Agreement designed to reestablish international fixed currency exchange rates.
Currencies are valued on either a fixed rate set by the government or on a floating rate, in which the free market determines the value of the currency. Fixed rates are usually more stable; floating rates can fluctuate wildly. Meeting in December 1971 at the Smithsonian Institution, ten industrialized nations voted to establish the Smithsonian agreement, which resurrected the system of international fixed currency exchange rates (although without the backing of the currencies by gold or silver). International fixed currency exchange rates—from the Bretton Woods agreement in 1945 (which, based on the gold standard, stabilized currencies and established the International Monetary Fund) to President Richard Nixon’s New Economic Policy of August 1971—pro-vided the postwar foundations of international monetary arrangements. Tension had long existed within the Nixon administration between the veterans of the Bretton Woods discussions and staffers including George Shultz, Nixon’s secretary of labor, who believed passionately in the price mechanism and a floating exchange rate system. Others, such as Secretary of State Henry Kissinger and Federal Reserve Chair Arthur Burns, successfully persuaded Nixon of the need to return to a par value system based on a fixed rate. The International Monetary Fund (IMF) likewise determined to strengthen the Bretton Woods system that had created it, and the IMF remained committed to establishing a once-and-for-all currency realignment based on its own internal computations. As a result, the Smithsonian agreement reestablished the par value system and allowed the devaluation of the U.S. dollar by about 8 percent. The price of gold rose to $38 per ounce, and the permitted variation around par values was increased to 2.25 percent. The agreement removed the 10 percent import surcharge that had been introduced in Nixon’s 1971 New Economic Policy.
Nixon hailed the negotiated realignment as “the most significant monetary agreement in world history.” He also recalled that the Federal Reserve had launched an aggressive rearguard action in 1971 to preserve the par value system. In that rearguard action, Burns of the Federal Reserve declared that the Senate must pass the Par Value Modification Act, 1972 legislation that called for compliance with the Smithsonian agreement. The act passed.
In just over a year, the Smithsonian edifice collapsed, primarily because of domestic U.S. difficulties that led Nixon to remove the United States from the gold standard. Burns extolled the Smithsonian agreement as “solidly based,” describing the alternative of wildly fluctuating rates and devaluations as “not pleasant to contemplate.” In July 1972, the Federal Reserve began for the first time since August 1971 to intervene in support of the dollar against the German currency, the deutsche mark.
Nixon supported floating rates and showed no interest in defending the Smithsonian agreement. In June 1972 Bob Haldeman, chief of staff at the White House, informed Nixon that the British pound was floating—that is, removed from the gold standard—but Nixon replied, “I don’t care about it.”
Haldeman pressed Nixon to take an interest in the international monetary crisis, telling him that Burns was particularly concerned about the Italian lira, which was also fluctuating in value. But Nixon retorted that he did not care about the lira. By March 1973, the major world currencies were floating. The final collapse of an international system of fixed currency exchange rates arrived unexpectedly.
Shultz later recalled that the administration hoped for a more fundamental reform and that the Smithsonian agreement merely functioned as a prelude to such a reform. Defending the par value system was, he believed, “a futile effort.” Shultz bemoaned the fact that economic policy had often adversely affected the market economy and said that reliance on the market system offered the best alternative. He noted that “the price of money is the most important price in an economy” and recalled that in supporting floating rates, he had helped to “achieve a major transformation in the international monetary system,” the emergence of “a flexible rate system.” Insiders believed that conservative economist Milton Friedman had influenced Shultz between 1969 and 1971. In December 1971, Friedman campaigned without noticeable effect to “keep the dollar free.” When the pound began to float in 1972, Friedman argued that the “sooner the Smithsonian agreement is undermined the better.”
In retrospect, the Smithsonian bargain among the top ten industrialized nations merely delayed the rendezvous with the political, economic, and intellectual forces pushing hard against the system of fixed exchange rates. The demise of the par value system in 1973 initiated a new episode in international monetary arrangements, and by 1975 many countries had started to experiment with floating rates. Thus the international policy revolution in which the Smithsonian agreement was abandoned and floating rates were embraced acted as a forerunner of—and precondition for—the domestic monetarist policy revolution that removed the United States from the gold standard.
