# Nixon Shock: Definition, Causes, and Economic Impact

![Nixon Shock: The aftereffect of a set of economic policies announced by President Richard M. Nixon in 1971.](https://www.investopedia.com/thmb/AbRUV93Rzksexe81sv4fRlqEE9Y=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/nixon-shock.asp-final-e966f3ebc9c540ab9e0171e1c19b2399.png)

*— Investopedia / Julie Bang*

## What Is the Nixon Shock?

The Nixon Shock relates to an economic policy shift undertaken by President Richard M. Nixon in 1971 to prioritize jobs growth, lower inflation, and exchange rate stability. The policy changes led to the collapse of the Bretton Woods system of fixed exchange rates established after World War II. It effectively ended the convertibility of U.S. dollars into gold. In addition, the Nixon Shock was the catalyst for the [stagflation](https://www.investopedia.com/terms/s/stagflation.asp) of the 1970s as the U.S. dollar devalued. Yet, thanks in large part to the Nixon Shock, central banks have more control over their nations' money and the management of variables such as interest rates, overall money supply, and [velocity](https://www.investopedia.com/terms/v/velocity.asp). Long after the Nixon Shock, economists are still debating the merits of this policy shift and its eventual ramifications.

### Key Takeaways

*   The Nixon Shock ended the convertibility of U.S. dollars into gold, marking the start of today's fiat currency system.
*   It led to the collapse of the Bretton Woods system, which had regulated fixed exchange rates since World War II.
*   Short-term, Nixon's policies were praised, but they contributed to the stagflation and dollar volatility of the 1970s.
*   The move gave central banks more control over monetary policy but also created risks associated with floating currencies.
*   Economists continue to debate the long-term benefits and drawbacks of the Nixon Shock.

## Analyzing the Impact: Nixon's "New Economic Policy"

The Nixon Shock followed President Nixon’s televised "New Economic Policy" address to the nation on August 15, 1971.  Nixon's speech focused on shifting U.S. attention to domestic issues after the Vietnam War.

1.  [Lowering the unemployment rate](https://www.investopedia.com/unemployment-rate-by-president-8637843)
2.  Stemming the rise in inflation
3.  Protecting the U.S. dollar from international money speculators

Nixon proposed tax cuts and a 90-day freeze on prices and wages to boost jobs and control [inflation](https://www.investopedia.com/terms/i/inflation.asp). To counter speculation against the USD, Nixon backed suspending the dollar's gold convertibility.

In addition, Nixon proposed an additional 10% tax on all [imports](https://www.investopedia.com/terms/i/import.asp) that were subject to duties. Similar to the strategy of suspending dollar convertibility, the levy was intended to encourage the U.S.' primary trading partners to raise the value of their currencies.

### Why Change Was Essential: The Bretton Woods System and Its Challenges

The [Bretton Woods](https://www.investopedia.com/terms/b/brettonwoodsagreement.asp) system was developed during an international conference held at Bretton Woods, New Hampshire in 1944. It involved the external values of foreign currencies. [Fixed](https://www.investopedia.com/terms/f/fixedexchangerate.asp) to the U.S. dollar, these values were expressed in gold at a price determined by Congress. In 1958, foreign currencies became convertible into gold.

However, a global dollar surplus imperiled the system in the 1960s. At the time, the U.S. did not have enough gold to cover the volume of dollars circulating throughout the world. That led to an [overvaluation](https://www.investopedia.com/terms/o/overvalued.asp) of the dollar.

The government attempted to shore up the dollar as well as the Bretton Woods system, with the Kennedy and Johnson administrations trying to deter foreign investment, limit foreign lending, and reform international monetary policy. However, their efforts were largely unsuccessful.

Anxiety eventually crept into the [foreign exchange market](https://www.investopedia.com/terms/forex/f/foreign-exchange-markets.asp), with traders abroad fearful of an eventual dollar [devaluation](https://www.investopedia.com/terms/d/devaluation.asp). As a result, they began selling USD in greater amounts and more frequently. After several runs on the dollar, Nixon sought a new economic course for the country.

### The Global Reaction to Nixon's Announcement

Nixon’s speech was not received as well internationally as it was in the U.S. Many in the international community interpreted Nixon’s plan as a unilateral act.

In response, the [Group of Ten (G-10)](https://www.investopedia.com/terms/g/groupoften.asp) set new exchange rates focused on a devalued dollar, known as the [Smithsonian Agreement](https://www.investopedia.com/terms/s/smithsonian-agreement.asp). That plan went into effect in December 1971, but it proved unsuccessful. 

Beginning in February 1973, speculative market pressure caused the USD to devalue and led to a series of [exchange parities](https://www.investopedia.com/terms/p/parityprice.asp). Amid still-heavy pressure on the dollar in March of that year, the G–10 implemented a strategy that called for six European members to tie their currencies together and jointly [float](https://www.investopedia.com/terms/f/float.asp) them against the dollar.

That decision essentially brought an end to the fixed exchange rate system established by the [Bretton Woods](https://www.investopedia.com/articles/forex/122215/bretton-woods-system-how-it-changed-world.asp) agreement.

> **Fast Fact**
>
> The Bretton Woods agreement created two major institutions that have stood the test of time: the International Monetary Fund and the World Bank.

## Long-Term Effects: Stagflation and Currency Volatility

At first, Nixon's policies were seen as a political success, but now their long-term effects are debated.

First, the policies were the primary catalyst for the stagflation of the 1970s. They caused instability in floating currencies, with the U.S. dollar dropping by a third during the 1970s. Over the past 40 years, the U.S. dollar has been anything but stable, with several periods of severe volatility.

From 1985 to 1995, for example, the U.S. dollar value index lost as much as 34%. After quickly recovering, it fell sharply again from 2002 to mid-2011.

Nixon also promised that his move would prevent costly recessions. Over the past few decades, however, the U.S. has suffered severe recessions including the [Great Recession](https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp) of December 2007 to June 2009.  

## Pros and Cons of the Nixon Shock

The Nixon administration's 1971 economic policy actions have provided advantages as well as disadvantages.

### Advantages

Today, we live in a world of mostly free-floating, market-traded currencies. This system has its benefits, especially when facilitating radical monetary policy actions such as [quantitative easing (QE)](https://www.investopedia.com/terms/q/quantitative-easing.asp).

Central banks have a greater degree of control over their nations' money and the management of variables such as interest rates, overall money supply, and velocity.

### Disadvantages

However, Nixon's policies also added uncertainties, leading to a large market for [hedging](https://www.investopedia.com/terms/h/hedge.asp) currency risks.

The financial crisis of 2007-2008, in particular, proved that central bank control is no guaranteed defense against severe recessions.

Decades later, economists still debate the merits and effects of the Nixon Shock.

Advantages of Nixon Shock

*   Government-backed money is generally more stable than commodity-based currency
    
*   Central banks have more flexibility to protect their economies from severe busts of the business cycle
    
*   Actions to protect gold reserves, which caused economic volatility, are now unnecessary.
    

Disadvantages of Nixon Shock

*   Led to stagflation of the 1970s
    
*   Severe recessions and U.S. dollar volatility still occur under the watch of central banks
    
*   Gold provided a self-regulating effect on the economy and currency, while the Nixon Shock empowered the government to manipulate variables
    

## What Was the Gold Standard and How Did It Work?

The gold standard is a monetary system in which the value of a country's currency is based on a fixed quantity of gold. In practice, central banks made sure that domestic currency (paper money) was easily convertible into gold at a specific fixed price. Gold coins also circulated as domestic currency alongside other metal coins and notes.

## When and Why Did Nixon End the Gold Standard?

President Richard Nixon closed the gold window in 1971 in order to address [the country's inflation problem](https://www.investopedia.com/us-inflation-rate-by-president-8546447) and to discourage foreign governments from redeeming more and more dollars for gold.

## What Is Fiat Money?

[Fiat money](https://www.investopedia.com/terms/f/fiatmoney.asp) is government-issued money that isn't backed by a physical commodity such as gold or silver. Instead, it is backed by the government that issued it.

## What Would Happen If We Returned to the Gold Standard?

Some economists argue that if we returned to the gold standard, prices would actually destabilize, leading to episodes of severe deflation and inflation. Moreover, in the event of a financial crisis, the government would have little flexibility to either avert or limit the potential damage.

## The Bottom Line

Nixon Shock refers to the aftermath of President Richard Nixon's August 1971 announcement of major economic policy changes intended to improve the country's balance of payments, prevent inflation, and lower unemployment. This was a pivotal moment that marked the end of the Bretton Woods system, changing how global currencies were valued. It suspended the U.S. dollar's convertibility into gold, which effectively moved the U.S. to a fiat money system. While initially seen as politically successful, these policies led to stagflation and floating currency instability. Economists continue to debate the merits and negative effects of these actions.

> **Article Sources**
>
> 1.  Richard Nixon Foundation. "[The Challenge of Peace: President Nixon’s New Economic Policy](https://www.nixonfoundation.org/2014/08/challenge-peace-nixons-new-economic-policy/)."
>     
> 2.  Federal Reserve History. "[Nixon Ends Convertibility of U.S. Dollars to Gold and Announces Wage/Price Controls](https://www.federalreservehistory.org/essays/gold-convertibility-ends)."
>     
> 3.  Federal Reserve History. "[Creation of the Bretton Woods System](https://www.federalreservehistory.org/essays/bretton-woods-created#:~:text=Countries%20settled%20international%20balances%20in,rate%20of%20%2435%20an%20ounce.)."
>     
> 4.  Office of the Historian. ["Nixon and the End of the Bretton Woods System, 1971–1973](https://history.state.gov/milestones/1969-1976/nixon-shock)."
>     
> 5.  Bloomberg. "[Dollar Index Spot Chart](https://www.bloomberg.com/quote/DXY:CUR)."