Reference no: EM131737511

Problem: NIXON CLOSES THE GOLD WINDOW ON AUGUST 15, 1971

After almost an entire decade of unparalleled prosperity, the US economy headed into recession in late 1969. Even worse, from the viewpoint of Nixon, the recovery that started in 1971 was unusually sluggish. In his view, drastic action was required to insure that the economy would be booming by election time in 1972. Every economist in the country knew how to stimulate the economy in the short run: cut taxes, increase government spending, boost money supply growth, and artificially suppress interest rates. Of course, that combination could be lethally inflationary in the longer run - but only after 1972. There was one restraint left. If Nixon put his program into effect, there would undoubtedly be a run on the dollar. US foreign reserves had already fallen to $12 billion, or about 8% of the world total, from $17 billion, or 27%, a decade earlier. The gold standard was the remaining check on fiscal and monetary profligacy - so Nixon chopped it off at the knees. He closed the international gold window, and for good measure added a temporary 10% surcharge on imports. On December 18, he devalued the dollar from $35 to $38/oz and removed the surcharge.

Later, the US officially went off the gold standard, and the price of gold rose to $200/oz in 1974 and an all-time peak of over $800/oz in early 1980. Nixon was trying to stimulate the economy; going off the gold standard was only a sideshow. He gambled that the inflationary impacts of the combination of a lower dollar, artificially depressed interest rates, rapid growth in the money supply, tax cuts, higher government spending, and the resulting substantial increase in the full-employment budget deficit could be postponed until after the election if wage and price controls were also kept in place through 1972. That turned out to be correct - with a vengeance. Seldom has there ever been such a graphic example of short-term gain at the expense of long-term loss. Net exports improved in 1973, but only because of the agricultural shortages and huge increases in farm prices based on the Soviet grain purchases. The end result was the recession of 1974, the most severe in the post-WWII period. However, the decision to abandon the gold standard was not the principal villain. Instead, it was the attempt to suppress inflation during an election year with wage and price controls, while at the same time stimulating the economy beyond its capacity. The weaker dollar contributed to higher inflation, but was not the major cause.