Nixon Shock: Definition & Effects

Instructor: Mark Koscinski

Mark has a doctorate from Drew University and teaches accounting classes. He is a writer, editor and has experience in public and private accounting.

In this lesson, you will learn the definition of Nixon Shock and the international economic circumstances surrounding it. You will also learn about the results of Nixon Shock.

Bretton Woods

After the Second World War, the United States became the economic powerhouse of the world. Under the Bretton Woods Agreement of 1944 all major currencies in the Western world were set to a fixed exchange rate against the U.S. dollar. This became known as pegging the currencies to the U.S dollar. All countries participating agreed to keep the market exchange rate of their currency within a plus or minus 1% band of the pegged rate. The participants would intervene in foreign exchange markets by buying or selling their own currency to maintain the value of their currency within the agreed upon band. The process of supply and demand would then return the currency to within the agreed upon band.

Gold Vault U.S. Depository
Gold Vault US Depository

The Bretton Woods Agreement effectively made the U.S. dollar the reserve currency for the Western world. The U.S. dollar anchored currencies around the world. The United States separately agreed to link the dollar to gold at $35 per ounce. Foreign nations could exchange dollars for gold when they wished. The purpose of this agreement was to further extend confidence in the dollar.

Changing Economic Climate

Unfortunately, the international economic situation began changing in the 1960s. Presidents Kennedy and Johnson attempted to contain exchange rate problems through a series of measures designed to support the dollar. Unfortunately, these measures were not wholly successful. By 1971, the U.S. had been financing a large ground and air war in Vietnam, imports had grown, and inflation was running at almost 6% annually. More U.S. currency was needed for international trade, and the money supply increased. The U.S. was now running a large trade deficit and dollars continued to flow overseas. Foreign exchange traders believed the U.S. currency's devaluation was imminent. As a result, they increasingly sold dollars and caused periodic runs on the currency.

The U.S. Dollar
US Dollar

Nixon Shock

Other nations, notably Switzerland and France, accumulated large numbers of dollars and demanded redemption for gold. The U.S. had pledged to do this, and its gold reserves began to decline. This caused the U.S to consider abandoning the fixed gold and dollar exchange rate. On August 15, 1971, President Nixon imposed a 90-day wage and price freeze to curtail inflation and a 10 percent import surcharge. The surcharge was an attempt to dissuade imports and reduce the trade deficit. He also ended the conversion of U.S. dollars into gold. These decisions were made without consultation with the international community and were labeled Nixon Shock by international leaders. They saw these actions as a shocking display of unilateralism on the part of the United States. Nixon's actions were more popular at home and were applauded by the American public. Another attempt was made to fix exchange rates but was not successful. The international community responded by removing their currencies from the Bretton Woods Agreement and allowed their values to float freely in the marketplace by 1973.

President Richard Nixon
President Richard Nixon

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