Chapter 25: Collapse of the Par Value System (January 1–August 15, 1971)
- International Monetary Fund
- Published Date:
- February 1996
Exchange Rates became the Fund’s paramount problem in 1971. The Board of Governors had failed to act on the par value system in Copenhagen in September 1970 mainly because, in the year preceding that meeting, the world’s exchange markets had remained calm. The succession of crises that had marked 1968 and most of 1969 had ended. Within eight months after the 1970 Annual Meeting, however, this calm in exchange markets disappeared. In May 1971 six European countries took exchange rate action, including resort to floating rates by the Federal Republic of Germany and the Netherlands. On August 15, 1971 the largest convulsion of all shook the international monetary system: the U.S. authorities suspended the convertibility into gold or other reserve assets of dollars held by the monetary authorities of other countries. Both the par value system and the convertibility of dollars into gold—two pillars of the monetary system designed at Bretton Woods—thereby collapsed.
This chapter relates these reverberating events. But first, the other, relatively minor, changes in par values and other adjustments that were made between January 1 and August 15, 1971 are discussed. (Similar changes that were made in the years 1966 through 1970 were covered in Chapter 23.)
Par Value and Other Adjustments
Effective on January 24, 1971 at 12:01 a.m., Belgrade time (January 23, 1971 at 6:01 p.m., Washington time), the par value of the Yugoslav dinar was changed from 8.0000 U.S. cents per dinar to 6.66667 U.S. cents per dinar, a devaluation of 16.7 per cent. This was the first effective change in Yugoslavia’s par value since July 1965, when multiple currency practices were abolished. To give the Fund time for consideration, the National Bank of Yugoslavia alerted Mr. Schweitzer several days in advance of the intention to devalue.
The staff—a mission had been in Belgrade a few weeks before, in December 1970, in connection with a requested stand-by arrangement—supported the member’s proposed devaluation. The increase in domestic costs had eroded the competitive position, and there had been speculation against the dinar. The authorities were in the process of taking a number of financial policy measures to support the proposed par value and bring about the desired shift of resources from the internal to the external sector.
Mr. Ivo Perisin, Governor for Yugoslavia, came to Washington to attend the Executive Board meeting held on Saturday, January 23, 1971. At that meeting Mr. Lieftinck explained that the deterioration in the balance of payments had been due mainly to an increase in imports that was much too rapid. These larger imports had resulted from an excessive rise in personal incomes. The fundamental disequilibrium that had developed could no longer be remedied by measures of domestic restraint alone.
The Executive Board agreed that fundamental disequilibrium existed and concurred in the change of par value.
New Monetary Units
On February 15, 1971 the United Kingdom and the Republic of Ireland adopted decimal systems for the pound sterling and the Irish pound, actions that did not involve any change of par value. In both cases the denominations for the new currencies were to be the pound and the new penny (1/100 of a pound), which was to replace the former system of pounds, shillings, and pence (sterling or Irish). The new penny was to be equal to 2.4 old pence. The new system was also to be adopted in the Falkland Islands and dependencies and in Gibraltar.
On the same day the Government of Malawi replaced the Malawi pound with a new currency, the kwacha, equivalent to 10 Malawi shillings. With the Fund’s concurrence, a par value of 120.000 U.S. cents per kwacha was established, but no appreciation or depreciation was involved.
Effective July 1 the Fund concurred in a proposed par value for a new monetary unit, the dalasi, introduced by The Gambia to replace the Gambian pound. The new unit was equivalent to 4 Gambian shillings. The par value was set at 48 U.S. cents per dalasi, which did not involve any appreciation or depreciation.
On August 9 the Fund agreed to a proposal by Barbados for an initial par value of 2 East Caribbean dollars per U.S. dollar.
Canada Retains a Floating Rate
During the period January 1–August 15, 1971 the exchange rate for the Canadian dollar continued to float, with quoted rates averaging 6–7 per cent above the par value.
Under the Fund’s evolving policy for quarterly consultations with members having floating exchange rates, the Fund held consultations with the Canadian Government in January, April, and July. Unemployment had become Canada’s most serious economic problem. With more than 6 per cent of the labor force unemployed, the Canadian authorities were trying to reactivate the economy without sparking a return to higher rates of price increase. They continued to be reluctant to set a par value. The Executive Directors, as well as the staff, continued to argue that it was preferable for Canada to return to the par value system: that system was in jeopardy and the continued floating of the Canadian dollar certainly did not help to bolster it.
After May, when the currencies of the Federal Republic of Germany and the Netherlands were also floating, and especially after August 15, when the official convertibility for the U.S. dollar was suspended, the Fund’s arguments concerning the need for a par value for the Canadian dollar necessarily became much weaker. The report of the staff’s visit to Ottawa on July 26–29 was not circulated to the Executive Directors until after August 15, when, following the suspension of official convertibility by the United States, exchange markets everywhere were disrupted. The Executive Directors began to center their attention on the exchange rate situations of all the major industrial countries and on the prospects for a general realignment of currencies. (These developments are discussed later in this chapter and in Chapter 26.) In these circumstances, the floating of the Canadian dollar was obviously less of an aberration from the system of par values, and the Executive Directors did not discuss the staff’s report.
Fresh Disturbances in European Markets
Although the renewed disturbances that afflicted European exchange markets in the first week of May 1971 were the sixth or seventh exchange crisis within three years, no one seemed quite prepared. It was only afterward that particular causes were sought for the onset in the first few months of 1971 of voluminous outflows of privately held foreign capital from the United States. Increasing alarm about the size of the U.S. balance of payments deficit had been evident in January 1971 in the Executive Directors’ comments during the 1970 Article VIII consultation with the United States, but no great change had occurred in 1970 and the first quarter of 1971 in the trade balances of the major industrial countries, nor in their “basic balances,” that would explain a sudden reversal of capital flows.
In their Annual Report for 1971, the Executive Directors attributed the shift in capital flows to the opening of an unusually wide gap between credit conditions and interest rates in the United States and in continental European countries.1 This gap had opened because both the United States and continental European countries were opting in favor of monetary policy, as against other anti-inflationary measures, to regulate their domestic economies and because, at the time, their cyclical positions and the ways in which they applied monetary policy diverged. Most relevant was the easing of monetary conditions in the United States while those in the Federal Republic of Germany were being made stringent. This explanation for the sudden outflows of yield-sensitive capital from the United States was also the one subscribed to by Mr. Arthur F. Burns, Chairman of the Board of Governors of the Federal Reserve System, speaking in Munich on May 28 at the 1971 International Banking Conference of the American Bankers Association.
The monetary authorities in the United States and Europe had already taken steps by April to bring their short-term interest rates closer together. Interest-induced capital movements were, however, overtaken by speculative capital movements. Many officials and academic economists had been making public references to “overvaluation of the dollar,” and speculators anticipated changes in the exchange rates of major currencies, including the dollar.
In the first few days of May the rush of funds into European markets took on gigantic proportions. The outflow of funds from the United States not only once again severely aggravated the balance of payments and reserve positions of that country, but the inflows made it virtually impossible for the authorities of the recipient countries to cope with the consequent inflationary threats to their domestic economies. These inflationary pressures worsened when countries bought dollars so as to keep the exchange rates for their currencies in terms of dollars stable and were then confronted with greatly augmented monetary reserves and enhanced bank liquidity. On Wednesday, May 5, the central banking authorities of Austria, Belgium and Luxembourg, the Federal Republic of Germany, the Netherlands, Portugal, and Switzerland closed their official exchange markets, and those of Finland, Greece, Norway, Singapore, and South Africa withdrew their support for the U.S. dollar and suspended dealings in deutsche mark, Netherlands guilders, and Swiss francs.
Managing Director Suggests a Technique
As European Cabinets and the Finance Ministers of the eec countries were assembling to decide what to do, the Executive Directors, although they had no specific proposals before them, met twice in formal meetings on May 5 and again in informal session on May 7. It was already evident that a new realignment of the par values of the major currencies was most unlikely. Mr. John B. Connally, appointed by President Nixon as Secretary of the Treasury in March 1971, had emphasized once more in a press release issued by the U.S. Treasury on May 4 the official view of the U.S. Government that no change in the present structure of parities was necessary or anticipated.
In an attempt to be helpful in this latest crisis, the Managing Director circulated to the Executive Directors first a statement, and then an aide-mémoire, which they could pass on to their authorities. He stressed that it was important for the Fund, in these difficult circumstances, to try to maintain the system of par values, if that was at all possible. Nonetheless, at least until the current uncertainties had been dispelled, some additional flexibility of exchange rates might be required to permit European authorities to reopen their exchange markets on Monday, May 10. To avoid floating rates for the deutsche mark and other currencies, which might do permanent damage to the system of par values, he suggested a widening of the upward margins, say, to 5 or 6 per cent from par in relation to the dollar. These wider margins would prevail only for a limited time, at most a few months, to test what if any changes of par value were needed.
Two ways might be used, Mr. Schweitzer suggested, to effect a temporary widening of the margins under the existing Articles. Under Article XVI, Section 1, the Fund could, in the event of an emergency or the development of unforeseen circumstances threatening the operations of the Fund, temporarily suspend the margin provisions. The Executive Board could, by unanimous vote, suspend these provisions for 120 days and the Board of Governors could, by a four-fifths majority of the total voting power, extend any suspension for a further 240 days. In deciding on such a suspension, the Executive Board could as a condition of the suspension determine the widened margins around parity that members would have to observe for the period of the suspension. During this period, active consideration would be given to amending the Articles.
Alternatively, the Fund could call on members to collaborate with it, under the provisions of Article IV, Section 4 (a), to observe the same specified wider margins in those cases where they felt unable to observe the 1 per cent margins.
Most of the Executive Directors expressed appreciation for the leadership shown by Mr. Schweitzer, and several of them, including Messrs. Dale, de Kock, Johnstone, Lieftinck, Palamenghi-Crispi, and Schleiminger, supported his suggestion for wider margins. Nevertheless, this suggestion was not implemented. Mr. Dale and Mr. Schleiminger wanted any widening of the margins to be made symmetrical, downward as well as upward. Mr. Lieftinck and Mr. Palamenghi-Crispi doubted that margins of 5–6 per cent were wide enough, while Mr. Gilchrist considered them excessive. Mr. Palamenghi-Crispi said that the Italian authorities favored a number of measures to control capital movements: controlling the supplies of money; freezing foreign deposits and placing charges on their unfreezing; instituting restrictions on nonbank borrowing abroad; and introducing controls on movements of capital. Mr. Koichi Satow (Japan) reported that the Japanese authorities were opposed to wider margins even temporarily, and Mr. Viénot called the Managing Director’s suggestion “premature,” inasmuch as eec members had not yet discussed widening the margins to deal with the current crisis, and “extremely dangerous,” since it provided an opportunity for a substantial change in the way the international monetary system operated.
New Measures by European Countries
On Sunday, May 9, 1971, five European members of the Fund and Switzerland took steps preparatory to reopening their exchange markets the next morning.
Federal Republic of Germany, Netherlands, Belgium, and Luxembourg
The Federal Republic of Germany informed the Fund that, for the time being, it would not maintain the exchange rates for its currency within the established margins. The Netherlands informed the Fund that it had found it necessary to take similar action, both because of the recent developments in foreign exchange markets and because of the action of the German authorities, since commercial transactions between the two countries were sizable. In other words, the exchange rates for both the deutsche mark and the Netherlands guilder would float. Both members gave assurances to the Fund that they would remain in close consultation with the Fund, that they would collaborate fully with the Fund in accordance with the Articles of Agreement, and that they would resume maintenance of the limits around their par values as soon as circumstances permitted.
Belgium and Luxembourg notified the Fund that the Belgian-Luxembourg Economic Union was changing the regulations concerning its free market for capital transactions with a view to stemming any large inflows of capital. Previously, the free market had been used as an instrument for containing excessive capital outflows; the rate in the free market could depreciate but not appreciate relative to the rate in the official market, as currencies acquired in the free market could be sold in the official market. Now the dual market system would be altered so that capital inflows could not be channeled through the official market. This and other changes affecting the scope and structure of the free market would make it possible for the rate in the free market to appreciate above that in the official market. Thus, the free market would be useful in discouraging large-scale inflows of capital.
As they had often done in the past few crises, the Executive Directors met on a Sunday evening (May 9, 1971). Mr. Schleiminger, Mr. Lieftinck, and Mr. van Campenhout all reported that the authorities of their countries saw no reason, either currently or in the foreseeable future, to change the par values of their currencies. In particular, the authorities of the Federal Republic of Germany had ruled out another revaluation: costs and prices were rising sharply, even relative to those in other countries, and the basic balance of payments was in deficit. Floating the deutsche mark would insulate the economy and buy time for a restrictive monetary policy to take effect. Restrictions were also being placed on capital transactions. These included the abolition of interest on nonresidents’ deposits and the requirement that residents obtain official authorization to sell domestic securities to nonresidents. Mr. Schleiminger pointed out that the authorities of the Federal Republic of Germany had few other options. The German public wanted some response. No suitable machinery existed for implementing administrative controls quickly and effectively. And agreement by the members of the eec on widening the margins of fluctuation for their currencies for a limited period had not been found feasible.
Although most of the Executive Directors understood the actions of the authorities of the Federal Republic of Germany, the Netherlands, and Belgium and Luxembourg, several of them were disturbed by the situation that was developing and expressed their deep concern for the par value system. Their decisions for the Federal Republic of Germany and the Netherlands, which in the customary way for such decisions noted the circumstances and called for close consultation with the Fund, went further than usual. Authority was specifically conferred on the Managing Director to initiate consultations between the member and the Fund. The intent was to help to keep the Fund involved in the exchange rate discussions of major countries to a greater extent and at an earlier stage by explicitly enabling the Managing Director to have informal communication with the authorities of members on their exchange rate policies. He could then use his discretion in deciding when consultations of a formal nature, culminating in a formal discussion and possibly a decision by the Executive Board, would be most useful.
Mr. Brofoss, insisting that much tighter restrictions on capital movements should be instituted on a worldwide basis to stop speculators from destroying the international monetary system, dissociated himself from the decisions.
In July, in the course of the next Article VIII consultation with Belgium and Luxembourg, the Fund approved the changes in the exchange regulations of those members.
Because of the concern of some Executive Directors about the threat to the par value system, because most of them again urged that the Fund have a more active role in exchange rate decisions that were increasingly being taken outside the Fund, and because the Managing Director had, at the outset of the latest crisis, come up with positive suggestions for handling that crisis, the press release issued by the Fund on May 9, 1971 in regard to the measures being taken by the Federal Republic of Germany, the Netherlands, and Belgium and Luxembourg included the following paragraph:
The Fund has given consideration to various ways of coping with the difficulties presently facing its members. In its consultations with members, and in its continuing work, the Fund will seek to maintain and strengthen the basic principles of the Bretton Woods system. The recent disturbances demonstrate the need to improve the international adjustment process and to bring about a better coordination among members with respect to their internal and external policies.
The Executive Board could not agree, however, that the Fund should expedite its study of limited exchange rate flexibility.
Also on May 9, 1971, Austria informed the Fund that, effective on that day at 7:00 p.m., Washington time, it proposed to change the par value of the schilling from S 26 to S 24.75 per U.S. dollar, a revaluation of 5.05 per cent. The staff’s assessment justified this revaluation, partly because of a fundamental disequilibrium but mainly as a protective move following the floating of the deutsche mark. Given Austria’s strong external position and its close relations with the Federal Republic of Germany, the action by the latter might otherwise stimulate an unwanted inflow of speculative capital from that country and other countries. Inasmuch as the change in par value for the schilling, together with all previous changes, did not exceed 10 per cent of the initial par value set by Austria in May 1953, the change fell within the provisions of Article IV, Section 5 (c) (i), and the Fund therefore merely noted the new par value.
The Swiss authorities on May 9, 1971 announced a revaluation of the Swiss franc from a parity equivalent to Sw F 4.37282 per U.S. dollar to Sw F 4.08415 per U.S. dollar, effective from May 10, 1971. In making the announcement, the Minister of Finance said that the revaluation was necessary to prevent an excessive flow of funds into Switzerland.
Difficult Issues Arise
By mid-1971 the problems of the international monetary system were being aired everywhere. Three major currencies—the Canadian dollar, the deutsche mark, and the Netherlands guilder—were now floating. The disequilibrium in international payments seemed greater than ever. There was much talk, especially among economists, that the U.S. dollar was overvalued relative to the currencies of some other industrial countries and that there ought to be a moderate change in the exchange rate relationships between the dollar and the other currencies. But official spokesmen for the United States and for other countries held disparate views about whether it should be the United States or those nations that had persistent surpluses which should take the initiative in correcting the disequilibrium by a change of par value. Should the dollar be devalued or should other currencies be revalued? In the meantime, the formation of exchange rate policy was being heavily dominated by short-term capital movements. Moreover, the likelihood was increasing that an otherwise minor political or financial crisis would unhinge the entire international monetary system or precipitate a general resurgence of protectionism.
The questions being raised by monetary officials paralleled those coming up in Executive Board discussions during these months—for example, in the Board’s informal sessions on the world economic outlook, in the 1971 Article VIII consultation with the Federal Republic of Germany, and in the Board’s continuing discussions about techniques for enhancing exchange rate flexibility. These questions were directed in the first instance to the immediate future. Need the floating rate for the deutsche mark continue for long? Within two months the Federal Republic of Germany had regained a measure of control over the liquidity of its banking system, with a moderate appreciation in the rate for the deutsche mark of 4 per cent, to DM 3.50–3.56 per U.S. dollar. Therefore, should not that country resume the maintenance of regular margins around its par value, especially since the floating rate for the deutsche mark was creating uncertainties and difficulties for transactions among members of the eec? Mr. Lieftinck had already confirmed that some of these difficulties existed for the Netherlands.
Other questions were directed to the longer run, but with the realization that the longer run was not so far in the future any more. Could the present floating of three major currencies be regarded as a test of how a general system of floating rates would work? To what extent had short-term capital movements been fostered because the mix of domestic policies that countries had been using to check inflation had relied excessively on monetary policy and insufficiently on fiscal and wage-price, that is, incomes, policies? Would capital flows be reduced sufficiently by better coordination of monetary policy among countries aimed at preventing very high interest rates and interest-rate differentials among countries? How could such international policy coordination be implemented? To what extent, and how, should capital transactions be made subject to restrictions? Was it even possible to place controls on capital movements between free economies that had become closely integrated economically and financially? How should the basic imbalances in international payments be rectified? And, lastly, in what forum should these and related questions be answered?
There were, of course, difficulties of a technical nature involved in answering these perplexing economic questions. But from discussions that had already taken place among international monetary authorities—and from statements that high monetary officials were increasingly making to the press, debating in public, as it were, their positions on international monetary questions—it was evident that sharp differences of opinion that were really political in character would have to be resolved as well.
Managing Director’s Initiative
Immediately after the events of the first ten days of May (described above), Mr. Schweitzer, seeking to give the Fund a more active, effective, and visible role in the solution of these problems, suggested to the Executive Directors a three-pronged program.
First, and most urgently, they should submit a final report on the question of exchange rate flexibility to the Board of Governors, preferably before the Annual Meeting in September; such a report should include specific recommendations for amending the Articles of Agreement. Mr. Schweitzer continued to believe that the fact that the Fund’s views on the exchange rate system remained unsettled could potentially disturb the world’s exchange markets.
Second, they should examine the ways in which the adjustment process might be improved and in which domestic economic and financial policies of nations might be better coordinated.
Third, they should study means of preventing short-term capital flows, including the use of more generally applied restrictions on such transactions.
The Executive Directors all welcomed the Managing Director’s initiative, although many had some difficulty with setting a deadline for a report on exchange rate flexibility. Mr. Suzuki and Mr. Viénot wanted assurances (a) that priority would not be assigned to the study of exchange rate flexibility at the expense of the other topics, and (b) that the possible final recommendation could be “no change in the par value system.”
United States Shapes Its Views
Before the Executive Directors had had time to act on the program suggested by the Managing Director, some issues that were even more controversial than those listed at the beginning of this section were brought forward. The Secretary of the U.S. Treasury, Mr. Connally, in a speech on May 28, 1971 at the International Banking Conference of the American Bankers Association in Munich that was praised by some as “telling it as it is” and “forthright” and criticized by others as “tough” and “unconciliatory,” brought into the open two very sensitive issues that until that time had been submerged in international discussions of the U.S. balance of payments deficit, namely, the cost of military defense and international trade policy.
Reciting the history of the United States in the field of international monetary cooperation since World War II, Mr. Connally pointed out that, despite its chronic payments deficits, the United States nonetheless had remained a major exporter of capital, had continued to make substantial outlays for defense costs abroad, had maintained a large foreign aid program, and had not heavily protected its domestic markets. Neither the U.S. deficit nor the enormous short-term money flows were “uniquely American” problems, and joint responsibility for their solution should be accepted. The responsibility of the United States was to bring inflation in its domestic economy under control; to that end, it had implemented stern fiscal and monetary policies, with considerable domestic tolls in terms of unutilized economic capacity, low profits, and unemployment.
Mr. Connally stated explicitly that the burden of defense costs had to be shared more fully among the allies of the free world and that action must be taken to make trading arrangements more equitable and to permit freer entry of imports into European and Japanese markets. The United States, he said emphatically, was not going to devalue the dollar and was not going to change the price of gold.
United States Suspends Convertibility
During the course of 1971 the U.S. balance of payments situation deteriorated more and more. In the first quarter the balance on the official settlements basis, seasonally adjusted, was in deficit by $5,506 million ($5,686 million excluding allocations of SDRs), a deterioration of $2.2 billion from the fourth quarter of 1970.2 In the second quarter there was a trade deficit, the first such quarterly deficit since 1935, and it appeared that for the year as a whole the first trade deficit since 1893 might develop. Contributing to the trade deficit was a strengthening of demand in the United States, as the authorities took stimulative monetary measures to combat the 1969–70 recession, and a slowing down of economic activity in Western Europe and Japan, where anti-inflationary measures still prevailed. As a result, the underlying downward trend in the U.S. trade balance was compounded by a cyclical situation less favorable than that in the preceding year. In addition, prolonged dock strikes reduced exports more than imports, and strikes or threats of strikes in several major industries also had an adverse effect on the trade balance. There may have been, as well, an acceleration of imports into the United States in anticipation of exchange rate changes or import restrictions. But apart from cyclical influences and special situations, the continuous upsurge in U.S. imports reflected a persistent growth in U.S. consumers’ preferences for imported products.
By far the largest factor responsible for the sharply deteriorating balance of payments position, however, was an enormous increase in short-term capital outflows. These, plus the trade deficit and a larger outflow on long-term capital account, gave rise to a U.S. deficit (official settlements basis) for the first half of 1971 of more than $22 billion at an annual rate.
The outward movement of capital was in part the response of participants in financial markets to the shift in comparative monetary conditions and interest rate levels. However, the deteriorating U.S. trade position was being accompanied by a huge advance in the trade surplus of Japan, suggesting a sharply growing imbalance in the global payments structure. Hence, large shifts of capital that were clearly speculative—in anticipation of, or hedging against, possible changes in exchange rates for major currencies—began to take place. A contributing factor to speculative capital movements was the spreading realization that the modest improvement of the U.S. current account in 1970 had been a temporary manifestation of a favorable combination of circumstances, and that the tapering off of the European boom, together with the commencement of a domestic economic upswing in the United States itself, was again exposing the fundamental weakness of the U.S. current account.
There was evidence of further large deficits to come. No early correction was in sight. Consequently, in July and early August another and even more massive flow of funds into foreign currencies got under way. A number of countries began to present more of their dollar holdings to the U.S. Treasury for conversion into gold. By August 15, the net U.S. reserve position—already weak at the beginning of the year—had deteriorated to the point where liabilities to foreign official authorities exceeded U.S. official reserves by almost $30 billion. The deficit on an official settlements basis for the third quarter alone would amount to nearly $13 billion.
Furthermore, public concern with the U.S. economic situation had deepened. Domestically, rising prices coexisted with unemployment. On the external side, a report issued on August 6 by the U.S. Congress recommended action in respect of the dollar and explained that a change in the exchange rate could probably come only by breaking the link with gold.3 It was argued that merely increasing the dollar price of gold not only had the unfortunate side effects of yielding windfall profits to gold producing countries and to those who had been accumulating gold, but held no assurance that exchange rates in terms of dollars would change: other countries might correspondingly alter the gold value of their currencies, leaving no change in the position of the dollar. A second possibility of effecting a change in the value of the dollar was impracticable because other countries were reluctant to revalue their currencies vis-à-vis the dollar.
On Sunday evening, August 15, 1971, President Nixon, in an address on radio and television, announced a far-ranging New Economic Program for the United States.4 The program reflected in part the findings of the Commission on International Trade and Investment Policy, which he had appointed in May 1970 “to examine the principal problems in the field of U.S. foreign trade and investment, and to produce recommendations designed to meet the challenges of the changing world economy during the present decade.” That Commission had given the President its report in July 1971.5 The program included measures to improve both the domestic economy and the balance of payments position.
In the domestic field, there were tax cuts to stimulate employment, but in order to achieve price stability more quickly, there were also reductions in budgetary expenditures and, in a sharp reversal of governmental policy, a 90-day freeze on prices and wages.
On the external side, a series of actions restricted the conversion into gold or other reserve assets of dollars held by monetary authorities abroad. First, the U.S. authorities notified the Fund that, with effect from August 15, 1971, the United States no longer, for the settlement of international transactions, in fact freely bought and sold gold under the second sentence of Article IV, Section 4 (b), of the Articles of Agreement. Second, further use of U.S. international reserve assets (gold, SDRs, drawing rights in the Fund, and foreign exchange holdings) was “strictly limited” to “settlement of outstanding obligations and, in cooperation with the Fund, to other situations that may arise in which such use can contribute to international monetary stability and the interests of the United States.” Third, the Secretary of the Treasury requested the Board of Governors of the Federal Reserve System to suspend the virtually automatic use of its swap network for the purpose of converting dollars into other currencies. Thus, what had earlier been referred to informally by financiers and bankers as a prospective “closing of the gold window” by the United States became a formal reality. Fourth, President Nixon announced that the United States was imposing, effective immediately, a temporary surcharge of 10 per cent on all dutiable imports not already subject to quantitative limitation. (In effect, the only exemptions to the surcharge were imports of raw materials and imports of a few manufactured commodities that were already subject to import quotas.)
Implications for the Fund
The U.S. actions had profound implications for the international monetary system and for the Fund. Under the par value system, the members of the Fund were obliged to maintain the exchange rates for their currencies within prescribed margins around agreed par values. In general, members other than the United States had chosen to fulfill this obligation by intervening in their exchange markets so as to peg the rates for their currencies, usually to the dollar. They bought dollars when the rate for dollars was depreciating in terms of their currencies and sold dollars when the dollar rate in terms of their currencies was appreciating. The United States, for its part, had opted to carry out its exchange rate obligations by being willing to buy and sell gold for dollars freely—that is, without limit—from and to the monetary authorities of other members, at the official price plus or minus the margin prescribed by the Fund. Thus, the monetary authorities of other members could, if they wished, exchange for gold any dollars they acquired.
The assumption of the obligation by the United States with respect to buying and selling gold for dollars, which had been spelled out in a letter of May 20, 1949 from the Secretary of the Treasury to the Managing Director, was rescinded by the letter to the Managing Director of August 15, 1971. One of the foundation stones of the international monetary system as it had operated since World War II under the Bretton Woods agreements—the convertibility of officially held dollar balances into gold—had crumbled. In the President’s statement, the United States also gave up the obligation of conversion through the Fund under Article VIII, Section 4, thereby further limiting the convertibility envisaged under the Bretton Woods system. Following the U.S. actions, the par value system, too, was formally in abeyance: other members of the Fund, which had to decide whether to continue to accumulate dollars or to let their exchange rates fluctuate, could no longer assure that they would intervene in exchange markets in such a way that transactions between their currencies and the U.S. dollar would take place within prescribed limits around par values.
Annual Report, 1971, pp. 9–11.
U.S. Department of Commerce, News, May 17, 1971, p. 1.
U.S. Congress, Joint Economic Committee, Action Now to Strengthen the U.S. Dollar: Report of the Subcommittee on International Exchange and Payments, 92nd Cong., 1st Sess. (Washington, 1971). This subcommittee was often referred to as the Reuss committee because it was chaired by Mr. Henry S. Reuss, Congressman from Wisconsin. (Mr. William Proxmire, Senator from Wisconsin, was the chairman of the Joint Economic Committee.)
Reproduced in Supplement to International Financial News Survey, Vol. 23 (1971), pp. 257–60.
U.S. Commission on International Trade and Investment Policy, United States International Economic Policy in an Interdependent World: Report to the President (Washington, 1971); released to the public in September 1971.