Currency Wars_ The Making of the Next Global Crisis - James Rickards [49]
The Smithsonian Agreement, like the Nixon Shock four months earlier, was extremely popular in the United States and led to a significant rally in stocks as investors contemplated higher dollar profits in steel, autos, aircraft, movies and other sectors that would benefit from either increased exports or fewer imports, or both. Presidential aide Peter G. Peterson estimated that the dollar devaluation would create at least five hundred thousand new jobs over the next two years.
Unfortunately, these euphoric expectations were soon crushed. Less than two years later, the United States found itself in its worst recession since World War II, with collapsing GDP, skyrocketing unemployment, an oil crisis, a crashing stock market and runaway inflation. The lesson that a nation cannot devalue its way to prosperity eluded Nixon, Connally, Peterson and the stock market in late 1971 as it had their predecessors during the Great Depression. It seemed a hard lesson to learn.
As with the grand international monetary conferences of the 1920s and 1930s, the benefits of the Smithsonian Agreement, such as they were, proved short-lived. Sterling devalued again on June 23, 1972, this time in the form of a float instead of adherence to the Smithsonian parities. The pound immediately fell 6 percent and was down 10 percent by the end of 1972. There was also great concern about the contagion effect of the sterling devaluation on the Italian lira. Nixon’s chief of staff briefed him on this new European monetary crisis. Nixon’s immortal response, captured on tape, was: “I don’t care. Nothing we can do about it.... I don’t give a shit about the lira.”
On June 29, 1972, Germany imposed capital controls in an attempt to halt the panic buying of the mark. By July 3, both the Swiss franc and the Canadian dollar had joined the float. What had started as a sterling devaluation had turned into a rout of the dollar as investors sought the relative safety of German marks and Swiss francs. In June 1972, John Connally resigned as Treasury secretary, so the new secretary, George P. Shultz, was thrown into this developing dollar crisis almost immediately upon taking office. With the help of Paul Volcker, also at Treasury, and Fed chairman Arthur Burns, Shultz was able to activate swap lines, which are basically short-term currency lending facilities, between the Fed and the European central banks, and started intervening in markets to tame the dollar panic. By now, all of the “bands,” “dirty floats,” “crawling pegs” and other devices invented to maintain some semblance of the Bretton Woods system had failed. There was nothing left for it but to move all of the major currencies to a floating rate system. Finally, in 1973, the IMF declared the Bretton Woods system dead, officially ended the role of gold in international finance and left currency values to fluctuate against one another at whatever level governments or the markets desired. One currency era had ended and another had now begun, but the currency war was far from over.
The age of floating exchange rates, beginning in 1973, combined with the demise of the dollar link to gold put a temporary end to the devaluation dramas that had occupied international monetary affairs since the 1920s. No longer would central bankers and finance ministries anguish over breaking a parity or abandoning gold. Now markets moved currencies up or down on a daily basis as they saw fit. Governments did intervene in markets from time to time to offset what they saw as excesses or disorderly conditions, but this was usually of limited and temporary effect.
The Return of King Dollar
In reaction to the gradual demise of Bretton Woods, the major Western European nations embarked on a thirty-year odyssey of currency convergence, culminating with the European Union and the euro, which was finally launched in 1999. As Europe moved fitfully toward currency stability,