In the spring of 1945 the United States
emerged after the Second World War as the preeminent global power. The two
previous empires, France and Britain, were devastated after the war and played
minor roles in the management of global affairs. Since then, the United States
faced only two major deterrents in its global hegemonic ambitions: nationalist
movements in the Third World and the Soviet Union. The United States exerted
its power in the world by leading militarily and economically. Along with
Britain, it led the creation of the framework for managing the global monetary system
called the Bretton Woods (named after the conference of forty-three countries at
Bretton Woods, New Hampshire in 1944). The pith of the U.S.-led system was the fixing
of exchange rates of the major currencies to the dollar; and the dollar, in
turn, was tied to gold at the guaranteed U.S. price of $35 per ounce. Because
the United States possessed sixty percent of the world’s gold, fixing the rate
of exchange to the dollar became de facto policy. The dollar became the source
of global monetary reserve.
In the United States, the Great Depression
of the 1930s was the adverse consequence of its decades long unregulated financial
sector. After World War II, Britain and the United States responded to the
financial crisis by deciding to tightly regulate the global financial sector
and created a system in which major currencies were tightly managed in order to
cut back speculation. Also, they restricted the flow of capital. The Bretton
Woods’s founders, Harry Dexter White and John Maynard Keynes, designed a
monetary system that could protect against competitive currency manipulations
and exchange controls. The new economic system proved effective in managing global
finance and trade. For over twenty years, the Bretton Woods underpinned a world
economy that was stable and prosperous. Under this system, between 1945 and
1971, developing countries did not experience any banking crisis.[1]
This all changed on 15 August 1971 when President
Richard Nixon and his Treasury Secretary John Connally decided to close the
gold window. The president ordered Connally to suspend all sales and purchases
of gold (to the misgivings of some important figures in his economic team like
Paul Volcker and Arthur Burns). The act cancelled the convertibility of the dollar
to gold, which was the staple of the Bretton Woods system. The Bretton Woods
did not long survive Nixon’s policy that by 1973, it was completely finished.
The consequences were dire. The closing
of the gold window put the private sector at foreign exchange risk. Until then,
the private sector was protected as governments maintained fixed exchange rates
tied the dollar, and the dollar to gold. Foreign exchange was stable – only
minimal speculation against currencies existed and thus, there was no need to
have large-scale currency dealing facilities in Wall Street that exists today. With
the demise of Bretton Woods, exchange rates fluctuated significantly. (As a
point of contrast, in 1971, as pointed out by two economists John Eatwell and
Lance Taylor, there were only eleven Wall Street banks that traded in foreign
exchange markets. By the late 1990s, when speculation against currencies became
rampant, there were nearly two hundred major foreign exchange trading
institutions doing business at Wall Street).[2]
In addition, the demise of Bretton Woods
precipitated the free-flow of capital. In 1973, Canada, Germany, and Switzerland
eliminated restrictions on capital movements. A year later, the United States
followed suit. Years later, other countries joined in: Great Britain in 1979;
Japan in 1980; France and Italy in 1990; Spain and Portugal in 1992.[3] The governments of these advanced
industrial nations were induced to eliminate capital controls in order to hedge
against the cost of fluctuating exchange rates on the private sector. Risk was
no longer supported by the public and was privatized.[4]
The privatization of risk imposed strains
on the domestic and global financial systems. Speculation against currencies
soared. It precipitated the creation of exotic financial instruments that
required the removal of regulatory barriers that obviated risk. The result of
this new financial system has been a world that is rife with major financial
crises. Lewis Lehrman, writing for The Wall
Street Journal on the fortieth anniversary of Nixon’s new economic policy,
described the result of his decision: “The ‘Nixon Shock’ was followed by a
decade of one of the worst inflations of American history and the most stagnant
economy since the Great Depression. The price of gold rose to $800 from $35.”
Moreover, the purchasing power of the dollar in 1971 declined to $0.18 by 2010.[5] The rest of the world felt the tremors
of financial crises; one region after another: Latin America’s Southern Cone in
1979-81; the Third World debt crisis of 1982; Mexico in 1994-95; Asia in
1997-98; Russia 1998, and Brazil in 1999.[6]
Eatwell and Taylor characterized this
series of global financial crises as:
This means that when a person opens a
savings or checking account at a local bank, it may be based on bad debt from
anywhere in the world.
One notable problem in the financial
sector that proliferated as a result of the unregulated financial market is
what economists termed “systemic risk.” Systemic risk, otherwise known as externality,
is the adverse side effect to society at large stemming from financial transactions
between firms. For example, when a firm sets up factory that belches out dirty
smoke in a town, it may make a good profit for the business and the town, but
the externality from the factory - the smoke and the pollution it causes - is
not accounted for in the company’s spreadsheets or the cost of the transaction.
In this system, the firm is not concerned about paying for, say, someone’s
medical bills because he or she develops respiratory problems associated with
the smoke. Or the firm does not account for the town population’s expensive dry
cleaning bills, which resulted from the dirty smoke. In a market transaction, the
risk is privatized [dirty smoke] and the cost socialized [people’s medical and
cleaning bills]. “In the same way,” as Eatwell and Taylor pointed out,
“financial firms do not price into their activities the costs of their losses
might impose on society as a whole. Yet those costs are a familiar consequence
of financial failures.”[8]
“Markets are inherently unstable,” the
business magnate George Soros recently remarked, and when the risks in
financial transactions are not priced into the market, more and more of them
can cause damage and crash the economy. The privatization of risk is the
problem: “Taking risks is what financial institutions are for,” explained
Eatwell and Taylor, “But markets reflect the private calculation of risk, and
so tend to under-price the risk faced by society as a whole.”[9] What happens when the economy crashes? In
our current political system, which is a money-driven political system, the
government steps in and bails out the banks that caused the damage to the
economy as a whole, thereby unjustifiably socializing the costs of privatized
market risks. In other words, the American taxpayer usually ends up paying for
the high cost of financial failures and economic crises caused by financiers.
A recent example is well known. The major
catastrophic events of the late 2000s reverberates today. A boom in the housing
market beginning in 2001 in the United States and in Europe precipitated a bust
that torpedoed the market in 2007. It created the greatest economic crisis
since the Great Depression. The housing market peaked in 2006 and in June 2007,
Wall Street showed signs of grave trouble: the investment bank Bear Stearns
went bankrupt. As regulators strove to quell the turmoil, what emerged in
September 2008 was a full-fledged crash. It entailed a global financial panic.
Hundreds of billions worth of mortgages and related investments went down; some
big investment banks turned into commercial ones. The federal government took
over the behemoth international insurance company, the American International
Group (AIG). Responding to the crisis, Congress passed a $700 billion bailout
plan in October 2008 and the Federal Reserve pumped money into the financial
system; both helped rein in a full-scale financial collapse. The activities of
financiers and the government over the course of thirty-seven years - starting
from Nixon’s economic policy in 1971 - contributed highly to the great crash of
2008. A brief history sketched out below of that fateful event in 1971 may help
readers gain some insight into the current character of the U.S. and world
economy - which since the 1970s has been dominated by finance instead of
manufacturing.
Against the backdrop of huge balance of
payments deficit reaching an annual average of $3.6 billion, anemic economic
growth, and high inflation, Nixon called his economic team, Paul Volcker,
George Shultz, and John Connally to concoct dramatic measures to deal with
America’s economic problems. In 1971, Nixon presided over his predecessor
Lyndon Johnson’s Vietnam War and Great Society program. The war itself had dire
fiscal consequences: soaring inflation coincided with the escalation of the
Vietnam War while the high cost of implementing Great Society programs compounded
it. Nixon dealt with both issues by deficit financing. In 1969, his budget
deficit reached $25 billion. The inflation rate reached five percent.
Meanwhile, energy prices rose threatening to exacerbate the already high
inflation rate. Nixon decided to cut spending and pushed the Federal Reserve
Board to raise interest rates. The result was stagflation: a combination of
high inflation and economic recession. Nixon implemented one economic policy to
another in an attempt to curb high inflation and end the recession. Finally, in
late 1971, he devalued the dollar and imposed a ninety-day freeze on wages,
prices, and rents. This new policy successfully remedied inflation and
recession, but only for a short time.
Another major factor that contributed to
Nixon’s new economic policy in 1971 was his response to the downturn in the
manufacturing sector in the United States from 1965 and 1973.[10] During this time, profits in the U.S.,
European, and Japanese manufacturing sector dropped steadily, followed by a
drop in the private economy in the United States. How did business bounce back
to restore profits? For one, business prodded Nixon to devalue the dollar
against the yen and the mark, which provided a basis from which the
manufacturing sector restored its vitality.[11] Though there are a number of
perspectives from scholars regarding the cause of the downturn in the
manufacturing sector in the late 1960s, the fact of the matter was there was a
fall in profits connected to labor rights. Concentrated capital needed to find
other venues for manufacturing where it can thrive without having to be
restricted by labor rights and union bargaining. Certainly, when Nixon
dismantled the Bretton Woods system, it liberalized capital flow. Since then,
firms could easily move manufacturing offshore where labor and environmental
constrictions were minimal to none. Firms do not have to deal with labor rights
and environmental restrictions in the Third World as they would in the United
States. Also, since then, they can focus solely on exploiting workers and the
environment to restore high profits. The other advanced industrial countries
emulated this U.S. government action. Political economist Robert Brenner lucidly
explains this trajectory:
[F]irms, assisted by the
governments, throughout the advanced capitalist world engaged in an ever more
self-conscious, systematic, and all encompassing effort to restore their profit
rates by means both of the obsessive reduction of costs, above all direct and
indirect labour costs, and the transformation of their ways of doing business.
They detonated an ever more vicious assault on the organizations of the working
class, so as to force down the growth, and in some cases, the level of
compensation and social services…They shifted capital out of high-cost,
low-profit manufacturing lines, especially into financial services and turned
increasingly to speculation.[12]
Nixon and his economic team on that
fateful Friday afternoon in August at Camp David did not foresee the trajectory
the financial sector was about to embark on when they decided to close the gold
window. When the gold window was closed on 15 August, the Bretton Woods system
struggled to survive. After three months of confusion by the major economies at
a meeting in Washington, they agreed on new fixed rates on foreign exchange;
but it soon fell apart. Nixon’s remedies were to allow the pound sterling to
float against the dollar in the summer of 1972; then when it failed, his administration
then tried to negotiate new fixed rates in 1973, but still to no effect.
Finally, in March that same year, the European Community agreed on a joint
float against the dollar; and by then, the Bretton Woods system was dead.[13] Among John Connelly’s compelling reasons
to recommend to Nixon to close down the gold window, historian Allen Matusow
argued that Nixon had his own reasons for destroying Bretton Woods:
Nixon closed the gold
window when he did not only because he thought he had to but because he wanted
to. It was his opening move in a historic offensive to correct the overvalued
dollar and reorder the trading world to serve his political purposes. Breaking
with the liberal premises of postwar U.S. foreign economic policy, he had
adopted the mercantilist paradigm, which he hoped would keep the United States
number one and help rally a New Majority in ’72.[14]
Whatever the motive of Nixon in
deciding to close the gold window - whether he was being politically expedient
or simply being pragmatic – the decision to dismantle the one economic system
that maintained financial stability and kept markets calm “sowed chaos for a
decade” – and today’s world generation, as Lewis Lehrman put it, “reaped the
whirlwind.”
[1] Ha-Joon Chang, Bad Samaritans: The Myth of Free Trade and
the Secret History of Capitalism, (New York: Bloomsbury Press, 2008), 87.
[2] John Eatwell and Lance Taylor, Global Finance at Risk: The Case for International Regulation, (New
York: The New Press, 2000), 2.
[5] Lewis E. Lehrman, “The Nixon Shock Heard ‘Round
the World,” Wall Street Journal,
August 15, 2011, sec. A.
[14] Allen J. Matusow, Nixon’s Economy: Booms, Busts, Dollars, and Votes (Kansas: The
University Press of Kansas, 1998), 148.
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