What Was the Smithsonian Agreement and Why Did It Fail?

In December 1971, finance ministers from the Group of Ten major industrialized nations gathered at the Smithsonian Institution in Washington, DC, for four days of intense negotiation aimed at rebuilding the international monetary system shattered by Nixon's August suspension of dollar-gold convertibility. They produced the Smithsonian Agreement—a realignment of major exchange rates involving dollar devaluation and revaluation of the deutschmark, yen, and other currencies, with wider permissible bands for exchange rate fluctuation. Nixon called it "the most significant monetary agreement in the history of the world." Within fifteen months, the modified fixed exchange rate system it created had collapsed under speculative pressure, and the world's major currencies had moved to floating exchange rates. The Smithsonian Agreement deserves study not for its success but for what its failure reveals about the limits of international monetary coordination when underlying economic imbalances remain unresolved.

Quick definition: The Smithsonian Agreement refers to the December 1971 accord among the Group of Ten major economies that attempted to restore a modified fixed exchange rate system following the Nixon Shock—involving dollar devaluation to $38 per ounce of gold, revaluation of the deutschmark and yen, and wider permissible exchange rate bands (2.25 percent vs. the previous 1 percent)—which collapsed in early 1973 as speculative pressure made the modified pegs unsustainable and major currencies moved to floating exchange rates.

Key takeaways

• The Smithsonian Agreement was negotiated December 17-18, 1971, at the Smithsonian Institution in Washington, DC, among the Group of Ten major industrialized economies.
• It involved dollar devaluation to $38 per ounce of gold (approximately 8 percent from $35), deutschmark revaluation of approximately 13.5 percent, and yen revaluation of approximately 16.9 percent.
• Wider exchange rate bands (2.25 percent vs. the previous 1 percent) gave currencies more flexibility before central banks were required to intervene.
• The 10 percent import surcharge Nixon had imposed in August was removed as part of the agreement.
• The agreement lasted approximately fifteen months—by March 1973, speculative pressure had forced the major European currencies and the yen to float freely.
• The failure demonstrated that exchange rate agreements cannot be sustained when underlying inflation differentials and current account imbalances remain unresolved.

The negotiating context

The four months between Nixon's August 15 announcement and the December Smithsonian Agreement were characterized by international monetary disorder. With the dollar's gold convertibility suspended but no new exchange rate framework established, currency markets operated under massive uncertainty. European central banks faced a dilemma: let their currencies float upward against the dollar (damaging export competitiveness) or intervene to hold the dollar up (accumulating unwanted dollar reserves).

Most European central banks initially intervened, buying dollars to prevent their currencies from appreciating sharply. But this meant absorbing the dollars that the suspended gold window had ceased to support—an unsustainable accumulation. The European Community countries briefly attempted a joint float against the dollar, but coordination proved difficult.

The Group of Ten negotiations were contentious. The fundamental question was how much exchange rate adjustment was required and who would bear it. Treasury Secretary Connally's negotiating position was aggressive: the United States wanted substantial revaluation of European and Japanese currencies—revaluation that would price their exports out of US markets—as compensation for what Connally framed as decades of European and Japanese free-riding on the dollar-centered system.

The Europeans and Japanese resisted the scale of revaluation Connally demanded. The final agreement represented a compromise: substantial but not maximal adjustment, with the United States accepting a formal dollar devaluation (to $38/ounce) rather than claiming that only other currencies were moving.

The agreement's terms

The Smithsonian Agreement's key provisions:

Dollar devaluation: The official dollar gold price moved from $35 to $38 per ounce—an 8.57 percent dollar depreciation. This was symbolic as much as substantive: with gold convertibility suspended, the official gold price was not operationally meaningful. But formally devaluing the dollar acknowledged that the previous $35 rate had been unsustainable.

European currency revaluations: The deutschmark moved approximately 13.5 percent in trade-weighted terms; the French franc approximately 8.6 percent. European currencies generally strengthened against the dollar, making European exports more expensive in dollar terms and US exports more competitive in European markets.

Yen revaluation: Japan's yen revalued by approximately 16.9 percent—the largest revaluation in the agreement. Japan had maintained a fixed 360 yen per dollar rate since 1949; the new rate was 308 yen per dollar. Japanese authorities resisted strongly, aware that yen appreciation would damage their export-driven growth model.

Wider bands: Exchange rates could fluctuate 2.25 percent above or below the new central rates before central bank intervention was required—compared to the 1 percent bands under Bretton Woods. The wider bands provided more flexibility but also more uncertainty for international trade and investment.

Import surcharge removal: Nixon removed the 10 percent import surcharge he had imposed in August, fulfilling the European and Japanese demand that this punitive measure be lifted.

Why the agreement failed

The Smithsonian Agreement contained an inherent contradiction: it attempted to restore fixed exchange rates without addressing the underlying conditions that had made the previous fixed rates unsustainable. Those conditions—US inflation differentials, persistent current account deficits, and capital flow liberalization—continued after December 1971.

Inflation differentials: The United States continued to experience higher inflation than Germany, Japan, and other major trading partners. Under fixed exchange rates, higher US inflation meant US goods became progressively more expensive internationally while foreign goods became cheaper in US markets—exactly the pressure that had made Bretton Woods unsustainable. The Smithsonian Agreement realigned rates to reflect accumulated inflation differentials, but did nothing to address the differential itself.

Capital flow liberalization: By the early 1970s, capital controls had been substantially reduced across major economies. Speculative currency flows—bets by sophisticated investors on which exchange rate pegs would or would not hold—could move enormous sums rapidly. A speculative attack on a fixed exchange rate peg required only that investors believe the peg was overvalued; self-reinforcing dynamics could then make the attack profitable by forcing the very devaluation being bet upon.

Inadequate adjustment: Many observers—and some participants—believed the December 1971 realignment was insufficient. The dollar had been overvalued at $35/ounce relative to the deutschmark and yen by more than the Smithsonian adjustments corrected. Partial adjustment left the new pegs still potentially misaligned, providing a target for future speculative attack.

US monetary policy: Nixon's 1972 election-year economic management included significant monetary stimulus. The Federal Reserve, under Arthur Burns (who was subject to Nixon administration pressure), maintained accommodative monetary policy through 1972—contributing to inflation that further eroded the Smithsonian pegs' sustainability.

The 1973 collapse

By early 1973, the Smithsonian Agreement's pegs were clearly unsustainable. Massive speculative flows out of dollars accelerated through January and February. In February 1973, the dollar was devalued again—from $38 to $42.22 per ounce of gold, a further 10 percent depreciation. The devaluation failed to restore confidence.

In March 1973, the major European economies and Japan made a decision they had resisted for nearly two years: they allowed their currencies to float freely against the dollar. The Swiss franc and other smaller currencies followed. The era of floating exchange rates for major currencies had begun.

The transition to floating rates was not announced as a deliberate policy choice but emerged from the practical impossibility of maintaining fixed rates in the face of speculative pressure and inflation differentials. Countries that had built their economic models around export competitiveness—particularly Germany and Japan—discovered that floating rates introduced a new form of uncertainty: exchange rate volatility that could significantly affect export revenues and corporate planning horizons.

The lessons for monetary coordination

The Smithsonian Agreement's failure contains several enduring lessons about international monetary coordination:

Exchange rate agreements cannot substitute for macroeconomic adjustment. The Smithsonian Agreement realigned rates without addressing the underlying inflation differential between the United States and its trading partners. When the differential persisted, the new pegs became unsustainable for the same reasons the old ones had been.

Wider bands are not equivalent to floating rates. The 2.25 percent bands gave more flexibility than the previous 1 percent, but this flexibility was insufficient when the required real exchange rate adjustment exceeded the band limits. Speculative capital flows could quickly push currencies to band limits, requiring intervention that exhausted reserves.

Partial realignment invites speculative attack. If investors believe exchange rate adjustment is insufficient, they have incentives to bet on further adjustment. Credibility requires either comprehensive adjustment to equilibrium rates or clear commitment to defend pegs with whatever policy instruments necessary.

American unilateralism constraints international cooperation. The Nixon Shock's unilateral announcement damaged the trust that multilateral monetary cooperation requires. European negotiators at the Smithsonian had to consider the possibility that the United States might again act unilaterally if the agreement's terms became inconvenient—which reduced their willingness to make substantial concessions.

Real-world examples

The Smithsonian Agreement's failure has influenced subsequent approaches to international monetary coordination. The Plaza Accord of 1985—where the United States, Japan, Germany, France, and Britain agreed to coordinated intervention to depreciate the dollar—was more successful partly because it addressed actual exchange rate misalignment (the dollar had appreciated dramatically in the early 1980s) rather than attempting to restore fixed rates in a floating rate world.

The European Monetary System (EMS) of 1979-1992 attempted to maintain fixed exchange rates within Europe even after the global system moved to floating—essentially recreating within Europe the conditions Bretton Woods had provided internationally. The EMS faced recurrent crises as inflation differentials and speculative attacks tested its pegs, culminating in the 1992 crisis that forced sterling and the Italian lira out of the system. The eventual transition to the euro—eliminating exchange rate adjustment entirely within the eurozone—was partly a response to the instability of maintaining fixed rates among separately governed economies.

Common mistakes

Treating the Smithsonian Agreement as equivalent to Bretton Woods. The Smithsonian Agreement attempted to restore a modified fixed exchange rate system, but without the institutional infrastructure, capital controls, or US economic dominance that had made Bretton Woods work. The structural conditions for sustained fixed rates had changed; the agreement was attempting to maintain a regime whose foundations had eroded.

Blaming the agreement's failure solely on speculators. Speculative pressure exploited the agreement's vulnerabilities, but those vulnerabilities reflected genuine macroeconomic imbalances. Speculators don't create exchange rate misalignment; they identify and act on it. The Smithsonian Agreement failed because the rates established in December 1971 were not sustainable given US inflation and current account dynamics.

Treating the transition to floating rates as unambiguously positive. Floating exchange rates provide more flexibility and eliminate the unsustainability of fixed rate systems, but they introduce exchange rate volatility that creates real costs for trade and investment. The post-1973 period was characterized by significantly more exchange rate volatility than the Bretton Woods era—a trade-off with real economic consequences.

FAQ

Was Nixon's claim about the Smithsonian Agreement really believed?

Almost certainly not by the sophisticated economists and officials involved. The agreement was a political achievement—bringing major trading partners to agreement—but its economic sustainability was doubtful from the start. Nixon's extravagant characterization reflected his political communications style rather than economic analysis. The subsequent fifteen-month lifespan confirmed the doubters.

Why did Japan accept the large yen revaluation?

Japan accepted the revaluation under American pressure—the import surcharge would have remained in place if Japan had refused, and Japanese export industries depended critically on US market access. The 16.9 percent revaluation was economically significant and damaged Japanese export competitiveness, but the alternative was worse. Japan's acceptance of significant yen appreciation at American insistence has been a recurring pattern in US-Japan economic relations.

Did the Smithsonian Agreement accomplish anything lasting?

The removal of the import surcharge was immediately beneficial for international trade. The wider exchange rate bands (2.25 percent) became the standard for subsequent European fixed-rate arrangements. The negotiating process itself—intensive multilateral economic diplomacy among the major economies—was a precedent for subsequent G-7 economic coordination. But the central objective—restoring a workable fixed exchange rate system—was not achieved.

How did floating exchange rates affect international business?

Floating exchange rates created a new category of business risk: currency exposure. Companies selling products internationally faced uncertainty about what their foreign currency revenues would be worth when converted to home currency. This created demand for hedging instruments—currency forward contracts, options, swaps—that largely didn't exist when exchange rates were fixed. The foreign exchange derivatives market, now among the world's largest financial markets, developed largely in response to floating rate volatility.

What would have been needed for the Smithsonian Agreement to succeed?

Success would have required addressing the underlying macroeconomic imbalances: reducing US inflation to match German and Japanese levels; either expanding the adjustment margins further or committing to defend pegs with interest rate policy; maintaining capital controls to limit speculative flows; and establishing some mechanism to prevent the US from pursuing inflationary monetary policy that eroded the agreed parities. None of these conditions was met.

Related concepts

• Bretton Woods Overview
• The Nixon Shock of 1971
• Vietnam War Spending and Inflation
• Stagflation and the 1970s
• The Depression's Global Dimensions

Summary

The Smithsonian Agreement of December 1971 attempted to restore a modified fixed exchange rate system after the Nixon Shock—realigning rates through dollar devaluation and deutschmark and yen revaluations, with wider bands for exchange rate flexibility. Nixon called it the most significant monetary agreement in history; it lasted approximately fifteen months. The agreement failed because it attempted to restore exchange rate stability without addressing the underlying inflation differentials, capital flow liberalization, and US current account imbalances that had made Bretton Woods unsustainable. By March 1973, speculative pressure had forced the major European currencies and the yen to float freely, beginning the era of floating exchange rates that has characterized international monetary arrangements since. The Smithsonian Agreement's failure demonstrated that exchange rate agreements cannot substitute for the macroeconomic policies required to make exchange rate commitments credible.

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