with Bullion Vault : Click here.
City correspondent for The Daily Reckoning in London, Adrian Ash is
head of research at BullionVault.com – giving you direct access to investment
gold, vaulted in Zurich, on $3 spreads and 0.8% dealing fees.
Please Note: This article is
to inform your thinking, not lead it. Only you can decide the best place for
your money, and any decision you make will put your money at risk.
Information or data included here may have already been overtaken by events
– and must be verified elsewhere – should you choose to act on
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