Fifty years ago this Sunday, President Richard Nixon announced a bold economic plan, including the severing of the U.S. dollar’s ties to gold. Since then, the world’s monetary system has consisted of (mostly) freely floating currencies. The dollar nonetheless remains the primary legal tender used internationally for trade, finance, and as a store of value, which has conferred upon the U.S. enormous advantages. Whether that will continue for the next half-century is far from certain.
The Bretton Woods system, in effect back then, reflected America’s economic pre-eminence after World War II. Currency exchange rates were fixed, relative to the dollar, which, in turn, was exchangeable for gold at a fixed $35 an ounce. The idea was to avoid the currency instability and competitive devaluations of the 1930s, but with greater flexibility than allowed under the classical gold standard, which most economists agreed had helped trigger and spread the Great Depression.
But the Bretton Woods regime led to a trilemma: Countries couldn’t simultaneously have fixed exchange rates, free capital flows, and independent fiscal and monetary policies. They could choose only two of the three. A fixed exchange rate essentially meant adjusting economies to a nation’s currency, requiring restrictive policies when inflation rose or trade accounts went into deficit.