Under the agreements of 1944 the American dollar functioned as a virtual world currency, conferring great advantages on the US vis-à-vis the other capitalist powers. These advantages were limited, at least in theory, by the provision that the US dollar could be redeemed in gold at the rate of $35 per ounce.
As is often the case with financial arrangements, the gold backing system functioned very well so long as it was not actually tested. But it was founded on a contradiction. The system would continue to operate while the mass of US dollars circulating in the rest of the world was backed by gold held in the US. But the very expansion of the international economy tended to increase the need for international liquidity in the form of US dollars. That is, the more the global economy expanded, the shakier became the relationship between the dollar and gold.
In the 1960s, the dollar overhang—the difference between the dollars in international circulation and the value of the gold backing held in Fort Knox—began to grow as a result of increased US investment abroad and military spending. US administrations imposed policies aimed at restricting capital movements and like their British counterparts before them, US financial interests found the Euro dollar market a useful means for circumventing the actions of their own government.
US administrations also had an ambivalent attitude to the Euro dollar market. While trying to restrict capital outflows to counter the balance of payments deficit, the existence of the Euro dollar market meant that foreigners would be more likely to keep their holdings in dollars, thereby easing the pressure on the US currency.
However, the growth of the Euro dollar market had exactly the effect that Keynes and Harry Dexter White, the chief US negotiator at Bretton Woods, had foreshadowed. Growing amounts of finance capital were now able to move around the world outside the control of governments. The system of fixed exchange rates could not be sustained. The pound came under pressure in 1967, followed by the dollar in 1968. In 1971, a qualitative change took place as the US, for the first time since before World War I, experienced a balance of trade deficit, leading to the Nixon announcement on August 15.
In the immediate aftermath of the decision there were attempts by Japan, as well as the European powers, to resurrect the Bretton Woods system, at least in some form, through the exercise of capital controls. The US opposed all such measures because they would have restricted its freedom of operation both internationally and at home.
Under Bretton Woods, or any other system of regulation, the US would have had to take action to rectify the imbalances in its international position. One method would have been to cut back military spending, particularly on the Vietnam War. But this would have meant weakening the position of the US vis-à-vis the other major powers. In 1971 an administration grouping under the leadership of Paul Volcker (later to become chairman of the US Federal Reserve Board) concluded that financing for US deficits has “permitted the United States to carry out heavy overseas military expenditure and to undertake other foreign commitments” and that an important goal was to “free ... foreign policy from constraints imposed by weaknesses in the financial system.” Looking back from the 1990s, Volcker commented that “presidents—certainly Johnson and Nixon—did not want to hear that their options were limited by the weakness of the dollar.”
Another way to reduce the balance of payments deficit, ease the pressure on the dollar and so maintain a system of regulation would have been to cut spending in the United States. But the consequences would have been to induce a severe recession. Facing a rising tide of militancy in the working class, the student radicalisation produced by the Vietnam War, and the rebellion of black youth in the cities, this was not considered an option.
Moreover, there was considerable support for the view within US ruling circles that if the system of controls on capital movements were scrapped, the US would be able to maintain its hegemonic position because of its weight within the world economy. Other nations would want to hold dollars because of the role it played in the international monetary system. This outlook was summed up by the treasury secretary in the Nixon administration, John Connally, in remarks to a European audience as follows: “The dollar may be our currency but it’s your problem.” Or, as he told an American audience: “Foreigners are out to screw us. Our job is to screw them first.”