Smithsonian Agreement: What it is, How it Works

What Is the Smithsonian Agreement?

The Smithsonian Agreement was a temporary agreement negotiated in 1971 among the ten leading developed nations in the world, namely Belgium, Canada, France, West Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States. The deal made adjustments to the system of fixed exchange rates established under the Bretton Woods Agreement and effectively created a new standard for the dollar, as the other industrialized nations pegged their currencies to the U.S. dollar.

The Smithsonian Agreement Explained

The Bretton Woods Agreement was a complicated system based on gold that began to unravel in the 1960s, as the global stock of gold became insufficient to meet the global demand for international reserves. The Smithsonian Agreement resulted in a partial devaluing of the U.S. dollar, but it was not enough to address the underlying issues of the Bretton Woods Agreement, and it lasted just 15 months before the broader system collapsed.

The Smithsonian Agreement became necessary when then-U.S. President Richard Nixon stopped allowing foreign central banks to exchange U.S. dollars for gold in Aug. 1971. A sharp jump in the U.S. inflation rate in the late 1960s had made the existing system unstable and was driving a shift to foreign currencies and gold at the expense of the U.S. dollar. The move by President Nixon triggered a crisis, which led to an appeal from the International Monetary Fund for negotiations among the Group of Ten (G-10). This negotiation, in turn, led to the Smithsonian Agreement in Dec. 1971.

The agreement devalued the U.S. dollar by 8.5% relative to gold, raising the price of an ounce of gold from $35 to $38. The other G-10 countries agreed to revalue their currencies against the U.S. dollar as well. President Nixon praised the agreement as "the most significant monetary agreement in world history."

However, the par value system continued to deteriorate. Speculators pushed many foreign currencies up against their now-higher valuation limits, and the value of gold was driven higher as well. When the U.S. unilaterally decided to devalue its dollar by 10% in February 1973, raising the price of gold to $42 per ounce, it was too much for the system. By 1973, most major currencies had shifted from a fixed to a floating exchange rate relative to the U.S. dollar.

End of the Gold Standard

The decision by President Nixon to “close the gold window” was the end of the U.S. commitment to set a fixed price for gold. The U.S. dollar was now a fiat currency. The decisions helped complete the shift away from the gold standard, which began in the early 1930s when Congress enacted a joint resolution that barred creditors from demanding repayment in gold. Then-President Franklin D. Roosevelt ordered individuals to return high-denomination gold and gold certificates to the Federal Reserve for a fixed price.