‘Nixon Shock’ from 50 years ago has lessons for today’s politics of money

On August 15, 1971, US President Richard Nixon announced, in a televised address, that the United States was “closing the gold window,” starting the next day. While that may not have rung the bell among the common people in America and elsewhere, the decision, later called the ‘Nixon Shock’, was one of the most decisive ruptures in US (and global) monetary history. Ending the US dollar’s convertibility to gold (at $35 to an ounce of gold at the time) dissolved the centuries-old link between ‘money’ and ‘precious metals.’ Currency now became a ‘legal tender’ whose value was determined not by the availability of a precious metal (like gold, silver) but by the credibility of a particular country and its macroeconomic policies.

As Harold James argued, “this epochal event — marking the end of the Bretton Woods era — has uncanny resemblances for today. For example, just as Nixon was struggling to extricate the United States from its long, costly and unwinnable war in Vietnam, Joe Biden has now ended America’s long, costly and unwinnable intervention in Afghanistan. Similarly, Nixon used his address to announce a policy programme with goals similar to those being pursued by the Biden administration now. ‘We must create more and better jobs,’ Nixon said, ‘We must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.’”

Nixon’s shock announcement caused a colossal disruption in the global currency markets, particularly for emerging economies. Latin American nations (like Colombia, Brazil, Argentina, etc.) saw a series of currency crises — combined with the explosion of debt bubbles later. The frequency of economic crises increased substantially. Pre-determined, fixed exchange rate currency exchange regime entered the ‘flexible exchange rate system’ era in which valuation of one sovereign’s currency against another was left entirely to ‘market forces’, heightening uncertainty, leading to more currency arbitrage.

Despite this, the US dollar — thanks to the Petro-dollar market and the US’ geopolitical dominance — never lost its hegemonic position in the international monetary system. America’s exportable model of ‘finance-based capitalism’, relying on freer capital account convertibility, easier flow of investments across borders, and a subsequent wave of hyper-globalisation, allowed most nations to continue trading in US dollars, giving it a popular reserve currency status.

But, how long can this continue in today’s financial world?

As money lost its connect to precious metals after the ‘Nixon Shock’, similarly, money today no longer needs to be linked to ‘paper currency’ or a ‘sovereign (public) legal tender’. The emergence and popular acceptance of ‘private digital currency’ (bitcoin, dogecoin, etc.) has changed the game. Trust in government’s ability to control and manage money has also been deeply eroded post the 2008 financial crisis. Also, the United States no longer enjoys the same economic position/relative share of economic trade and investment as it did back in the 70s, 80s and 90s. We are now in a multi-polar world, economically at least, with key regional anchors (China, India, Brazil, Nigeria etc.).

New, digital technology-backed currencies pose increasing risks to the hegemonic role of the US dollar, the lingua franca of exchange. Some dangers, as James argues, are already visible in the US Treasury market, where there have been liquidity strains (in 2020) and a weakening of foreign demand. The dollar’s long pre-eminence is being challenged, not so much by other currencies (though both the euro and renminbi may aspire to the throne), as by new methods of speaking the same cross-border monetary language as the dollar. And so, as the digital money revolution accelerates, the era of fiat money issued by national governments may be drawing to a close.

What’s more troubling is the weakening (post-Bretton Woods) link between ‘monetary stability’ and ‘fiscal prudence’. Both before the pandemic and in the midst of it, governments and central banks have been rolling out large stimulus, quantitative easing programmes without working out a medium-to-long term debt and fiscal consolidation strategy.

Not only does this raise the risk of inflation (with more money supply creating low purchasing power) but with multiple forms of monies (public, private) it also limits the options for both central banks and treasuries (or the finance ministries) in undertaking any serious debt-reduction and better fiscal management strategies.

Going forward though, a vital question to ask is: What does the future of money and the politics of control over its creation and distribution look like?

Yanis Varoufakis offers an interesting proposition: the idea of ‘central bank digital currencies.’ Financial gatekeepers like the Bank of International Settlements (BIS) are embracing central bank digital currencies because they can see that, if they do not, someone else will, whether it is the People’s Bank of China, whose own digital currency is at an advanced stage of development, or, more ominously, Big Tech. Their objective is to usher in digital currencies that preserve the current oligarchy’s (bankers’) monopoly over money.”

Varoufakis might be just about right.

The time for a central bank digital currency is perhaps here. However, the main struggle to be observed is in the conflict between ‘public money’ and ‘private digital money’, the trust in them and over who controls the ‘payment system’ and ‘money tree’. To mitigate this growing conflict, a series of discussions ought to be positioned around the need to ensure greater ‘transparency’, ‘resilience’ and ‘trust’ for the form of money widely accepted, created around the world.

No central bank-backed digital currency will be without its own vulnerabilities (and political conditions). At the same time, pre-existing forms of (paper) currency, the long-dominance of the US dollar will continue to see competition from substitutes in the private technology-backed payment systems.

The politics of money creation, its management, distribution, much like ‘consumer data’, is likely to engender an ugly battle between the powers of the nation-state and the private Big Tech space. One can only speculate how this ‘power battle’ will turn out for the macroeconomic implications it poses (on inflation, transactions, interest rates and fiscal policy).

(The writer is Director, Centre for New Economic Studies, Jindal Global University)