article

As the probability of Trump's election victory increased, his policy proposals have also attracted attention, especially the "devaluation of the dollar" and "raising tariffs" as his two main strategies.

Previously, Trump threatened to impose a 10% tariff on all imported goods, and there were reports that Trump's core advisors were plotting a policy of devaluing the dollar. Some analyses pointed out that currency revaluation is likely to be a priority for Trump in his second term.

In fact, historically, raising tariffs and currency devaluation have been used together, with the most famous example being the "Nixon Shock" in 1971.

Following significant political turmoil such as the assassination of a presidential candidate in 1968 and the incumbent president's withdrawal from the race, the United States found itself in an economic crisis characterized by inflation, trade deficits, a plummeting dollar, and massive outflows of gold.

On August 15, 1971, after the Camp David meeting, Nixon announced the suspension of the convertibility of the dollar to gold and a temporary (90-day) 10% surcharge on all taxable imports to the United States; following the "Nixon Shock," countries signed the Smithsonian Agreement at the end of 1971, which devalued the dollar by 7.89% against gold and by 10% against major currencies.

Advertisement

Subsequently, global markets were thrown into turmoil, with the yen and the Deutsche mark, among other non-US currencies, appreciating significantly. However, as the inflation situation in the United States worsened, the Smithsonian Agreement also came to an end two years later.

"Nixon Shock" - The Great Devaluation of the Dollar

Since the establishment of the Bretton Woods monetary system, the sword of Damocles of insufficient U.S. gold reserves has been hanging high, and this sword finally fell in the 1970s.

As the U.S. trade deficit continued to deteriorate, the United States experienced a trade deficit in 1970 for the first time in a century;

In May, the price of gold soared rapidly, and the dollar was heavily shorted in the international foreign exchange market; by mid-year, the United States had only $10.2 billion in gold, but overseas officials held $40 billion in foreign exchange reserves, and a run on the U.S. gold reserves would quickly deplete them.From a political standpoint, the Nixon administration at the time emphasized that the United States should shed its heavy tasks and burdens of leading and managing the world, and it was time to refocus on domestic American interests.

Under immense pressure, the United States had two options to remedy the balance of payments deficit: a contractionary monetary policy or a weak currency. At that time, to avoid increasing unemployment rates in pursuit of re-election, Nixon naturally abandoned the former and chose a more adventurous step.

On the afternoon of August 13, 1971, Nixon, Federal Reserve Chairman Burns, soon-to-be Treasury Secretary Connally, Deputy Treasury Secretary Paul Volcker, and 12 senior advisors from the White House and the Treasury Department held a secret meeting at Camp David, engaging in intense debates.

Although Burns initially opposed decoupling from gold, Nixon was concerned that if Burns questioned his decision, the global market would go berserk, so he brought Burns on board. Eventually, they reached a consensus to abandon the Bretton Woods system, leaving a stain on the independence of the Federal Reserve.

At 9 PM on August 15, after the Camp David meeting, Nixon delivered a televised speech, historically announcing a suspension of the dollar's convertibility to gold; simultaneously, a temporary (90-day) 10% surcharge was imposed on all tax-related imported goods in the United States.

Following the television address, the U.S. stock market began to plummet, the Japanese stock market crashed, and the dollar exchange rate in the Tokyo market fell, which the Japanese financial community referred to as the "Nixon Shock."

It is worth mentioning that extreme foreign exchange pressures often accompany currency agreements and coordinated interventions. The United States used a 10% tariff and other protectionist measures to exert pressure on trade partners, urging them to revalue their currencies.

The then Treasury Secretary Connally once said a famous phrase, "The dollar is our currency, but it's your problem," which perfectly encapsulates the intentions of the United States.

By the end of 1971, countries signed the "Smithsonian Agreement," which stipulated the reestablishment of the official gold market, devaluing the dollar by 7.89% against gold, while also adjusting exchange rate parities, with the dollar depreciating by an average of 10%.

However, this did not do much to restore confidence. In early 1973, gold prices rose to $90 per ounce, triggering Europe to sell dollars and hoard gold.Western Europe and the Japanese foreign exchange markets were closed for 17 days. After negotiations, an agreement was reached where Western countries abandoned the fixed exchange rate system in favor of a floating exchange rate system. This marked the end of the Smithsonian Agreement, and the collapse of the Bretton Woods monetary system.

History rhymes but does not repeat

History does not simply repeat itself, but it often follows the same rhythm. In its latest report, Goldman Sachs points out:

There are similarities between the current situation and that of 1971, with the US dollar being highly valued and foreign holdings of US assets at an all-time high. However, market factors are not as conducive to a weaker dollar as they were in the past, and a unified currency agreement seems unlikely. Nevertheless, the US may continue to push other countries to take measures to rebalance global trade.

Trump and his team continue to propose tariffs and a devaluation of the dollar to gain protectionist advantages in global trade. However, there are significant challenges that make this policy more difficult to manage than in the 1970s and 1980s. Macroeconomic factors continue to drive the dollar's strength, and intervention in this environment is challenging.

US fiscal consolidation (reducing deficits and debt) and fiscal expansion in other countries may be a more rational and effective way to achieve global trade rebalancing and a weaker dollar.

Today, the conditions for a "Nixon Shock" still exist, but there are clear differences between the current environment and the past context. Goldman Sachs states:

The dollar remains the world's reserve currency. Current account imbalances are more severe than before. The US budget deficit has grown, and fiscal spending is expected to increase in the event of a potential Trump victory.

However, the current market environment is different from the time of the Smithsonian Agreement. Market factors are not pushing the dollar to weaken; on the contrary, the dollar has remained strong. The Smithsonian Agreement was essentially about realigning exchange rates with market forces, and policy interventions tend to be more successful when they are consistent with the fundamentals, but this is not the case today.

There is currently no evidence that the market is selling dollars or dollar-denominated assets. In fact, foreign allocation to US portfolio assets is at an all-time high, which may be related to the dominance of the technology sector in the stock market and the increase in US risk-free interest rates.Additionally, the current foreign exchange market system is also vastly different from the past, with the world shifting from fixed exchange rate arrangements to more flexible exchange rate regimes, and the U.S. Treasury rarely intervening in the foreign exchange market in recent years. From 1970 to 2019, the proportion of hard currency pegged exchange rate arrangements decreased from around 80% to just over 50%. Although today only 20% of currencies are floating, the Euro/U.S. Dollar transaction alone accounts for nearly a quarter of all foreign exchange transactions, while the U.S. Dollar/Deutsche Mark transaction accounted for nearly two-thirds of all transactions.

Current trade relations also differ from the past, when the United States' largest merchandise trade deficit countries were Canada, Japan, and Germany, all of which were politically aligned with the U.S. during the Cold War. If countries participating in the Smithsonian Agreement were to revalue by the same amount today, the trade-weighted U.S. Dollar would only depreciate by 3.5%.