What is Nixon Shock
Nixon Shock is a phrase used to describe the aftereffect of a set of economic policies touted by former President Richard Nixon in 1971. Most notably, the policies eventually led to the collapse of the Bretton Woods system of fixed exchange rates that went into effect after World War II.
BREAKING DOWN Nixon Shock
Nixon Shock followed President Nixon’s televised New Economic Policy address to the nation. The crux of the speech was that the U.S. would turn its attention to domestic issues in the post-Vietnam War era. Nixon outlined three main goals for the plan: creating better jobs, stemming the rise in cost of living and protecting the USD from international money speculators.
Respectively, Nixon cited tax cuts and a 90-day hold on prices and wages as the best options for boosting the job market and tamping down cost of living. As for speculative behavior toward the dollar, Nixon supported suspending the dollar’s convertibility into gold. In addition, Nixon proposed an additional 10 percent tax on all imports that were subject to duties. Similar to the strategy of suspending dollar convertibility, the levy intended to encourage the U.S.’ main trading partners to raise the value of their currencies.
The Bretton Woods Agreement revolved around on the external values of foreign currencies. Fixed versus the U.S. dollar, the value of foreign currencies was expressed in gold at a price determined by Congress. However, a dollar surplus imperiled the system in the 1960s. At the time, the U.S. did not have enough gold to cover the volume of dollars circulating throughout the world. That led to an overvaluation of the dollar.
The government attempted to shore up the dollar and Bretton Woods, with the Kennedy and Johnson administrations trying to deter foreign investment, limit foreign lending and reform international monetary policy. However, their efforts were largely unsuccessful.
Nixon Shock and the End of the Bretton Woods Agreement
Anxiety eventually crept into the foreign exchange market, with traders abroad fearful of an eventual dollar devaluation. As a result, they began selling USD in greater amounts and more frequently. After several runs on the dollar, Nixon sought a new economic course for the country.
Nixon’s speech was not received as well internationally as it was in the U.S. Many in the international community interpreted Nixon’s plan as a unilateral act. In response, the Group of Ten (G–10) industrialized democracies decided on new exchange rates that centered on a devalued dollar in what became known as the Smithsonian Agreement. That plan went into effect in December 1971, but it proved unsuccessful.
Beginning in February 1973, speculative market pressure caused the dollar to devalue and led to a series of exchange parities, i.e., when the exchange rate relationship is one-to-one. Amid still-heavy pressure on the dollar in March of that year, the G–10 implemented a strategy that called for six European members to tie their currencies together and jointly float them against the dollar. That decision essentially brought an end to the fixed exchange rate system established by Bretton Woods.