Partners and Rivals: Political Economy and American Diplomacy, 1969-1974

Chapter 3: Beyond Bretton Woods, 1971-1972

Justin King – University of Wisconsin-Madison

Abstract: This paper is an adaptation of the third chapter of my senior thesis, Partners and

Rivals: Political Economy and American Diplomacy, 1969-1974. In this larger project, I argue that the Nixon administration’s bifurcation of economic and strategic policy making led to short- sighted actions which both undermined American alliance relationships and contributed serious, wide-ranging economic crises around the world. Economic shortsightedness led to unforeseen strategic failures, a fact which I contend should lead contemporary scholars to re-evaluate both

Nixon’s foreign policy and the salience of international economics in American diplomatic history. In this chapter, I argue that the Nixon administration badly mishandled the collapse of the Bretton Woods fixed exchange rate regime, selfishly and needlessly damaging relations with

American allies and contributing to significant subsequent strategic challenges. I draw on recently declassified State Department documents, memoirs, and notable secondary sources to make this new argument about the failures of Nixon administration’s storied diplomacy.

The two preceding chapters, omitted here, discuss the basis for the postwar international economic order and the early trade policies of the Nixon administration, respectively. The fourth chapter deals with issues of oil, inflation, and the ultimate strategic and economic consequences of economic policies discussed through the larger work. This paper synthesizes the most salient elements of my research with the fulcrum of my larger thesis project to demonstrate specific failures of coordination between international economic and strategic priorities during the 1971 monetary crisis and thereafter.

1 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974

“America today has the best opportunity in this century to achieve two of its greatest ideals: to bring about a full generation of peace, and to create a new prosperity without war…We must protect the position of the American dollar as the pillar of monetary stability around the world”. -President Nixon, speech announcing the “New Economic Policy,” August 15th, 1971

During its first two years in office, the Nixon administration searched for a new strategy of international economic policy. Neither Nixon nor his close inner circle took much interest in international economics, with the exception of some politically-salient trade issues such as

Japanese textile imports. Instead, Nixon was consumed with the “high politics” of détente diplomacy with the Soviet Union and China. The strategic implications of ending the war in

Vietnam also loomed large in the administration’s foreign policy. Key international economic matters were seen as abstract, technical problems in spite of their direct relevance to American partnership with other capitalist democracies.

While the administration’s new trade policies of 1969-1971 strained relations with

American allies, they did little to affect the immense inequalities in the balances of trade and payments. On monetary matters, the Nixon administration only half-heartedly revisited the policies of its predecessors. In fact, both key balances continued to worsen throughout the first two years of the administration. Yet the Nixon administration did little to counteract these growing economic liabilities.

The economic weaknesses apparent at the beginning of Nixon’s presidency were becoming increasingly acute. American gold stocks ran ever lower as foreigners exchanged

American dollars for Fort Knox’s gold under the terms of the Bretton Woods system. Overseas dollar holdings continued to grow. America’s share of international trade continued to drop. All of the pillars upon which the Bretton Woods fixed exchange rate regime had been constructed were now wobbling. Economic forces were already pushing the United States towards a major

2 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 action to correct these imbalances. In 1971, long-term economic trends, radical new ideas, and catalyzing crises led the Nixon administration to enact new international economic policies with catastrophic effects on other states.

Comparative Gold Holdings s

r 30000 a

l l n i o 25000 s D

g . 20000 n S i . d U l

15000 f o o H

10000 s d l n o o 5000 i l G l i 0 M 1948 1951 1954 1957 1960 1963 1966 1969 Year

United States United Kingdom France Germany Italy Japan 1

Three key things changed in 1971. First, Nixon became increasingly concerned with his prospects for reelection and thus the state of the domestic economy. Second, Nixon appointed

Texas Governor John Connally as Secretary of the Treasury as part of his electoral strategy.

1 Data from imfstatistics.org, compiled and arranged by the author

Third, the United States’ trade and balance of payments deficits finally reached a crisis point requiring some form of dramatic action.

Overall economic trends did necessitate some readjustments in the original monetary system agreed to at Bretton Woods in 1944. By 1971, many observers expected that the United

States would need to revalue the dollar in order to correct for changes and imbalances in the international economy which had developed since 1944. No one expected that the United States would devalue the dollar, end convertibility of the dollar into gold, abandon its IMF obligations, impose trade restrictions, and refuse to negotiate a settlement for months. Yet this is exactly the strange story of the Nixon administration’s adventure in international monetary policy during from 1971 into 1972. Where prior administrations had carefully engaged with economic issues,

Nixon and his inner circle were apathetic. Where Nixon’s predecessors had stressed multilateralism and partnership towards common interests, Nixon stressed unilateralism and self- interest. Where prior presidents had tread cautiously, Nixon acted boldly, even rashly.

What happened in 1971 was starkly at odds with past American policies in both style and substance. In style, the Nixon administration abandoned partnership and multilateralism for naked unilateralism. In substance, the Nixon administration imposed self-interested measures which directly injured foreign economies, in some cases dramatically so. These dramatic departures from prior policies had a significant impact not only on the United States’ alliance relationships, economic stature, and general foreign policy, but also had profound secondary consequences for economies around the world. Indeed, the Nixon administration’s short-sighted economic and electoral goals ran contrary to long-term American strategic objectives. This dramatic failure of policy making provides a striking example of how international economic and strategic policies can intersect with world-changing consequences.

Electoral Imperatives

Economics and domestic politics are intimately connected, especially in democracies. A growing economy is likely to boost the fortunes of the ruling party by increasing popular support for its candidates. Meanwhile, high unemployment, slow growth, or high unemployment are likely to push voters towards alternative solutions offered by opposition parties. It is thus no small wonder that political leaders consistently work to promote near-term economic growth and well-being, sometimes at the cost of long term priorities. The Nixon administration was no exception. Indeed, the long-term costs of its short-term needs eventually proved enormous.

During the first months of 1971, Richard Nixon faced both a sluggish economy, sagging approval ratings, and growing price inflation which sapped both public welfare and macroeconomic stability.2 Nixon even considered the problems he faced so serious that he

“might not even be nominated for reelection in 1972,” let alone win.3 Newsweek declared that the economy might prove to be “Richard Nixon’s ‘Vietnam.’”4 Nixon believed that slow growth had been a major factor in his electoral defeat in the presidential election of 1960, and was determined not to suffer a repeat of that event. Letting the economy take its natural course was not an acceptable outcome.

The easiest method for expanding the economy would have been to simply expand the money supply, thereby stimulating consumption and investment. Then as now, domestic economy was managed by the Federal Reserve Board’s monetary policies. Since Federal

Reserve Chairman Arthur Burns and the Federal Open Market Committee (FOMC) set the interest rates which in turn determined money supply and economic growth, this was the natural

2 Allen J. Matusow, Nixon’s Economy: Booms, Busts, Dollars, and Votes, (Lawrence, KS: The University of Kansas Press, 1998), 93. As Matusow’s work concentrates heavily on the domestic political and economic issues to which this paper provides an internationally-oriented complement, I am incredibly indebted to his ground-breaking work. 3 Richard Nixon, RN: The Memoirs of Richard Nixon, 497. 4 Matusow, 93; citing Newsweek (Jan. 25, 1971), 27.

5 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 place to exert pressure. However, Federal Reserve Chairmen do not take orders from presidents.

In fact, the Federal Reserve, like all central banks, is explicitly isolated from short-term political pressures. The most obvious economic route was closed to Nixon by design. All the same,

Nixon still tried mightily to pressure Burns into more pro-growth policies.5

By and large, Nixon had to find another source for his economic miracle. He was not without options, though all entailed costs. Nixon could still use fiscal policy, ramping up spending to stimulate the domestic economy in classic Keynesian fashion. However, such a policy would also increase inflation. Nixon could institute measures to fight inflation, but only at the risk of slowing the economy. Neither option was an effective long-term solution on its own. For more concerted efforts, such difficult policies would also require congressional cooperation.

To boost the domestic economy and maximize his chances of reelection, Richard Nixon had to look beyond the ordinary tools available at the domestic level. Unlike most heads of state,

Nixon had the advantage of leading the world’s largest economy and its strongest political and military power. Under the terms of the 1944 Bretton Woods agreement, the United States was also the pillar of the international monetary system. All other currencies were fixed to the value of dollar by the American government’s guarantee to exchange gold for dollars at a rate of $35 per ounce.

Nixon thus had several trump cards in his hand, though each would entail leveraging

American power over traditional allies. Yet by combining these international advantages, Nixon would be able to overcome other obstacles to pro-growth economic policies. The structure of choices alone was not sufficient for such an outcome; Nixon had to be apprised of these policy possibilities and given impetus to enact them.

5 Matusow, 111.

The Change in Tone

The most critical factor in Nixon’s peculiar approach to international economic policy in

1971 was his newly appointed Secretary of the Treasury, former Texas Governor John Connally.

Connally was a powerful southern Democrat and a protégé of Lyndon Johnson. He had also been seriously wounded in the assassination of John F. Kennedy, struck by one of the bullets which felled Kennedy. There were few more influential or better-known Democrats in the

South. Connally’s appointment was thus a calculated maneuver by Nixon to shore up his political support in Texas. In the words of Kissinger, “Nixon considered his choice of one of the most formidable Democrats an extraordinary coup that sent him into transports of self- congratulatory pride for weeks afterward.”6

Connally was a shrewd politician, not an economist. His approach to policy at the

Treasury was not influenced by the strong orthodoxies which weighed heavily on men like

Federal Reserve Chairman Arthur Burns and Under Secretary for Monetary Affairs Paul

Volcker. In fact, Connally’s views had little if anything to do with even the most basic technocratic knowledge of economics, a fact which Connally himself neatly demonstrates in one exchange before the Senate Finance Committee: “Senator, that’s the theory of comparative advantage. In the first place, the reason I do not understand it is because I am not an economist.

But if I were an economist, I would not want to understand it because I do not believe it is going to work.”7

With little international experience, Connally was also prone to see issues in purely

American terms. As such, he can be accurately described as a mercantilist. Connally’s views were driven by a dogmatic belief that the United States was being economically victimized by its

6 Henry Kissinger, White House Years, (New York: Little, Brown, & co, 1979) 951. 7 Matusow, 139; citing Senate Finance Committee, Foreign Trade: Hearings, 1971, 58.

7 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 trade partners. In Connally’s view, American allies in Western Europe and Japan had taken advantage of American generosity. In return for American aid and defense, these nations offered paltry defense contributions, copious criticism, and unfair trade practices which sapped

American economic strength. Connally thus felt it was time for a change: “No longer does the

U.S. economy dominate the free world. No longer can considerations of friendship, or need, or capacity justify the United States carrying so heavy a share of the common burdens.” 8 In the face of increased foreign competition, Connally wanted to free the United States to compete more aggressively. He even went so far as to promote the idea of forming an American “dollar bloc” to counter the growing EEC.9 As he put it quite bluntly in August of 1971, “My basic approach is that the foreigners are out to screw us. Our job is to screw them first.”10

Joining Connally was the newly appointed Assistant to the President for International

Economics, Peter G. Peterson. Peterson chaired the cumbersome CIEP, acting as its spokesman and for a time greatly influencing the President as “number one intellectual concubine.”11

Peterson argued forcefully – with the assistance of splashy charts and graphs – that the United

States’ economic position was rapidly declining. His infamous “Peterson Report” showed that the United States exports had fallen from 18.2% to 15.4% of world totals, and that imports were on pace to exceed exports.12 Peterson’s views made quite an impression on Nixon, who reportedly repeated many of Peterson’s ideas in his conversations.13 Neither of Peterson nor

Connally held mainstream views, but both had the ear of the president.

8 Kissinger, 952-953 9 Robert Solomon, The International Monetary System, 1944-1981. (New York : Harper & Row, 1982) ,191. 10 John S. Odell, U.S. International Monetary Policy: Markets, Power, and Ideas as Sources of Change. (Princeton: Princeton University Press, 1982) , 263, citing interview with a participant of the meeting. 11 William Safire, Before the Fall : an Inside View of the Pre-Watergate White House. (Garden City, N.Y. : Doubleday, 1975), 498. 12 David P. Calleo, The Imperious Economy. (Cambridge, MA: 1982), 65. 13 Odell, 249.

Crucially, Nixon and Connally had an exceptionally close relationship. Nixon was enamored with the plain-spoken, politically-savvy Texan. Nixon respected Connally on a deep level, once saying “Only three men in America understand the use of power. I do. John

Connally does. And I guess Nelson [Rockefeller] does.”14 Acknowledging an equal was no small compliment from such a shrewd politician. Nixon even considered appointing Connally as his Vice President following Spiro Agnew’s resignation, only later opting for Gerald Ford.15

Nixon’s tendency towards insecurity and distrust was not at all apparent in his relations with

Connally. William Safire cheekily summarizes this relationship in the title of his chapter on

Connally: “The President Falls in Love.”16

This personal relationship had an enormous impact on the formation of international economic policy. When asked if he would like to consult the new CIEP on certain monetary issues, Nixon replied “No…The Connally 1-man responsibility route is best. This is an area in which he should be the lead man.”17 Nixon’s confidence aligned with Connally’s domineering style.18 Indeed, for eighteen months John Connally became the chief voice within the Nixon administration on international economic and monetary issues, despite his total lack of technical credentials or crucial international experience. Fatefully, this brief and influential tenure also coincided with the terminal crisis of the Bretton Woods system of fixed exchange rates.

Creating a Crisis

In the summer of 1971, a climactic series of crises began to buffet the already shaky

Bretton Woods fixed exchange rate regime. Under the policy of “benign neglect,” the dollar had been wandering from its assigned value for many months. The United States government

14 Safire, 498. 15 Safire, 508. 16 Safire, 497-508. 17 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972 ; International Monetary Policy, 1969-1972, Document 159 18 Odell, 244.

9 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 refused to intervene in international currency markets to keep the dollar – the very core of the international monetary system – at its assigned value. In fact, Treasury officials calculated that the dollar was effectively overvalued by as much as 15% at that time.19 Overseas dollar holdings were now so large that any sharp rise in demand to trade these surplus dollars in for gold would bring the system to collapse. There simply were too many dollars and too little gold to cover the

American position of free convertibility between the two mediums. All that remained was a catalyzing crisis to push the United States over the edge.

In May of 1971, rumors of an appreciation of the German mark set off a wave of wild speculation. Traders exchanged dollars for marks at a furious pace, overwhelming the ability of the West German government to maintain its currency’s assigned value.20 The West German

Bundesbank absorbed $1 billion in dollars in a single hour of trading, and was forced to halt trading altogether. The central bank simply lacked the assets to fight such an enormous shift in currency markets. Thereafter, the mark effectively floated, its value determined entirely by private markets without the customary managing by the West German government. Reacting to this massive change by Europe’s economic hub, several other states revalued or floated their currencies, allowing their values to be determined solely by supply and demand in international exchange markets. Central bankers feared an expensive repeat of the West German experience.

International trust in the fixed exchange rate regime was beginning to unravel, and Treasury officials secretly began planning for a potential suspension of dollar/gold convertibility.21

At this moment, In June, the United States posted its first trade deficit since 1893, catching the attention of officials in the Nixon administration. The trends had been apparent for some time, but their realization still came as an unpleasant harbinger of deteriorating economic 19 Paul Volcker and Toyhoo Gyothen, Changing Fortunes: The World’s Money and the Threat to American Leadership. (New York : Times Books, 1992), 72. 20 Volcker, 73. 21 Volcker, 75.

10 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 dominance. The size of the trade shift was less important than the apparent evidence of economic weakness. The administration took this as bad news for the domestic economy.

Internationally, a large and growing trade deficit removed one of the last tools for reigning in the

United States’ balance of payments. Money was now flowing out of the United States faster than ever.

In August of 1971, the government of the United Kingdom requested a massive loan in the amount of $3 billion to guarantee its dollar holdings. This was a tremendous sum which, if publicized, would almost certainly trigger a rush to trade dollars for gold. The easiest way to solve both the trade deficit and the instability of the fixed exchange rate regime was to simply realign the value of the dollar relative to other currencies. A large enough revaluation would erase the United States’ trade and balance of payments deficits with a simple act of accounting.

Decreasing the value of the dollar would both make American exports less expensive overseas and

Rather than a measured and cautious approach, Nixon focused on combining a disparate series of domestic and international measures into a single “New Economic Policy” to be enacted almost immediately. Inflation-control measures which economic advisors had long contemplated were now thrown together with extremely aggressive international trade and monetary measures devised by Connally. In some cases, the proposed policies even had mutually-counteracting effects on the economy. The confident and comprehensive impression of action was deemed more important than overall policy coherence.

There was little debate over the timing or implantation of the policies. Sensing a crisis brewing, Nixon was eager to protect economic stability going into an election year. “Could we do the whole program tonight? Tomorrow Night? Let’s go to Camp David tomorrow and

11 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 announce the whole program Monday.”22 Nixon had made up his mind. Now it was just a matter of bringing his inner circle up to speed and deciding how to frame the new initiative.

At Camp David, Nixon secretly met with his economic advisors not to absorb their criticisms, but to bludgeon them into supporting the policies he had already decided upon. In fact, newly released tapes show that “Connally suggested that at Camp David all should be encouraged to participate in the discussion, without letting on that the decisions had already been made.”23 The purpose of the meeting was largely to transform the New Economic Policy’s potential opponents into complicit actors.

During a tense meeting, Burns and Volcker resisted Nixon and Connally’s proposals.

Both were concerned that a cycle of economic retaliation similar to the 1920s would result from such a harsh action. In their minds, the legacy that Cordell Hull, Harry Dexter White, and John

Maynard Keynes articulated at Bretton Woods in 1944 was still very much alive. However,

Burns and Volcker were ultimately forced to capitulate and accept the President’s views. Burns’ strenuous objections did, however, cause the President to reconsider, albeit briefly, ceasing the convertibility of the dollar into gold.

In the end, though, there was little to debate. Nixon had largely decided to accept

Connally’s propositions as a package. Thus the “debate” at Camp David never really was a debate, but a dictation of policy dressed up as a sincere discussion. Other authors, notably

Joanne Gowa and John Odell, have failed to realize this important distinction. Once all of the key officials had been persuaded to accept the principal proposals, Nixon could move on to implementation.

22 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 164. 23 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 164.

Discussion quickly turned toward how the new policies would be presented to the public.

Important details about the policies were left to be considered later. Nixon insisted on an immediate, brief, and bravado-driven speech to inform and reassure the public. Substance was less important that style. In the end, Nixon himself spent an entire sleepless night drafting a speech laden with “gutsy rhetoric” that avoided the serious long-term implications of his proposed policies. In this dramatic “big play,” public perception was more important than substantive policy. Nixon later confessed that his main worry was not economic impacts at home or abroad, but simply whether Monday’s headlines would read “Nixon Acts Boldly” or

“Nixon Changes Mind.”24

The foreign policy implications of these new policies were the last thing on anyone’s mind.25 Secretary of State William Rogers was typically excluded from important policy decisions, and was in any event “bored stiff” by such matters.26 Henry Kissinger, Nixon’s trusted point-man on all things international, was preparing for another round of negotiations with the North Vietnamese in Paris. There was thus no voice at Camp David to raise the crucial diplomatic questions and consider the policies under discussion within the broader context of

American foreign relations. The exception, of course, was Nixon himself.

Yet Nixon failed to consider the substantial effects of these dramatic policies on other states. In particular, the United States’ closest allies such as Britain, West Germany, France,

Italy and Japan would suffer serious economic costs in three ways. First, the suspension of gold/dollar convertibility would remove the central pillar of the international monetary order

24 Nixon, 520. 25 Revealingly, Nixon does not even mention foreign reactions in the few pages of his memoirs devoted to the New Economic Policy. Instead, he spends a few paragraphs discussing the domestic side of the program before moving on to a discussion of the “high politics” of the SALT-I negotiations. The phrase “Bretton Woods” does not even appear in the index. However, Nixon does include the singularly ironic statement that “It is unfortunate that the politics of economics has come to dictate action more than the economics of economics,” on page 522. 26 Joanne Gowa, Closing the Gold Window: Domestic Politics and the End of Bretton Woods. (Ithaca: Cornell University Press, 1983), 159. Citing interview (presumably with Rogers).

13 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 with unknowable and potentially catastrophic results. Second, the imposition of import surcharges would directly harm the competitiveness of their crucial exports to the United States, particularly in the case of Japan. Third, the likely floating and subsequent revaluation of the dollar would leave these states permanently disadvantaged in their trading relations with the

United States. For all of these ills, key American allies could place blame squarely, and rightly, on the shoulders of Richard Nixon.

The potential turmoil in the international economic – and perhaps political – systems was the great unknown. As they had recovered from the Second World War, Western Europe and

Japan had become increasingly wealthy and independent with the help of American aid and protection. Reversing this trend completely and demanding what was in effect a massive redistribution of wealth would spark serious tensions within these critical alliance relationships.

Resentment of American hegemonic political and economic power, outrage over the Vietnam war, and frustration over trade policy had already soured relations between the United States and its strategic partners.

Nixon and Kissinger’s strategy of détente with the Soviet Union fundamentally rested upon negotiating from a position of strength. Only as a credible and equal rival could the United

States bargain with the Soviet Union and intensify relations with the People’s Republic of China.

An openly fractured alliance and an admission of diminishing economic strength would greatly weaken the United States within the context of détente. Moreover, such a move would violently and dramatically change the tenor in the great alliance of capitalist democracies which the United

States had constructed in the postwar era.

The Nixon administration’s prized foreign policy initiatives now contrasted sharply with its economic and electoral imperatives. In ending the common monetary system and

14 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 aggressively moving to improve the United States’ position in the international economy, the

United States would end its role as economic patron to its allies. This move would be a declaration that while Western Europe and Japan were American strategic partners, they were now also American economic rivals. A new era would begin in the postwar capitalist world, and it would begin with a serious economic conflict with important allies during a critical period of diplomatic engagement with the common foe, the Soviet Union.

At this stage, however, there were few alternatives to consider. Now that a crisis had developed and a run on the dollar seemed imminent, it was too late to engage in a serious process of multilateral negotiation. The time for effective multilateral engagement had already come and gone many years earlier. The potential crisis itself had already been apparent during the Johnson administration.27 Yet due to his earlier neglect of monetary issues, Nixon now had to take a difficult course into unknown territory for the international economic system. Negotiations would now come after, not before, aggressive American actions, causing strained relations with critical American allies.

If this harsh treatment of American allies bothered Nixon, it didn’t show. If anything, the frustrating trade diplomacy and the perspectives of his new advisors probably inclined Nixon towards giving these American allies a good, hard knock. Certainly Connally, with his beliefs of foreign economic exploitation of the United States, would not object to such a policy. When

Federal Reserve Chairman Arthur Burns warned of the potential for foreign retaliation, Connally simply challenged “Let ‘em. What can they do?”28

In any event, details were not Nixon’s strong suit. Instead, he looked at the problem broadly. “The question is, is the U.S. going to strive to be Number One economically?”29 27 Francis Gavin, Gold, Dollars, and Powers: The Politics of International Monetary Relations, 1958-1971. (Chapel Hill: University of North Carolina Press, 2004), 59. 28 Safire, 514. 29 Safire, 517.

The Shock Heard ‘Round the World

At 9 PM Eastern on Sunday, August 15th, 1971, Nixon unveiled his economic gambit to the world in a televised address to the nation. The program was formally known as the “New

Economic Policy” (NEP), but was more colloquially known around the world as the “Nixon

Shock.”30 The NEP reflected virtually every one of Connally’s proposals in a hodge-podge of foreign and domestic measures, some of which were in fact contradictory.31 .

On the domestic side, the NEP’s centerpiece was a 90-day freeze on wages and prices meant to control inflation. The Federal budget and taxes alike were slashed. An excise tax on automobiles was even repealed in hopes of stimulating sales and overall economic activity.

Americans were meant to feel richer, consume more goods and services, and thereby boost overall economic growth. Eventually, this combination of policies would lead to higher inflation that would largely eliminate gains in wealth – hopefully not before Nixon took credit for fattening American wallets.

On the international level, the NEP ended the United States’ policy of converting dollars into gold under the obligations of the Bretton Woods system. The NEP also included a 10% surcharge on all imports to serve as a bargaining chip in monetary relations, a 10% reduction in foreign aid, and new export and investment tax credits. In so doing, the United States blatantly

30 In Japan, this was actually referred to as the second Nixon Shock, the first having been Nixon’s opening of relations with the People’s Republic of China. 31 For example, the logic of tax cuts and inflation controls clash. Tax cuts increase the money and consumption available in the economy, generally leading to higher inflation. A price control system could contain the upward pressure on the wages, goods, and services, but not indefinitely. Eventually, this unstable system would have to collapse. In the meantime, however, it would prove incredibly popular.

16 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 abandoned its formal obligations under the Bretton Woods system and threw its strategic allies into economic chaos.32

Nixon also drew on an important intangible: confidence. Nixon stressed jobs and growth, spoke of “defending the dollar,” and offered rugged reassurances on highly technical issues.

Nixon’s speech portrayed a confident command of problems and a concern for helping the ordinary American. This confidence-inspiring style of delivery was arguably every bit as important for Nixon’s domestic economic goals as the substance of the policies themselves.

Together, this combination of means aimed to stimulate the domestic economy, dampen inflation, boost exports, and ultimately boost support for Nixon in the 1972 presidential election.

Some of the costs would eventually fall on American consumers. Many of the costs, however, were to be directly demanded from American trading partners who also happened to be crucial strategic allies. There were simply no votes in pleasing foreign allies, and Nixon was keenly aware of this fact.

In the midst of these policies, Nixon also took his revenge on Japanese Prime Minister

Eisaku Sato for failing to restrain Japanese textile exports to the United States.33 Sato received no warning of this economic earthquake, just as he had received no warning about the United

States’ opening of relations with the People’s Republic of China. Beyond these insults, Nixon invoked the quite harshly named Trading with the Enemy Act of 1917 to discriminate against

Japanese textiles imports. This obscure law provided the Nixon administration with the nominal legal cover it required for such a violation of longstanding GATT rules. Fulfilling Nixon’s old campaign pledge to Strom Thurmond was a higher priority than close relations with this important strategic partner.

32 Odell, 167. 33 Volcker, 79.

The domestic measures met with widespread adulation in the United States. The combination of confidence, inflation controls, and international competitiveness measures boded well for economic growth. The American stock market roared ahead. The Dow Jones Industrial

Average posted its largest one-day gain up to that point. One paper proclaimed “New Score Is

Dow 32, Nixon 72.,” a headline which certainly would have pleased Nixon.34 Polls confirmed widespread public agreement with Nixon’s message.35 This was precisely the extraordinary coup

Nixon had hoped for. The impression of courageous action masked a serious economic defeat for the United States, which had been forced to retreat from its position of international monetary dominance.36

Meanwhile, the international measures produced a panic. Stock markets in Europe and

Japan tumbled. European currency markets simply shut down in the chaos. Japanese currency markets remained open as the government attempted to maintain the old ratio of 360 yen to the dollar, mistakenly believing that a dollar revaluation was not inevitable.37 Within two weeks,

Japan absorbed $3.4 billion in currency trading, increasing its official dollar reserves by 42% before allowing the value of the yen to be determined by the market.38 No state or central bank could stand against the enormous changes sweeping through the international economic system.

Denmark countered the import surcharge by enacting its own 10% tax on all imports, realizing the fears of retaliation many economists had long held. Perhaps other states would instate similar surcharges and quota systems, grinding international trade to an impoverishing halt just as during the Great Depression. As foreign governments knew all too well, any

34 Matusow, 156. Citing New York Times, Aug. 22, 1971, IV, 1. 35 Matusow, 156. Citing Wall Street Journal, Aug. 17, 1971, 3. 36 David Calleo is quotable here: “Just as defeat in Vietnam had to be hidden behind an elaborate series of diplomatic initiatives designed to demonstrate America’s continuing control of the world situation, so the dollar’s fall had to be masked by spectacular initiatives in the economic sphere,” Calleo, 62. 37 Volcker, 81. 38 Matusow, 168.

18 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 revaluation of the dollar would ultimately transfer wealth from their societies back to the United

States, a bitter reminder of American power. As one author puts it, “No American interest was served by exposing Europe’s weakness so brutally.”39

Foreign nations anxiously waited for the Nixon administration to put forth a proposal for a new monetary system. Yet no such proposal was forthcoming. This was for two reasons.

One, Connally felt that a period of uncertainty would make other states more receptive to the eventual American proposal. Two, there was, in fact, no proposal to present. The Nixon administration aimed for a realignment of exchange rates, but without the dollar’s rate firmly fixed to gold, there could be no center of stability in the system. All that was clear on August

15th, 1971, was that some currency revaluation would likely have to take place. No serious further planning had been completed.

Thus began Connally’s great adventure in confounding finance ministers around the world. At his first meeting with finance ministers in London, Connally openly asserted that currency revaluations would have to be enacted which would shift the American balance of payments from negative $9 billion to positive $4 billion. This was, in effect, a ransom for $13 billion from the other states in the system that would come directly from their trade balances.40

Until that ransom was paid, the international monetary system would remain adrift. As Connally later put it, “the dollar may be our currency, but it’s your problem.”41

Weeks later, speaking to delegates meeting at the IMF in Washington, Connally hinted that progress was possible – if other states revalued their currencies and began to dismantle trade barriers. Connally’s real main objective remained these impediments to American exports. At a meeting in Rome, Connally suggested devaluing the dollar by ten percent, a huge figure that sent

39 Calleo, 78. 40 Odell, 278. 41 Volcker, 81.

19 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 foreign finance ministers into a frenzy. Connally continued to dangle potential figures for revaluation before foreign governments until formal talks finally began in December, 1971 – four months after the announcement of the NEP.42

All the while, foreign frustrations grew. The United States could weather the uncertainties in the international economy for the time being. Other states which were more dependent on trade with the United States and one another were not so fortunate.

Unemployment rose in every major developed nation.44 Uncertainty snarled international trade and domestic economies alike. Acrimony in allied relations advertised weakness and disunity in

42 This made many within the U.S. government uncomfortable as well. As Arthur Burns said in early 1972, “Connally uses brutal techniques…When Connally gets into foreign relations, God help us. FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 236. 43 Herbert Block, Herblock’s State of the Union (New York, NY: Simon and Schuster, 1972), 156. 44 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 198.

20 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 the American camp, reducing credibility within the context of détente with the Soviet Union and

China. Throughout the fall of 1971, the monetary crisis increasingly became an inter-allied crisis, just as the Nixon administration should have foreseen.

Beyond Bretton Woods

Sensing that the situation was growing out of control, Kissinger at last intervened, convincing Nixon to avoid further damage to American alliances. International economic issues had begun to exacerbate and eclipse the political and strategic issues which Kissinger understood and deeply cared about. It may have been true, as Volcker suspected, that “papers on the intricacies of international monetary affairs ended up at the bottom of Kissinger’s in-tray, assuming they got that far.”45 Kissinger may not have understood the specifics, but he certainly understood the risks that Nixon’s New Economic Policy was taking with American allies.

The “Nixon shock” came on top of a war in Vietnam that had long been unpopular with

American allies, acrimonious trade relations, and, in the case of Japan, the surprise announcement that the United States was opening relations with the People’s Republic of China.

The Europeans and Japanese were rather acutely aware of the ways in which American power had been wielded against their will of late. British Prime Minister Edward Heath, referring to

Connally, fumed “I knew they killed the wrong man in Dallas.”46 One aide warned Kissinger that

The longer we go without a reasonable U.S. position, the more confused our friends become, the

more skeptical they are that we want to cooperate to solve the present problem, and the more

vulnerable they are to the importunements of those who wish to develop a European position

counter to our interest on economic issues, and political/security issues as well.47

45 Volcker, 65 46 John Campbell, Edward Heath: A Biography, (London : Jonathan Cape, 1993), 343 47 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 202.

Kissinger, who had “never understood Connally,” whom he considered “anti-foreigner,” was at last ready to make his move by mid-November.48 Since the start of the NEP, Nixon had been largely absorbed by other matters.49 Nixon grudgingly accepted Kissinger’s admonitions, and scheduled a meeting with the French government to hash out an initial settlement. In return, the crisis now became Kissinger’s problem in another, unexpected way.

Kissinger, who “knew nothing about economics and thought that economic leaders were usually political idiots,” was awkwardly placed in the role of chief negotiator on one of the greatest economic crises of the century.50 Without the technical knowledge to wheel and deal,

Kissinger drove a hard and unalterable bargain, cleverly giving the impression of toughness rather than incompetence. Connally conferred with Kissinger during breaks to adjust the

American bargaining position. More interested in a football game than the currency values,

Nixon himself waited in the wings for a decisive solution.51 Meanwhile, Kissinger seems to have been preoccupied with a brewing conflict between India and Pakistan.52 Kissinger is notably uncomfortable in discussing this situation in his memoirs:

So it happened that a solution to the monetary crisis was being negotiated between Pompidou, a

leading financial expert and a professional banker, and a neophyte; even in my most

megalomaniac moments I did not believe that I would be remembered for my contributions to the

reform of the international monetary system.53

48 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 236. Also see H.R. Haldeman, The Haldeman Diaries, (New York, NY: G.P. Putnam’s Sons, 1994), 340 49 Haldeman, 340-372. 50 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 71. This particular quotation is a paraphrase of Kissinger’s actual words. 51 Much more interested, in fact. Nixon was anxious to return to Washington following an exciting Redskins victory. He had excitedly visited a Redskins practice several weeks earlier, and was a die-hard fan. See Haldeman, 340-372, for context. 52 Haldeman, 384, and preceding entries. 53 Kissinger, White House Years, 960

After all of this trouble, little attention was given to the critical negotiations which framed the outcome. In the end, Kissinger and Pompidou agreed that the dollar would be devalued by 8.6%. Both sides knew that some devaluation was necessary, but French pride was well-served by a prominent role in setting the conditions for that devaluation. The hypothetical price of gold would now hypothetically be $38 per ounce. The price was only hypothetical because the “gold window” would remain closed; the United States would not actually exchange dollars for gold as it once had. Rather, the effective value of the dollar would simply change in accord with such a price change. This initial settlement paved the way for what the administration hoped would be the final act of the monetary crisis.

The remainder of the new exchange rates were negotiated during a mid-December conference at the red brick castle of the Smithsonian Institution in Washington, DC. West

Germany adjusted the mark upwards by about 14%. Japan, apparently the principal target of the entire maneuver, agreed to revalue the yen upwards by roughly 17%, a massive amount. Japan’s finance minister, Mikio Mizuta, called this currency adjustment “the greatest economic shock that Japan had experienced since the end of the World War.”54 The average increase was about

10% among the major economies at the conference. These were truly enormous changes which reconfigured the international balance of trade in favor of the United States.

The participants also agreed to accept wider bands of variation in their currencies of plus or minus 2.25%. The gold window was forever closed; the United States would never again guarantee gold for dollars. While new exchange rates could be discussed, ultimately there was no single, solid “anchor” for the system. The central feature of the Bretton Woods fixed exchange rate regime, gold/dollar convertibility, was dead.

54 James, 237.

These results were largely congruent with American goals, as shown in recently declassified documents.55 In return for the favorable revaluations, Connally at last relinquished the American import surcharge. Though the Smithsonian Agreement was meant to be the final word on monetary matters, what Nixon hailed as “the most significant monetary agreement in the history of the world” was a fragile compromise.56 Paul Volcker recalls muttering to an associate “I hope it lasts three months.” Volcker was overly pessimistic, but not by very much.

In reality, the agreement would hold for just six months.

Into 1972, the Nixon Administration’s expansive policies increased the money supply and loosened credit, stimulating the economy in an election year.57 Ironically, this temporary boom also sucked in huge quantities of imports from overseas, worsening the new trade deficit.

Consumption, production, and incomes all rose, producing inflation in spite of price controls.

American inflation spread abroad, quickly undoing the careful balance agreed to at the

Smithsonian. The size of the American economy was simply too big not to fundamentally affect the rest of the international economic system. With the United States unprepared to stand by the new system, and unwilling to propose another more comprehensive scheme, adherence to the

Smithsonian agreement lapsed.

When the Nixon administration finally ended the wage and price controls of the NEP in

January of 1973, dollars began to flow abroad in strength. This touched off a cascade of troubling monetary consequences that set Paul Volcker jetting to Tokyo and Bonn for desperate negotiations.58 The West German finance minister worried aloud that a new crisis would lead to

“economic war between the United States and Japan.”59 Japan again revalued the yen by 17%.

55 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 200. Targets are described as follows: Japan, 15%; Germany, 10%; France, 5%, etc. 56 Public Papers of Richard Nixon, 1971 (Government Printing Office, Washington, DC: 1972), 1195-1196. 57 James, 238. 58 Volcker, 103-108 59 James, 241.

This revaluation was achieved by allowing the yen to float temporarily on the open market without the customary government management. Several European currencies revalued by the same means.

Subsequently, Volcker and the Nixon administration did not commit to defending the new currency rates. The strong verbal commitments once made to multilateral cooperation and exchange rate maintenance were absent. By pursuing another “non-policy,” the Nixon administration was choking off the basis for any fixed exchange rate regime at all. Temporary floating of currencies gave way to indefinite floating. Without the power of the United States’ economy to stabilize global exchange rates, a pattern of floating and minimal currency management became the new norm. Markets, not governments, would henceforth determine the values of nations’ currencies. The new system was, in fact, a non-system.

In response to this new era of monetary instability and American economic hostility,

Western European countries began to coordinate exchange rates among themselves. In effect, these states fixed exchange rates within Western Europe, while floating against other currencies.

Stabilizing exchange rates among states whose interests were much more tightly aligned was far easier than settling the trans-Atlantic dispute. This European Monetary Union (EMU) was the first essential step in creating a common currency in the form of the Euro.

The official death of Bretton Woods did not occur until 1976, when the Jamaica meeting of the IMF signed a formal treaty eviscerating the old system. Years of negotiations led only to continual deadlock, with the United States and its trading partners poles apart.60 The unintended consequences of Nixon’s NEP, the end of the Bretton Woods system, and exogenous factors united to ensure that no new system would emerge. What these massive international economic

60 Several scholars have noted the irony of the United States’ situation. In 1944, the United States argued for the structures of the Bretton Woods system because it was a strong exporting economy. In the 1970s, the United States argued for an unstructured system as an importer. The reverse in priorities, while rational, is nonetheless striking.

25 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 changes did create was a series of unintended consequences and unexpected strategic problems for the United States.

Unintended Consequences

There are four additional noteworthy unintended international consequences of the NEP and the end of the Bretton Woods system. These extend beyond the proximate and obvious effects of uncertainty, instability, and widespread international frustration with the United States.

First, the International Monetary Fund (IMF) was never the same again. As IMF

President Pierre-Paul Schweitzer watched Nixon flicker across the television that night in 1971, he watched the end of the IMF as he knew it.61 By 1973, every single member of the IMF was acting in direct violation of their formal obligations to the institution.62 With its mission of maintaining the fixed exchange rate regime no longer relevant, the IMF became an institution in search of mission. As developed states ceased to require the IMF’s services, it shifted its attention to monetary and financial matters in the developing world.63 So began a long and controversial history of tinkering with the finances of some of the world’s poorest countries.64

However one wishes to assess the IMF’s legacy since that time, the end of the fixed exchange rate regime provided the impetus for this new IMF mission.65

Second, the need for global capital controls evaporated. Such government restrictions on the international flow of funds had long been necessary to stabilize exchange rates, since large net flows of currency could destabilize effective currency values. Early in the Nixon

61 Inviting Schweitzer to view the address on a television set at the Treasury Department was how the Nixon administration tried to finesse the requirement of consulting and informing the IMF on such critical monetary matters. The same slapdash treatment applied to other important leaders. Japanese Prime Minister Eisaku Sato received ten minutes’ warning from Secretary of State Rogers that he might want to watch the President’s speech that evening. Thinking of others was not exactly a strongpoint of administration policy that weekend in August. 62 James, 258. 63 James, International Monetary Cooperation Since Bretton Woods, offers the definitive account of this transition. 64 A history which, I might add, is being studied and summarized by University of Wisconsin-Madison political science professor Mark Copelovitch. 65

26 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 administration, officials had privately concluded that such controls were of questionable effect and sought to end their usage.66 With the end of fixed exchange rates, though, there was no need for any major government to continue to use capital controls. The United States ended its capital controls program in 1974, and other states soon followed suit. As a result, funds could now flow freely around the globe. This would have a tremendous impact on the arena of international finance, allowing funds to flow without restriction, seeking profits and fleeing crises. Liquid capital became both a blessing and a curse, as quick movements of money could facilitate development but also destabilize economies.

Third, the devaluation of the dollar effectively lowered the price of oil. During early discussions of dollar devaluation, one official raised an important point: what about contracts and commodities specifically denominated in dollars? Connally reportedly replied pointedly,

“Forget about those Arabs.”67 The official had a point, however. Oil had long been priced in dollars on the international market. This made sense when the dollar’s value was fixed and central to the international monetary system. However, with the dollar’s value sinking, oil was effectively being devalued as well.68 One author quotes the Kuwaiti Oil Minister as saying

“What is the point of producing more oil and selling it for an unguaranteed paper currency?”69

This was only a partial contributor to the 1973 Oil Crisis, but it was one impetus for that dramatic economic upheaval. Devaluation of their exports gave the increasingly-organized

OPEC states now in control of the majority of world production a clear incentive to restrict supplies. No one gave much thought to this problem at the time, but the Nixon administration would later have the opportunity to regret this neglect.

66 FRUS 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972, Document 54. 67 Odell, 245. Citing an interview with an anonymous official. 68 James, 253. 69 James, 253

Fourth, the demise of the fixed exchange rate regime contributed to extant inflationary pressures. Under floating rates, governments were no longer firmly constrained in their domestic fiscal and monetary policies which tended to alter affect currency values. To stimulate the economy, an individual state could simply print more money, injecting capital and jumpstarting growth. Since elected officials are quick to take the credit for such growth, the incentives for such a policy are obvious. The byproduct of this policy was inflation, which would ordinarily be tolerable within certain bounds. However, with many states simultaneously increasing the money supply, world inflation was creeping unusually high. This was in addition to sharply rising commodity prices and, later, the 1973 Oil Crisis.70

Partners and Rivals

The Nixon Administration’s international economic policies of 1971-1972 put an exclamation mark on a trend years in the making. Throughout the postwar era, the United States had consistently acted as both the military protector and the economic patron of its allies in

Western Europe and Japan. As these states recovered, they came to challenge both American political hegemony and international economic dominance. These conflicts sharpened with

Nixon’s more aggressive trade policies in 1970-1971, and reached a crescendo with the “Nixon

Shock” of 1971. Nations which the United States had rebuilt in its own democratic, capitalist image had long been natural strategic partners. Now, these states were also open economic rivals.

In contrast, the Nixon administration’s foreign policy is famous for its détente policies of friendly engagement with the Soviet Union and the People’s Republic of China. In the case of

China, the Nixon administration entered a tacit strategic alliance against the Soviet Union, which had been sparring with Mao’s China. This shift was also accentuated by ongoing and

70 James, 260

28 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 intensifying relationships with right-wing and military governments in other strategic regions.

While these overtures towards enemies and unsavory regimes are well known, they are thrown into stark relief by the Nixon administration’s actions towards its allies. While old strategic allies became economic rivals, ideological and strategic rivals became partners. States with similar systems and values were brusquely cast aside, while states with diametrically opposed values and practices were embraced. The longstanding postwar order had been turned on its head.

As enemies became partners, partners became rivals. The Nixon administration failed to integrate its economic and strategic priorities, and American interests materially suffered as a result. This was not a necessary outcome of détente or the realignment of American economic interests during the early 1970s. Rather, it was the product of poor policy formulation, coordination, and execution.

The larger trends of economic growth in Western Europe and Japan and strategic parity with the Soviet Union cannot be ignored. It was manifestly in the United States’ interest to pursue policies of détente with the Soviet Union and China, just as it was clearly in the United

States’ interest to strengthen its economic position. The problem fell in reconciling these interests with valuable American relationships with allies in Western Europe and Japan.

Nixon administration could have made much wiser and more artful choices in its relations with allies. Rather than acting unilaterally, the Nixon administration could have engaged in multilateral bargaining. Rather than offering months of frustration and negotiation, the Nixon administration could have offered a clear plan for a new international economic order.

Rather than cajoling Western Europe and Japan as dangerous rivals, the United States could have reassured and cooperated with these powers as longtime allies. Unfortunately, Nixon chose expedient policies which sacrificed international relationships for short term economic and electoral gains.

As it happened, poor relations with Western Europe and Japan became a critical hindrance to American strategy in subsequent years. Allied relations were so damaged that

Kissinger’s 1973 “Year of Europe” initiative, aimed at revitalizing American allied relationships, failed disastrously. When the 1973 Arab-Israeli War broke out, the United States found itself

71 Herbert Block, 156. Note that trade issues are on the top of the pile of “offenses.”

30 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 virtually alone in aiding Israel and countering Soviet threats to directly intervene in the conflict.

This was in spite of the fact that direct Soviet intervention in the region was a very serious threat that would have triggered a potentially catastrophic showdown between the United States and the

Soviet Union. The interests of the United States and its allies could not have been clearer, and yet frustrated and fearful American allies sat on the sidelines.

The 1973 Oil Crisis emerged directly from that war and at least partially from the original devaluation of the dollar. Strategic and economic choices now blew back in the form of a global economic catastrophe. As OPEC choked off oil supplies, prices spiraled upwards. Shortages crippled industry throughout the world. Meanwhile, the costs of goods, services, and transportation rose with the cost energy. Economies ceased growing while prices skyrocketed.

The dismal era of stagflation had arrived.

All of this raises fundamental questions about the role of political economy in American diplomacy. How should economic and strategic issues be balanced? How should policy leaders coordinate and concert their actions around coherent strategic goals? There are perhaps no easy or universal answers to these important questions. One point should be clear, however:

Economic and strategic interests cannot be treated as separate and distinct, for one often has an enormous effect upon the other. Scholars of diplomatic history and international relations are often loath to touch the technical intricacies of economics, the unfamiliar realm of mathematically-minded technocrats. Yet as the case of the Nixon administration forcefully demonstrates, failing to integrate economic and strategic thinking can lead to serious consequences which may even undermine fundamental national interests.

In an era of accelerating global economic integration, these points will only grow more salient. The interplay of economic and strategic interests grows ever more problematic, as

31 Partners and Rivals: Political Economy and American Diplomacy, 1969-1974 contemporary relations with China manifestly demonstrate. Can a state be both a strategic rival and the United States’ most valuable trading partner? Can the United States, with its growing debts and government deficits, continue to finance its international power? As we move into the

21st century, great minds in foreign policy must think not only of guns and governments, but simultaneously of markets and money. Only by integrating our thinking across fields can we hope to adapt domestic and international policies toward our desired ends.

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