Resolution: 1971–2007

At the outset of this period there was a new serious threat to the exchange rate system that had been established at the Bretton Woods Conference of 1944. Large corporations recognized that the Bretton Woods quasi-fixed exchange rate system was no longer viable; they shifted very large amounts of funds into hard European currencies and the Japanese yen in the correct anticipation that the value of the U.S. dollar would fall relative to them when the system collapsed.1 In a desperate attempt to stem the dollar outflow, the Federal Reserve dramatically forced interest rates up in the spring of 1971. Yields on government securities and large denomination certificates of deposit were threatening to rise above ceilings that banks and thrifts could pay on deposits. This situation together with the first recession since 1961 induced President Nixon to make a draconian speech on August 15, 1971, that suspended convertibility of dollars into gold by foreign governments. In the speech he also imposed a 90-day freeze on prices and wages, imposed tariffs on imported vehicles, lowered excise taxes on vehicles, and expanded the investment tax credit.

In the new exchange rate environment, it seemed plausible that interest rates would be more volatile.2 Arthur Burns attempted to defuse this suspicion by simultaneously wearing two more hats; in addition to being chairman of the Federal Reserve Board he was an advisor to the Cost of Living Council that was promised in the Nixon speech and chairman of its Committee on Interest and Dividends, which was intended to moderate fluctuations in interest rates and dividends in a loosely structured incomes policy. These two chairmanships proved to be incompatible. By 1973 market interest rates were considerably higher than the rates that banks could pay on small time and savings deposits. Table 17 shows the extraordinary volatility of interest rates, which began with the Federal Reserve’s decision to raise the discount rate in December 1965. The table reports end-of-quarter monthly-average interest rates on 3-month treasury bills, 5-year government securities, and 20-year government securities, and quarterly first differences in each for 39 quarters.