Nixon Shock - Later Ramifications

Later Ramifications

The Nixon Shock has been widely considered to be a political success, but an economic mixed bag in bringing on the stagflation of the 1970s and leading to the instability of floating currencies. The dollar plunged by a third during the '70s, and in 1997 several Asian and Latin countries faced currency crises. Even to the present, Paul Volcker regrets the abandonment of Bretton Woods. "Nobody's in charge," Volcker says. "The Europeans couldn't live with the uncertainty and made their own currency and now that's in trouble."

In 1996, Paul Krugman summarized the post-Nixon Shock era as follows:

The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987—which started out every bit as frightening as that of 1929—did not cause a slump in the real economy. While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible—and, in some countries, they have been quick to take the opportunity.

Debate over the Nixon Shock has persisted to the present day, with economists and politicians across the political spectrum trying to make sense of the Nixon Shock and its impact on monetary policy in the light of the recent financial crises. Conservative columnist David Frum sums up the situation this way:

The modern currency float has its problems. There is no magical monetary cure, monetary policy is a policy area almost uniquely crowded with trade-offs and lesser evils.

If you want a classical gold standard, you get chronic deflation punctuated by depressions, as the U.S. did between 1873 and 1934.

If you want a regime of managed currencies tethered to gold, you get regulations and controls, as the U.S. got from 1934 through 1971.

If you let the currency float, you get chronic inflation punctuated by bubbles, the American lot since 1971.

System 1 is incompatible with democracy, because voters won’t accept the pain inherent in a gold standard.

System 2 is incompatible with the free market economics I favor.

That leaves me with System 3 as the worst option except for all the others.