How Richard Nixon Wrecked Free Trade
How Richard Nixon Wrecked Free Trade
by Jeffrey A. Tucker at Brownstone Institute
The year was 1971 and the claims against dollar-based debt were pouring in from every country. The rumor was that the US did not really have the gold to pay. Foreign holders of US assets decided to test the promise, just in case.
Sure enough, Nixon panicked and shut the gold window, in effect defaulting on the terms of the deal, as did his predecessor FDR back in 1933. Nixon too was panicking over the draining of gold from the US Treasury. His intention was to protect the US dollar.
Briefly, the US attempted a fixed-rate regime without settlement but failed. Two years later, the US announced a new system, one that they claimed would be better than ever. Henceforth, the US would be backed by nothing but confidence. But all would be well, we were told. All countries in the world would be in the same position, paper vs paper. And there would be a big market for arbitrage between them. Lots of profit opportunities.
Indeed it was true. Today the global foreign exchange market has an average daily trading volume of up to $7.5 trillion, though it depends on the volatility. In any case, currency speculation is a huge industry that specializes in earning big bucks off small change.
This market was a new one: whereas money for the previous several hundred years had been rooted in something more fundamental, now it would forever float based on the credibility of governments and their promises to pay with paper..
Of this there has been no doubt since 1973: the US paper dollar is king of the world, the global reserve currency in which most all accounts between countries are settled. Since that time, the US economy has experienced dramatic inflation: dollar purchasing power in 1973 has been reduced to 13.5 cents. Debt (government, industry, and household) has exploded. The industrial distortions at home have been legion. The upheaval in household finance from inflation created he necessity of two incomes per household to keep up.
In international trade, the dollar and petrodollar became the new gold. But whereas gold was a non-state asset shared by nearly all countries, an independent mediator of all enterprises and nations. The US dollar was different. It was attached to a state, one that presumed to run the world, an empire the likes of which history had never seen.
This became undeniably true by the end of the Cold War, when the planet became unipolar and the US extended its ambitions without check to all parts of the world, an economic and military empire without precedent.
Every empire in history meets its match at some point and in some way. In the case of the US, the surprise came in the form of economics. If the US dollar would become the new gold, other countries could hold it as collateral. Those other countries had a secret weapon: low production costs for manufacturing, backed by wages for labor that were a tiny fraction of the US.
In times past, such disparities were not really an issue. Under the theory of David Hume (1711–1776), which held true for centuries from the time he advanced it, accounts between nations would settle in ways that would provide no permanent competitive advantage to any single state. All prices and wages between all trading nations would equilibrate over time. At least there would be a tendency in that direction, thanks to gold flows that would increase or decrease prices and wages, leading to what David Ricardo theorized and would later be called the law of one price.
The theory was that no country that was part of the trading system would have any permanent advantage over any other. That idea held true so long as there was a non-state mechanism of settlement, namely gold.
But with the new paper dollar standard, that would no longer be the case. The US would rule the world but with a downside. Any country could hold and accumulate dollars and beef up its industrial structures to become better at doing anything and everything than the empire itself could do.
The first nation to catch on after 1973 was Japan, the defeated enemy of the Second World War that the US helped to rebuild. But very soon after, the US started to see its traditional industries disappear. First, it was pianos. Then watches and clocks. Then it was cars. Then it was home electronics.
Americans started to feel a bit odd about this and tried to emulate various management strategies in Japan, without recognizing that the core problem was more foundational.
Nixon, who pulled the trigger on this new system of global finance, had also shocked the world with this triangulating outreach to China. Some ten years later, China was trading with the world. Following the collapse of Soviet communism, China held on to its one-party rule and eventually joined the newly established World Trade Organization. That was just following the turn of the millennium. It kicked off 25 years of doing to US industrial production what Japan had barely begun to practice back in the day.
The game plan was simple. Export goods and import dollars as assets. Deploy those assets not as currency but as collateral for industrial expansion with the huge advantage of comparatively low production costs.
Unlike the days of the gold standard, the accounts would never settle because there was no real independent mechanism to make it possible. There was only the imperial currency which could be forever hoarded in any exporting country without causing prices and wages to rise (because the domestic currency was a different product entirely, namely the yuan).
This new system pretty well blew up the traditional logic of free trade. What was once called the comparative advantage of nations became the absolute advantage of some nations against others without any prospect that conditions would ever change.
And change they did not. The US gradually lost to China: steel, textiles, clothing, household appliances, tools, toys, shipbuilding, microchips, digital tech, and more besides, to the point that the US held essential only two advantages on the international scene: the natural resource of oil and its byproducts plus financial services.
To be sure, you could look at this situation from a market angle and say: so what? The US gets to consume anything and everything at ever lower prices while shipping abroad endless quantities of useless paper. We get to live the high life while they do all the work.
That perhaps seems fine on paper, though maybe it seems odd. The reality on the ground was different. Because the US specialized in financialization with an infinite production of paper-dollar assets, prices never adjusted downwards, as we had seen for centuries in every money-exporting country.
With the capacity to print forever, the US could fund its empire, fund its welfare state, fund its gigantic budget, fund its military, and all without bothering with actually doing much of anything beyond sitting behind screens.
This was the new system that Nixon granted the world, and it seemed great until it did not. We should refrain from blaming him entirely because he was merely trying to rescue the country from being utterly pillaged by the actions of the administration that preceded his own.
After all, it was Lyndon Johnson who said we could have both guns and butter thanks to the capacity of the Federal Reserve and US creditworthiness abroad. It was he who broke the system put together a generation earlier by the architects of the system known as Bretton Woods, which at least attempted to broker a deal that dealt with the problem of money.
These men, in the waning years of the Second World War, had plotted carefully for the previous decade a new system of international trade and finance. They had every intention of creating a system for the ages. Crucially, it was a comprehensive architecture that thought through trade, finance, and monetary reform all at the same time.
These were scholars – including my mentor Gottfried Haberler – who understood the linkage between trade and monetary settlement, who were fully aware that there was no system that could possibly endure that did not deal with the problem of settlement of accounts. Haberler’s own book (1934/36), called The Theory of International Trade, dedicated the bulk of his text to issues of monetary settlement without which free trade, in which he strongly believed, could never work.
Indeed, Nixon’s new system, proclaimed by many at the time to be the most wonderfully perfect system of international monetary management ever, kicked off precisely what is at issue in the current moment. The issue is the trade deficit, which is roughly identical to the net exports of goods and services.
The defenders of free markets today – and I’m a proponent of exactly this – say none of this matters. We get goods and they get paper so who cares? Politics, cultures, and the search for meaningful lives with class mobility apparently disagree with this dismissive wave of the hand. The moment has come in which the world trading system must again deal with what the fathers of Bretton Woods spent a decade researching and plotting to prevent.
The theory in the world of Trump – pushed by his chairman of the Council of Economic Advisors Stephen Miran in his magnum opus – is that tariffs alone can serve as a proxy for currency settlement in its absence while preserving dollar supremacy.
The likely outcome of the current turmoil will be a Mar-a-Lago Accord of fixed exchange rates enforced by economic might. There is reason for doubt that such a system can last. For all the world, what the Trump administration is doing so far looks like some version of mercantilism on the moderate side or straight-up autarky on the extremist side.
No one knows for sure. Whatever new businesses thrive in the presence of trade barriers will not become exporters because they will not be able to compete on price and cost internationally. They will be dependent on trade barriers, forever adjusted to rebalance trade in the US’s favor, to sustain themselves. They then become craven lobbyists for the preservation and likely increase of tariff barriers, so long as there is a friendly government in charge.
How can any stable system of international trade truly work in an era of fiat currency of US dollar dominance? Sadly, in our soundbite culture of universal attention-deficit disorder, none of these larger questions are being asked, much less answered. Whether the policy prescription is universal tariffs or none, so long as the underlying question of monetary settlement is unaddressed, no one’s policy ambitions will likely be satisfied.
Richard Nixon in his memoirs explains his thinking: “I decided to close the gold window and let the dollar float. As events unfolded, this decision turned out to be the best thing that came out of the whole economic program I announced on August 15, 1971….A Harris poll taken six weeks after the announcement showed that, by 53 percent to 23 percent, Americans believed my economic policies were working.”
Like most statesmen in most times, he made the only decision open to him and only watched the polls for ratification of a job well done. That was a half-century ago. Then came other central plans from NAFTA to the World Trade Organization, which, in retrospect, appear to be efforts to stem the tide. Here we are today, with a public fury at deindustrialization, inflation, and upheaval emanating from the Goliath government and its overreaching offshoots that swept Trump into office.
The confusion and tumult of today was born long ago, kicked into political reality by lockdowns and the aftermath, and won’t likely be solved by bromides and barricades. The chances of restoring the gold standard of old are slim to none. A far clearer path would be a drive to make the US more competitive with fewer domestic barriers to enterprise and a balanced budget that would stop the infinite export of US debt. That means dialing back on every form of public spending, including on the military.
Speaking of gold, whatever happened to the plan by Elon and Trump to audit the gold in Fort Knox? That rather vanished from the headlines, probably because no one knows for sure what the implications would be upon the discovery of an empty room.
How Richard Nixon Wrecked Free Trade
by Jeffrey A. Tucker at Brownstone Institute – Daily Economics, Policy, Public Health, Society