The Nixon Shock

By Ichiro Suzuki The weekend of August 13-15 has marked the 50th anniversary of President Richard Nixon’s announcement that sent massive shockwaves throughout the global financial markets. With the announcement, the U.S. Treasury Department had halted the convertibility of the dollar for gold. Thus, the Bretton Woods system that governed the post-war financial system was upended and the gold standard was dead. The system contributed immensely to prosperity in the Western world through reconstruction of Europe and Japan. By the end of the 1960s, however, the United States came to a point of not being able to underpin the fixed exchange rate system as gold flowed out of the U.S. to Europe and Japan that were growing faster than the U.S. The shocking announcement sent the greenback into a tailspin not only against gold billions but also other currencies that were pegged against the dollar. Half a century later, gold is worth $1,781 per ounce, way up from $35 at the time of the Nixon shock, rising by 50 fold, for a compound annual rate of return of 8.1%. The S&P500 index at 99 at the time of the shockwave, is now trading at 4,468, for a 45 fold jump and a 7.9% return per annum. Gold is on par with the U.S. equity market on its performance. Unlike gold bullion, however, stocks pay dividends that on average have been 2% of share prices. Dividends raise equity market’s total returns to approximately 10% per annum. (The extra two percentage points represent growth premium given to equity over gold that has no growth. A 2% difference over half a century is a big deal.) The Nixon Shock had unleashed the Japanese yen’s meteoric rise. In the 40 years that followed the shock, the yen rose from the fixed exchange rate at 360 against the dollar to 75 in 2011, almost quintupling for a compound annual gain of 4%. The exchange rate became an obsession to Corporate Japan, whose export prowess was always challenged by ever-appreciating currency. While a rising currency weeded out weak and uncompetitive industries and companies, those that managed to survive such a pressure established their positions by moving up the ladder into higher value added product zones and the niches that cannot be copied by followers with ease. While the yen almost always rose on a long-term trend, of course with occasional corrections, in every decade of the 40 years that followed the Nixon Shock, the Japanese currency has reversed its direction in the fifth decade. In 2011, the average exchange rate of the yen was under 80 against the dollar. On the 50th anniversary, it is trading at 110, for almost 40% devaluation in the fifth decade after the shock. Something may be changing. There is a chance Japan’s economic fundamentals are beginning to break at last though the economy continue to register relatively strong current account surpluses at 2-3% of GDP. The demise of the gold standard had released the global economy from growth constraints imposed by the supply of the commodity. Monetary base no longer had to be backed by gold billions stored in the central bank’s safe. In the last 50 years, money supply rose from 60% of global GDP to 130%, with a marked upswing in the last ten years or so, since the Federal Reserve Bank embarked on quantitative easing in the aftermath of the global financial crisis. Other major central banks followed suit. Money supply boost through central banks’ purchase of assets were once again implemented amid the pandemic’s assault on the global economy. In the meantime, correlation between the growth of money supply and the economy is trending lower. It is taking a greater amount of money supply boost to generate the same unit of economic growth as before. As monetary expansion’s side effects, asset prices are driven higher in recent years. The upending of the Bretton Woods system did not drive the dollar to its demise. Despite its almost universal fall against other assets, credibility was instilled into the greenback due to its depth and liquidity as well as hard-earned market’s confidence in the Fed’s monetary policy. The dollar remains the world’s reserve currency, making the Federal Reserve Bank the central bank for the world. While demise of the dollar has always been a popular topic in the financial markets, no other currency has realistically shown the ability of replace the greenback as the reserve currency. The dollar can hold onto such status until one day the market discredits the Fed, maybe in the event of its failure to contain resurgent inflation. Even the synthetically created single European currency is no match for the dollar in terms of its depth, and the central bank’s willingness to intervene in the market, i.e. in the form of injecting liquidity at the time of a crisis. China may have an ambition on its currency in the global financial markets. However, the renminbi needs to be freely floated without restrictions on the currency before China seeks the RMB’s greater role. Five years after the RMB was added to the basket of currencies that consist of the IMF’s special drawing rights (SDR), the Chinese currency remains as restricted as before. There is one asset that did not rise against the greenback over the last 50 years. The British pound has a distinction of losing 40%+ against the dollar over the last half a century. A unit of GBP bought 2.4 dollars until late summer of 1971 after 1967 devaluation. 50 years later, the pound is trading at approximately 1.4 dollars. A series of devaluation since 1967 was a proof of economic woes that post-war Britain long suffered. The pound has made its low in late summer of 1985, on the eve of the Plaza Accord, at 1.05. Then it rebounded along with other currencies. On top of the dollar's precipitous fall after the Plaza Accord, Prime Minister Margaret Thatcher was revitalizing the economy, rescuing it from the ‘British disease’. Since then, the GBP has been ‘relatively stable’, breaking the one way post-war direction, that was down. Against the JPY, the GBP fell to 152 today, way down from 864 at the time of the Nixon Shock. About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.