Nixon was inheriting an overheated economy—inflation was already a concern.
For the first years after World War II, Bretton Woods (named for the New Hampshire resort where delegates from 44 Allied nations met in 1944) worked perfectly. Japan and Europe were still rebuilding, and foreigners were eager for dollars they could spend on American cars, steel, and machinery. Even as they accumulated currency reserves, America’s trading partners were content to park them in interest-bearing dollars rather than in inert metal. And since the U.S. owned over half the world’s official gold reserves—574 million ounces at the end of World War II—the system seemed secure.
One day in 1960, when Volcker was working at Chase Manhattan, someone burst into his office with news: Gold was at $40. Volcker couldn’t believe it. The price receded, but it was a worrisome foretaste. Jitters in the gold market were an early symptom of domestic inflation.
By the time Nixon took office, officials knew they were sitting on a powder keg. As Volcker, then 41, recalls, he warned incoming Treasury Secretary David M. Kennedy that they had two years to save the dollar. America’s balance of payments deficit in 1969 had reached $7 billion—small by today’s standards but scary then.
What he did care about was the domestic economy, especially the politically sensitive unemployment number. And despite his instructions to Burns, in 1970 the U.S. suffered a recession, triggering a rise in unemployment to 6 percent, its highest mark in a decade. To Friedman, money supply was the single key tool at the Fed’s disposal. Friedman viewed money in terms of supply and demand: If the Fed printed more dollars, then money would be worth less and goods would cost more, i.e. inflation. But he also saw overly tight money as having worsened the Great Depression.
Rampant domestic inflation was mirrored, franc for franc, in markets overseas. Foreign governments intervened to buy dollars to shore up America’s currency (and their export trade). This left their central banks swollen with greenbacks. “Foreigners buying dollars caused a monetary expansion, similar to today,” says Ronald McKinnon, an economist at Stanford University. Meanwhile, America’s gold stock had dwindled to $10 billion, half its 1960 level. The gold standard now existed only in name, for foreign banks held far more dollars than the U.S. held gold. This left the U.S. vulnerable to a run.
The gold exodus continued and, to make matters worse, the U.S. began running a substantial trade deficit, a politically charged issue given that unemployment remained at 6 percent. Nixon had to act, but his advisers were split. Volcker, as well as Shultz, wanted to close the gold window. Burns was vehemently opposed. Severing the gold link would turn money into … paper. If the government no longer had to preserve the dollar’s value in metal, how could the Administration claim, with any credibility, to be countering inflation?
Connally brilliantly packaged the program not as America abandoning its commitment to the gold standard but as America taking charge. He turned the dollar’s collapse, which could have appeared shameful, into a moment of hubris.
Addressing the nation on Sunday, Nixon blamed currency speculators and “unfair” exchange rates rather than U.S. monetary policy. Politically, he hit the jackpot. Monday’s nearly 33-point rise in the Dow was the biggest ever to that point. Nixon’s “New Economic Policy” drew raves from the press.
The world gravitated from the certainties of Bretton Woods to the dizzying market cycles we’ve lived with since. Donald Kohn, who joined the Fed in 1970 and retired last year as vice-chairman, thinks Bretton Woods was doomed. But bankers have yet to find as rigorous a standard as gold. And they have become ever more apt to please politicians, deferring recessions at the risk of inflating asset bubbles.
The new Fed chief, Volcker, did tame inflation; unlike Burns, he had the fortitude to subject the country to a brutal recession. But the dilemma faced by Burns—how to withstand the demands of the public for limitless monetary expansion—did not go away. We see it now in the troubles of nations from Greece to Ireland to the U.S. And the anguish that Burns felt is Ben Bernanke’s unfortunate inheritance.