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The Big Float

When the US effectively floated the US dollar in 1971, many foresaw the end, or at least the beginning of the end, of the Bretton Woods system and, with it, American monetary and economic hegemony. Yet the dollar-based system survives – along with the same old criticisms of it.

BERKELEY – August 15 is not a red-letter day on most calendars. True, August 15, 1969, was the first day of the Woodstock music festival. And the Panama Canal opened to traffic on August 15, 1914. Mostly, though, mid-August finds officials and others on holiday.

But not on Sunday, August 15, 1971. That evening 50 years ago, at the conclusion of three days of crisis meetings, President Richard M. Nixon announced that the United States was preemptively closing the “gold window,” the financial facility through which the country made gold available to foreign governments and central banks at $35 an ounce. To contemporaries and historians alike, Nixon’s announcement marked the end, or at least the beginning of the end, of the Bretton Woods international monetary and financial system. And that meant it marked the end, or at least the beginning of the end, of American economic and monetary hegemony. The postwar period when the US could all but unilaterally determine the monetary structure and financial fate of the Free World was drawing to a close.

Or was it? What exactly ended with Nixon’s decision? Clearly, it ended the era when the dollar was firmly anchored to gold at a fixed domestic-currency price, and when other currencies were equally firmly anchored to the dollar. Over the subsequent four months, an agreement was reached under which European currencies and the Japanese yen were revalued by an average of 10%, the dollar price of gold was raised from $35 to $38 an ounce, and fluctuation bands surrounding the new exchange-rate parities were widened from +/- 1% to +/- 2.25%. In this way, at least the façade of the Bretton Woods international monetary order was maintained.

By early 1973, however, reality had intruded, and the reconstructed system collapsed. Bretton Woods gave way to what economist John Williamson dubbed the international monetary “nonsystem.” By abandoning fixed parities for their currencies, governments embarked on the unprecedented experiment with floating exchange rates that has preoccupied them ever since.

Weekend Revolutionaries

In his new book, Jeffrey E. Garten describes how we got to this point. His focus is the weekend in August 1971 when Nixon’s economic brain trust assembled at Camp David to chart a new course. In the first part of his account, Garten introduces the cast of characters: Nixon, Treasury Secretary John Connally, Treasury Under-Secretary Paul Volcker (responsible for crafting the administration’s international monetary plans), Office of Management and Budget Director George Shultz, and Federal Reserve Chair Arthur Burns. Garten then recounts the weekend’s events, hour by hour, using official documents, the Nixon Tapes, memoirs and diaries, including those of Volcker and Burns, and, importantly, interviews with the participants.

Camp David

Garten, an emeritus dean of the Yale School of Management, brings closely adjacent experience to his tale, having served on Nixon’s White House Council on International Economic Policy starting in 1973, and he tells his story with verve. The resulting interplay of personalities is reminiscent of the conflicts of monetary officials in the 1920s as recounted in Liaquat Ahamed’s acclaimed study Lords of Finance.

Above all, readers will be reminded of how much individuals and their quirks matter for the course of history. Nixon, for example, had an abiding distaste for economics, to which he devoted no more attention than absolutely necessary. (His signature remark, “I don’t give a shit about the lira,” has its deserved place of prominence in Garten’s account.). The president’s goal was to manage international economic issues in a way that would avoid undercutting his foreign policy priorities, such as a diplomatic opening to China and an arms-control agreement with the Soviet Union. Nixon also wanted to ensure that inflation and a weak economy would not become obstacles to his re-election.

Connally was a flamboyant and ruthless political operator without strong ideological predispositions or economic principles. An unbending nationalist, he sought, as we would say today, to “put America first.” Shultz was Connally’s opposite: soft spoken and strongly principled. His Chicago School opposition to controlling prices extended to exchange rates; he firmly believed that currencies should be allowed to float.

In this view, Shultz was opposed by Volcker, an advocate of fixed exchange rates. Burns was disdainful of intellectual opponents, despite lacking coherent views on international monetary matters and, startlingly for a Fed Chair, even domestic monetary matters. His goal was to contain cost-push inflation through the imposition of wage and price controls, the instrument to which Shultz was adamantly opposed.

Disagreeing to Agree

That this difficult collection of individuals could have agreed on anything, even in the calming confines of Camp David, is remarkable in itself. The resulting agreement entailed closing the gold window (over Burns’s objections), imposing a wage and price freeze (over Shultz’s objections), and applying a 10% import surcharge (over Volcker’s objections) – this last measure as a way to give the US leverage in international negotiations over the new constellation of exchange rates.

Garten’s narrative shows Nixon to have been the key decision maker, despite his lack of economic expertise or even firmly-held economic views. His objective, put simply, was to appear decisive to the public and to draw a line under the crisis in order to get on with other diplomatic business. Also striking is Nixon’s willingness, Joe Biden-style, to tolerate free-flowing discussion among his aides and advisers – for three days, anyway, and as long as the topic was not his own re-election.

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But Garten’s otherwise admirable focus on personalities tends to obscure the role of structural factors. Three Days at Camp David could be clearer about the economic forces fueling the tensions in foreign-exchange markets that came to a head in August 1971. Had the post-World War II economic recoveries of Europe and Japan, in conjunction with their leaders’ reluctance to revalue their currencies, eroded US international competitiveness? Had the US failed to put its own economic house in order? Did the recovery of international capital mobility in the 1960s create irreconcilable conflicts between US monetary and fiscal policies targeting full employment and prosecution of the Vietnam War, on the one hand, and maintenance of a stable dollar, on the other? Did the “Triffin dilemma” – the idea that an expanding world economy’s demand for international reserves meant official US foreign liabilities would inevitably exceed US gold reserves – doom Bretton Woods?

We don’t know the answer, because Garten doesn’t assign weights to the contributing factors and argue for their relative importance. He doesn’t mention the Triffin dilemma. Yet these questions matter, because different answers point to different directions for feasible and desirable international monetary reforms – and thus have different implications for whether the Camp David meeting should be regarded as a success or a failure.

This leads to the broader question of the extent to which the meeting truly “transformed the global economy” (Garten’s words). Contrary to expectations at the time, the dollar remains the dominant international and reserve currency even today, just as it was before. Closing the gold window did nothing to change this. Moreover, freely floating exchange rates are still the exception to the rule. According to one recent calculation, the currencies of countries representing some 60% of global GDP are still pegged to the dollar or else follow the greenback at a distance.

Maybe a more appropriate conclusion is that the secret meeting at Camp David and the negotiations that followed safeguarded the global economy. A major breakdown of international economic cooperation between the US, Europe, and Japan was averted, partly through the timely intervention of Nixon’s national security adviser, Henry Kissinger (a monetary and financial “neophyte,” as Kissinger himself put it). The 10% US import surcharge was lifted once agreement was reached on a new set of exchange-rate parities, and the global trading system survived. The spirit of Bretton Woods was preserved, as Garten himself concludes.

But Garten notes a widely voiced criticism of the Camp David meeting and subsequent international negotiations, namely that they left unresolved fundamental issues concerning the structure of the international monetary system. This is not surprising, he observes, given profound differences of opinion among those present about what constituted a feasible and desirable structure. The same might be said of international negotiations: US and foreign officials had wildly opposing views of how the system should be reformed. Discouragingly, that remains true 50 years later.

A Float to Nowhere

Charting a path forward is not what Garten’s book is about, and he offers no suggestions. Others, however, have devised proposals and plans for international monetary reform. A notable recent contribution is José Antonio Ocampo’s Resetting the International Monetary (Non)System. Ocampo, a professor at Columbia University and former finance minister of Colombia, is a prominent critic of the dollar-based, International Monetary Fund-led global monetary order. His book is self-recommending – especially because it can be downloaded for free courtesy of the United Nations University World Institute for Development Economics Research (UNU-WIDER).

Camp David

Specifically, Ocampo is critical of the prevailing orthodoxy that places a disproportionate adjustment burden on countries running balance-of-payments deficits while not imposing symmetric obligations on surplus countries. Likewise, the international system’s dependence on the dollar exposes other countries to erratic US policies and generates procyclical boom-and-bust cycles. It also places countries at the tender mercies of the Fed for currency swaps when there is a shortage of dollar liquidity. Today, when market participants are asking when the Fed will start raising interest rates, a step that could disrupt capital flows to emerging markets, these concerns are widely shared.

From this diagnosis follow Ocampo’s recommendations for reform. First, the IMF should symmetrically require surplus and deficit countries to adjust (as John Maynard Keynes unsuccessfully advocated at Bretton Woods in 1944). This can be achieved through stronger mechanisms of macroeconomic policy coordination, including greater cooperation in managing exchange rates and more generous extension of automatic credit lines to deficit countries.

Second, the world should move away from the dollar in favor of an internationally issued global reserve asset (as Keynes also argued unsuccessfully in 1944). Ocampo advocates expanding the issuance of IMF special drawing rights (SDRs, the Fund’s reserve asset). In addition, he argues that central banks should diversify their foreign-exchange reserves by adding euros and Chinese renminbi to their portfolios, thereby limiting their exposure to US policies.

This is less than a comprehensive reform of the international monetary and financial system. Still, even these limited proposals may be unrealistically ambitious. The IMF reviews global imbalances and issues periodic reports. But, short of sanctions, which it does not possess, the IMF cannot compel adjustment by countries whose currencies are strong and that are gaining, not losing, reserves. And it is hard to imagine chronic surplus countries authorizing the creation and application of such sanctions.

However admirable the principle of more extensive international policy coordination may be, it is honored mainly when a crisis erupts, if then. To institutionalize it would require the US or China to compromise valued domestic macroeconomic policy objectives.

Same as It Ever Was

For its part, the IMF has created a limited number of financial facilities that are disbursed automatically, but access to most of its resources is still heavily conditioned on externally mandated policy reforms. This is because the IMF’s Articles of Agreement require it to safeguard its members’ quota contributions, as these are the only financial resources the Fund has to lend. Its high-income members, who contribute the bulk of these resources, are understandably disinclined to change this convention. In particular, the US Congress is not likely to agree to procedural changes that place US contributions at risk.

Similarly, congressional approval would be required for substantial increases in SDR issuance, something that Republicans would instinctually denounce as giving away hard-earned US taxpayer money to foreigners. Even more radical – and unrealistic – would be an agreement authorizing the IMF to issue new SDRs unilaterally in a crisis, recalling the liquidity injections and dollar currency swaps the Fed provided in 2008 and again when the COVID-19 crisis began.

The Fed is so endowed because it is accountable to Congress and therefore compelled to use its capacity in politically acceptable ways. In contrast, there is no global government to hold the IMF accountable, rendering national authorities reluctant to grant it more extensive emergency powers.

As for the euro and the renminbi, neither possesses the attractions of the dollar. The eurozone lacks a European Treasury to complement the European Central Bank. There is a dearth of AAA-rated, euro-denominated Treasury securities for central banks to hold as reserves. As for China, it maintains capital controls restricting foreign access to Chinese financial assets, which limits the utility of its currency for cross-border financial transactions. Even central banks and governments able to access the renminbi hesitate to hold and use it, fearing unexpected changes in the rules of the game.

Everyone, it seems, wants reform, but there is no consensus about what such reform should entail. What Garten writes about 1971 – that there existed profound disagreements about the appropriate structure of the international monetary system – is still true today. Until that changes, a nonsystem it will be.