Forex: The Monetary Crisis of 1971
Before the SDRs had a sufficient time to demonstrate their effectiveness, former President Nixon on August 15, 1971, announced a series of measures designed to improve the American economy by reducing inflation and unemployment, stimulating production, and reducing or eliminating its balance of payments' deficits.
As far as the international monetary system was concerned, the most important measures he announced were the refusal of the United States to continue to redeem officially held dollars in gold and the imposition of 10 percent surtax on the importation of a list of goods. Although the redemption of officially held dollars in gold had never been mandatory, it had been the policy of the United States ever since the Gold Reserve Act of 1934 became law.
Between 1950 and 1970, the net deficits of the United States totaled slightly more than $39 billion as measured by the gross liquidity concept. In 1969, the deficit amounted to $7 billion, that for 1970 was $3.8 billion, and that for 1971 gave promise of also being large.
The dollar had finally become redundant on the world's foreign exchange markets. That is to say, the supply of dollars was in excess of the demand for them. However, the redundancy of the dollar cannot be blamed exclusively on balance of payments' deficits--- some of the excess dollar supplies were the result of the multiplier effect of operations on the Eurodollar market.
This redundancy became clearly evident in 1971 when the dollar exchange rates came under heavy downward pressure, especially vis-à-vis the West Herman mark, the Swiss, Belgian, and French francs, the Dutch guilder, the Italian lira, and the Japanese yen.
To comply with the provisions of the IMF Articles of Agreement, those countries whose currencies rose in relation to the dollar bought dollars with their own currencies to prevent their currencies from rising above the support point in terms of dollars.
This increased their stock of dollars and the amount of their own currency outstanding, thereby contributing to inflationary measures in their own countries. Some countries finally stopped supporting the dollar in this way by buying it against their own currency, and allowed their currency to float and to seek its natural market level against the dollar and other currencies.
Since the United States was not obliged to sustain the dollar exchange rates, and since the dollar was widely demanded by other nations as a reserve medium and the Eurodollar market utilized increasingly large amounts of dollars, the United States was able to run balance of payments' deficits for a long period of time, and in substantial amounts.
This 'privilege' was denied in all other currencies, and some nations, notably France, resented the fact that the United States could continue to invest abroad and buy foreign enterprises while running balance of payments' deficits.
