It was Sunday night on Aug. 15, 1971, and many Americans were watching television — the most popular show that evening being the Western series Bonanza. At 9pm, the show and its rivals on the other two networks were interrupted by the somewhat less popular figure of then-US president Richard Nixon.
The word “bonanza,” according to the Oxford English Dictionary, was introduced into American English in the 1880s to describe a highly productive or profitable mine, such as the silver mines of the Comstock Lode in Bonanza.
Ironically, Nixon was disrupting Sunday evening to tell Americans that the days of precious metal were over. The link between the US dollar and gold — a link that dated back to the country’s adoption of the gold standard nearly a century before — was to be severed. The age of fiat money — that is, of currency backed by nothing more than the credibility of the US Department of the Treasury — had dawned.
Illustration: Mountain People
Not that Nixon put it like that. Americans by then were used to presidential addresses about Vietnam. It was less usual to have a lecture on the economy on a Sunday night. However, as Jeffrey E. Garten explains in his gripping account of the speech’s origins and consequences, Three Days at Camp David, the announcement had to go out before financial markets opened on Monday. In his own charmless way, Nixon was dropping a bombshell.
NIXON’S BOMBSHELL
“The time has come for a new economic policy for the United States,” Nixon said. “Its targets are unemployment, inflation and international speculation.” There followed a succession of presidential pledges, in ascending order of radicalism: to introduce tax breaks to encourage investment; to repeal the excise tax on automobiles (but only US-made ones); to bring forward planned income tax deductions (although with offsetting spending cuts); to impose a 90-day “freeze” on all prices and wages; and — the bombshell — “to suspend temporarily the convertibility of the [US] dollar into gold.” Finally, Nixon announced a 10 percent tax on all imports — in a word, a tariff.
For foreign leaders, finance ministers and central bankers, this was stunning. Not only would the US dollar cease to be convertible into gold; the US was apparently turning away from the free trade it had embraced at the end of World War II and reverting to protectionism — although this proved to be just a threat to get the Europeans and Japanese to accept the US dollar’s devaluation. In the words of Henry Brandon, the chief Washington correspondent of the London Sunday Times, this was the “moment of the formal dethronement of the Almighty Dollar.”
Except that it was not.
From the distance of 50 years, the most surprising thing about what the Japanese called “the Nixon shock” was precisely that it did not mark the end of the era of the US dollar’s dominance. On the contrary, the US currency has only grown more important — its privilege even more exorbitant — since Nixon severed its link to gold.
The arguments for a crisis of the US dollar back in 1971 are familiar to modern ears. Inflation was rising. The budget deficit was worrisome. The trade deficit was growing. Asian and European competitors were eroding US economic leadership.
Nixon’s economic bombshell needs to be seen in the broader context. He and his national security adviser, Henry Kissinger, were struggling to extricate the US from an unpopular war in Vietnam. They were in the midst of a bold attempt to deal directly with China’s communist government in the hope of putting pressure on the North Vietnamese and their Soviet backers.
As Garten tells the story, 15 white men repaired to Camp David and thrashed out Nixon’s new economic policy. John Connally, then Treasury secretary, got most of what he wanted: in particular, to “screw the foreigners before they screw us.”
The losers were Paul Volcker, then a Treasury undersecretary, and the other financial technocrats who had hoped to re-engineer the Bretton Woods system — with the IMF’s special drawing rights (a synthetic reserve currency) taking the place of gold. Yet Connally was playing the part of a wrecking ball.
“I will be perfectly frank with you,” Connally told reporters after Nixon’s TV address. “None of us know for certain what will occur.” Politically, it delivered the boost to the administration’s popularity that Connally and Nixon had anticipated.
However, the collateral damage to US foreign policy — as Asian and European markets and currencies went haywire — took many months to repair. Not until the Smithsonian Agreement in late December were new exchange-rate arrangements in place, whereby everyone else accepted the reality of the US dollar’s devaluation.
Even this did not last. First Britain devalued, then Italy (prompting Nixon’s famous outburst: “I don’t give a shit about the lira”). The US dollar had to be devalued again in February 1973. By the end of that year, most major currencies were floating — the outcome always preferred by Connally’s far more sophisticated successor as Treasury secretary, George Shultz.
The 1970s became a horror show of double-digit-percentage inflation. At its worst, the US dollar had depreciated by about 50 percent more than the Japanese yen and the German Deutschmark. Yet neither currency displaced the US dollar, despite numerous prophecies of that outcome.
The US dollar rallied strongly in the first half of the 1980s — to the extent that there had to be a coordinated intervention to weaken it under the September 1985 Plaza Accord. It had another wave of strength in the second half of the 1990s.
CONTINUED DOMINANCE
Contrary to most predictions before the global financial crisis of 2008-2009, the US dollar strengthened rather than weakened at times of economic stress, from the bankruptcy of Lehman Brothers Holdings to the COVID-19 pandemic.
Why was this? Why has the US dollar remained dominant, despite the apparent instability of this “nonsystem” — as the economist John Williamson called it — of sometimes floating, sometimes pegged exchange rates?
First, although the “great inflation” of the 1970s was disruptive, it proved to be curable. As the US Federal Reserve chair, Volcker administered the bitter medicine of higher interest rates and a recession that, combined with the supply-side reforms of then-US president Ronald Reagan’s administration, fundamentally reset expectations. Independent central banks succeeded so well in reducing inflation that in 2004, Ben Bernanke, then a Fed governor, boasted of a “great moderation.”
Second, the system of liberalized capital markets born around this time gave the US dollar even more international utility than it had enjoyed under Bretton Woods. As the dominant currency not only in central bank international reserves but also in a rising share of international trade transactions, the US dollar was more than ever the sun around which the other currencies of the world revolved.
Third, the terrorist attacks of Sept. 11, 2001, strengthened rather than weakened the US-centered international financial system. Direct hits on the World Trade Center, a short distance from the New York Stock Exchange, could only briefly disrupt the smooth operation of US financial markets. When the US government went after those who had financed al-Qaeda and other extremist groups, it discovered a hitherto underestimated superpower: the ability to impose financial sanctions on any country or entity that defied Washington.
The increasing exertion of this superpower in response to a variety of different challenges to US power — from the Russian annexation of Crimea to Swedish bank secrecy — revealed the full extent of US financial paramountcy. Excluding any actor from the US dollar payment system was revealed as a more effective geopolitical lever than sending an aircraft carrier strike group.
True, the US could not restore Crimea to Ukraine, but it could inflict real pain on the Russian economy and the Russian political elite. Here was a powerful incentive to retain the US dollar’s dominance.
Yet, the core of this financial power was and remains the US banking system, and two recent developments have exposed the weakness of this core: First, the financial crisis originated in the undercapitalization and poor management of the US banks and their European counterparts. Second, technological innovations began to expose the banks’ fundamental inefficiency.
As Princeton University historian Harold James said last month: “The dollar’s long pre-eminence is being challenged, not so much by other currencies ... as by new methods of speaking the same cross-border monetary language as the dollar. As the digital revolution accelerates, the national era in money is drawing to a close... The demand for a monetary revolution is growing.”
“The world is quickly moving to money based on information rather than on the credibility of a particular government,” James said. “Nixon’s closing of the gold window marked the end of a commodity-based monetary order, and the beginning a new world of fiat currencies. We are moving toward another new monetary order, based on information.”
The past 18 months have been an exciting phase of the monetary revolution. The COVID-19 pandemic has sped up innovation in decentralized finance, as well as adoption by a wider range of investors and institutions of established cryptocurrencies, such as bitcoin and ethereum.
CRYPTO’S OPPONENTS
Over the past few months, the custodians of the established order have waged a wave of attacks on cryptocurrency.
In the latest BIS annual report, research head Hyun Song-shin denounces cryptocurrencies as “speculative assets rather than money ... used to facilitate money laundering, ransomware attacks and other financial crimes.” Dismissing bitcoin and stablecoins, he says that central banks must expedite the adoption and issuance of their own digital currencies, following China’s lead.
Last month, Martin Wolf of the Financial Times sounded an even more combative note, saying that central banks and governments “have to get a grip on the new Wild West of private money,” and the best way would be to introduce digital currencies of their own.
These messages are being received and amplified in Washington. The President’s Working Group on Financial Markets, which is led by US Secretary of the Treasury Janet Yellen, has expressed concerns about two stablecoins: tether, which is under investigation by the US Department of Justice, and Facebook’s Diem, which was supposed to launch last month.
Perhaps the most startling illustration of this new mood was the speech given by US Securities and Exchange Commission Chairman Gary Gensler at the Aspen Strategy Forum on Aug. 3: “Primarily, crypto assets provide digital, scarce vehicles for speculative investment. Thus, in that sense, one can say they are highly speculative stores of value... We also haven’t seen crypto used much as a medium of exchange. To the extent that it is used as such, it’s often to skirt our laws with respect to anti-money laundering, sanctions, and tax collection... Right now, we just don’t have enough investor protection in crypto. Frankly, at this time, it’s more like the Wild West.”
Gensler went on to say that pretty much everything that moves in the world of cryptocurrencies is almost certainly an unregistered security. Likewise, any platform where cryptocurrencies were traded or lent is subject to securities laws — and possibly also to commodities laws and banking laws. All he asked of the US Congress was “additional plenary authority to write rules for and attach guardrails to crypto trading and lending.”
As if to answer that classic plea by a regulator for yet more power, US President Joe Biden’s administration seized the opportunity presented by its own bipartisan infrastructure bill to insert a provision that, in the name of increasing tax revenue, would treat many, if not all, cryptocurrency participants as “brokers,” potentially requiring them to report to the US Internal Revenue Service.
Many of these participants merely serve as nodes in a network, processing encrypted information, and do not even have access to the information required by the proposed legislation.
A bipartisan group comprised of US senators Pat Toomey, Cynthia Lummis and Ron Wyden rode to the rescue with a compromise amendment, which, while far from perfect, would have spared bitcoin and ethereum miners, validators, hardware makers and, most importantly, programmers themselves.
Another bipartisan pairing, US senators Mark Warner and Rob Portman, proposed a competing amendment that would have created a carveout only for bitcoin miners.
Yellen and the White House backed the Warner amendment, as it offered a legislative basis for the universal digital financial surveillance they seek without the political battle that standalone legislation would likely require.
While bitcoin is the most widely held and most valuable cryptocurrency, it is ethereum’s rapid, decentralized financial system based on smart contracts that worries the Treasury.
The Warner amendment was an analogous attempt to choose “which foundational technologies are OK and which are not in crypto,” to quote Coinbase Global CEO Brian Armstrong, a sentiment echoed by Tesla founder Elon Musk. In the end, the amendments fell by the wayside and the original language stands.
The right response came from US Senator Ted Cruz, who proposed striking all cryptocurrency language from the bill. As “no more than five” US senators could answer “what the hell a cryptocurrency even is,” he said, “the barest exercise of prudence would say we shouldn’t regulate something we don’t yet understand. We should actually take the time to try to understand it.”
Venture investor Adam Cochran said: “There is currently no greater way to risk the supremacy of the US dollar, than by introducing anti-crypto legislation... The risk of cryptocurrency replacing the sovereignty of the US dollar is not that people will start to denote everything in bitcoin. It’s that this industry will set up shop elsewhere and it will use that currency.”
A monetary revolution as profound as the one that swept away the remains of the gold standard is taking place, but there is a difference. In the 1970s and 1980s, the attempts by governments to regulate the revolution were swept away. Nixon’s price and wage controls were an abject failure, just as the economist Milton Friedman (and Shultz) had foreseen. Under Reagan, it was deregulation that enabled US financial institutions to become the dominant players in international markets.
INNOVATIVE ENERGY
The innovative energy has passed to the “crypto bros,” leaving the established banks and their friends in Washington scrambling to make the barriers to competition even higher. If cryptocurrency is the Internet of money, then the world is still at quite an early stage of its development. Restrictive regulation in the mid-1990s might have strangled in its infancy the commercialization of the World Wide Web. Restrictive regulation of cryptocurrencies could turn out to be an expensive mistake.
Avichal Garg of Electric Capital is right in thinking that the best strategy to preserve the dominance of the US dollar is precisely to encourage the international adoption of US dollar-linked stablecoins, rather than to stamp them out. As the Internet of money grows, the US dollar is well-placed to be the preferred global on and off-ramp, connecting the nascent “metaverse” to the physical world where taxes are still paid in the fiat currency.
Surely the best way to win a race with totalitarian rivals is not to copy them, but to out-innovate them. Make the wrong decision at this historic turning point is to interrupt a much bigger bonanza than Nixon did.
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