The Nixon Shock Doctrine Revisited
FLORENCE – Richard Nixon has been dead for 15 years, but he is making another comeback in America. The 37th President of the United States believed that international monetary relations are unlikely to be transformed by talking. Instead, he thought that radical unilateral action was required. Today, pressure is increasing for the US Treasury to follow Nixon’s misguided example and issue a finding (due by April 15th) that China is manipulating its exchange rate.
Some 130 members of Congress have signed a letter demanding action on China’s currency. The campaign is enthusiastically endorsed by a leading US economist and trade specialist, the Nobel laureate Paul Krugman.
From today’s perspective, the problems of the Nixon era look relatively manageable, even trivial. The world’s currency reserves were held in a slightly lop-sided way: at the end of 1971, Germany had reserves worth $17.2 billion, and Japan’s were worth $14.1 billion – 14% and 11.5% of the world’s total, respectively. In 2008, the last year for which figures are available, Japan held 23.4 % of the world’s reserves and China held 44.8%. These figures are even higher today.
In 1971, Americans were feeling the effects of a German and Japanese export surge. Germany had a current-account surplus of 2.1% of GDP at the time, while Japan’s was 4.4%. In 2008, the Japanese surplus was 3.2% of GDP, Germany’s was 6.7%, and China’s was 9.8%.
Then, as now, there were differing perspectives on the cause of the global imbalances. Europeans and Asians saw excessively loose US fiscal and monetary policy as the major culprit. Americans, by contrast, thought that Japan and Germany were artificially holding down their currencies’ value in order to get an unfair advantage for their politically powerful export industries.
Germany was more obliging in the face of US pressure, mainly because its security relied on America’s military presence. It undertook a small revaluation in 1969 and then let its currency float in May 1971. But Japan’s government was intransigent. Talking about the charms of market opening or about fairness did not help. Treasury Secretary John Connolly attacked Japan’s “controlled economy.”
There were two American strategies to prize open Japan’s supposedly closed economy. One strategy, termed “benign neglect,” was to let the surplus countries pile up reserves until they realized that they had a very big problem. But there seemed to be no end to the piling up of reserves, so the only remaining choice was confrontation.
Nixon intrinsically distrusted multilateralism. The conventional view, then as now, was that unilateral action risked unleashing a wave of protectionism. When Federal Reserve Chairman Arthur Burns objected on the grounds that other countries might retaliate, Connolly replied, “Let ‘em. What can they do?” The point was clear: “So the other countries don’t like it. So what?”
On August 15, 1971, Nixon imposed a temporary surcharge of 10% on imports “to ensure that American products will not be at a disadvantage because of unfair exchange rates.” At the same time, there was a wage and price freeze, an end to the Federal Reserve’s swap network of support for other central banks, and a limitation of gold transactions, implying a reduction in the value of the American currency.
None of these measures served to restore US economic growth rates or correct the surpluses of America’s competitors. To be sure, the Japanese and German external balances were subject to heavy swings in the course of the turbulent 1970’s. Large surpluses turned into deficits for Japan in 1973 and 1979, and for Germany in 1974, 1975, 1979, and 1980. But this was due not to bilateral corrections in these countries’ trade relationships with the US, but mostly to their energy dependence and the decade’s energy price shocks.
Between these deficits, large surpluses for Germany and Japan reappeared – as they have in the 2000’s. Some of the late 1970’s correction did follow from renewed intense US pressure for fiscal and monetary expansion, but that expansion caused inflationary pressure, which the Japanese and Germans then predictably blamed on the US.
After an initial inflationary surge, American economic growth fell off sharply in the 1970’s. The world became much more inflationary, and quite a bit more protectionist. This did not, however, imply a return to the 1930’s, in large part because energy dependence forced industrial countries to maintain an open trade regime so that they could earn the money to pay for oil and gasoline.
America’s currency unilateralism pushed everyone else to organize against the chaos emanating from Washington. The Europeans advanced their plans for regional monetary and economic integration. The dollar confusion encouraged the oil producers to form their (briefly) highly effective cartel, OPEC.
Only the most obvious of the targets of August 1971, Japan, was badly hit by what the Japanese called the second “Nixon shokku” (the first being Nixon’s announcement the previous month that he would visit mainland China in 1972). That was because, unlike Germany, Japan was standing on its own.
China today is not isolated in the way that Japan was in 1971. On the contrary, it will find an easy way to turn its resentment of American pressure into an issue of regional solidarity – exactly as the Germans did in the 1970’s.
Instead of leading to an American renaissance, the “Nixon shock” produced theories about American imperial overstretch and decline. Today, the fastest way to really make this “the Asian century” is to give Asian exporters a similarly unpleasant shock, thereby spurring the creation of an Asian community of surplus countries.
Can Barack Obama, fresh from his major domestic victory on health care, really afford to turn himself into Richard Nixon?