Goldgate to blame for present-day woes?

He will probably be best remembered in history for the gate-suffix that he gave to the English language (and wider) in the wake of the Watergate scandal. What should, however not be forgotten by world leaders is to what extent the globe’s financial crisis can be traced back to goldgate, also known as the Nixon-shock.

On August 15 this year it was exactly 40 years ago that then United Sates president Richard Nixon unilaterally scrapped the Bretton Woods system that had been in place since the end of World War II. In terms of Bretton Woods the US was committed to backing every dollar held abroad with gold. Other countries had the right to exchange their dollars for gold at $35 to the once.

Other currencies were fixed to the dollar, and the dollar as the currency of final settlement was pegged to gold.

On Sunday August 15, 1971 president Nixon addressed the American nation after a weekend at Camp David with his closest advisors. Blaming currency speculators and unfair exchange rates he announced that the link between the US dollar and gold was being cut.

The American economy at the time was deep in trouble, among others due to the costs involved in the Vietnam War. The final trigger might have been a demand on Thursday, August 12 by Britain that the US guarantee the value of $750 in terms of Bretton Woods.

Arthur Burns, who was the head of the Federal Reserve (Fed) at the time, wrote in his diary on hearing the news that the US was about to cut the dollar/gold-link: “What a tragedy for mankind.”

Goldgate, or the Nixon shock as it was called at the time, had its roots in the very same folly that caused the Watergate scandal – an all-powerful preoccupation with being re-elected president. Nixon was all too aware how damaging a faltering economy could be to his political ambitions.

It was the very same Burns who in 1960 warned the then vice-president Nixon that if the Fed tightened interest rates it could damage his changes to win the presidential elections against John F Kennedy. Nixon remembered this warning and, acutely aware of the power of the Fed, after he was inaugurated as president in January 1969 he appointed Burns as the head of the Fed with the instruction: “You see to it – no recession.”

Despite this instruction the US in 1970 was hit by a recession leading to, among others an unemployment rate of 6%, the highest mark in a decade. Nixon turned to other advisors and in the process the theories of Milton Friedman

-- that if left to the market, currencies would regulate themselves with only gradual adjustments -- took hold of his administration.

The initial reaction to the abandonment of the gold standard for the dollar served Nixon politically very well and the Dow rose the next day by nearly 33 points. Reaction in the media to what was perceived to have been a bold move was  also overwhelmingly positive.

By December of that year America succeeded in negotiating a broad revaluation of exchange rates. More devaluations followed and by 1973 currencies were floating freely.

The legacy

Nixon was re-elected at the end of 1972, but what was the legacy that Goldgate left the world?

Going hand-in-hand with the globalisation that marked the world economy in the last decades of the previous century, the system of free floating currencies that developed left us with a complicated system vulnerable to political manipulation and fraught with uncertainties. Some of the most marked results include:

• For the first time in history the level of currencies did not depend on the value of some tangible commodity, but on the amount of trust investors had in any particular currency;
• Europe could not live with the uncertainties and created the euro as its own currency as counterweight for the dollar;
• For the first time investors could bet or speculate on the direction of interest rates or the value of currencies and this led to a proliferation of speculative financial products and the world of fait money, that replaced Bretton Woods became subjected to the uncertainties of market cycles;
• The world of finance became a lot more vulnerable to political pressure. While under the Bretton Woods’ gold standard it was quickly visible when politicians were spending beyond their means, it is no longer that clearly detectible;
• Countries which would otherwise have been penalised for over-borrowing were allowed to get away with it to the point of the present crisis of sovereign debt;
• Investors, convinced that economic growth fuelled by this debt was genuine rather than artificial binges, made for a cycle of bubble and bust;
• The crisis of 2008 finally brought the realisation that those increases in asset prices and economic growth as artificial and unsustainable; and
• It brought us the world of rating agencies, but the world yet has to find a standard as rigorous as gold.

According to a report in Time magazine of 8 August this year, Burns in a speech titled The Anguish of Central Banking argued that central bankers around the world were failing because elected leaders were unwilling to risk displeasing their constituents.

But, as  is clear from recent developments in countries like Greece, and even the US the time has come that their hands will be forced.

In a comment piece in The Telegraph last month Edmund Conway wrote: “So are we nearing the end of this economic era? All the hallmarks are there.We’ve been through periods of faith in the system, peaking with the certain belief in the 1990s and early 2000s that inflation targets really would help keep governments on an even keel.

“We’ve had the financial crisis that usually marks the beginning of the end of established monetary systems. And now we are seeing the debasement.”