Introduction
Justifying its pursuit of a dramatically more protectionist trade policy than its recent predecessors, the Trump Administration claimed that tariffs serve as a useful negotiation tool to remake the global trade system, correcting perceived injustices against America. In his testimony to the U.S. Senate, Trade Representative Jamieson Greer explained that “nonreciprocal access … [has] contributed to these trade deficits,” and that the president’s Liberation Day tariff announcement encouraged Vietnam and India to reach out for negotiations.1 The president’s logic is not unheard of; previous administrations threatened to impose punishing tariffs to achieve economic goals. Analyzing the use of tariffs by the Nixon Administration in 1971 to negotiate a favorable adjustment of exchange rates suggests that this strategy is not worth replicating.
Background on the Post-War Trading System
President Franklin Roosevelt interpreted governments’ failure to mount an adequate response to the Great Depression through the lens of Wilsonian internationalism. He believed that tariffs and discriminatory trading policies raised barriers to global economic recovery. When WWII began, he saw an opportunity to enumerate a new set of principles, including the “enjoyment by all States … of access, on equal terms, to the trade and to the raw materials of the world which are needed for their economic prosperity.” In July 1944, the principles outlined by Roosevelt and his allies in the British government were enshrined in the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank) at the Bretton Woods Conference. Nations would trade according to a system of fixed exchange rates underpinned by the U.S. dollar, which was convertible to gold. In 1947, agreement was reached for across-the-board reductions in tariffs, codified in the General Agreement on Tariffs and Trade (GATT).2
The Nixon Shock
Twenty-five years after the GATT, America was struggling to uphold the post-war trade system. The strong recoveries of West Germany and Japan meant that the U.S. was importing increasingly more goods from these powers. By the late 1960s, the U.S. only had $10 billion worth of gold to support $50 billion worth of dollar holdings in foreign central banks, risking a potential run on the dollar. Because the dollar was the world’s reserve currency, the government could not devalue the dollar relative to other currencies. It could only devalue the dollar relative to gold, which officials were reluctant to do. The Nixon Administration, which took office in 1969, aimed to persuade America’s trade partners to revalue their currencies, enhancing the competitiveness of America’s exports and reducing capital outflows.3
President Nixon unveiled his New Economic Program (NEP), known as the Nixon Shock, on August 15th, 1971. The result of three days of secretive discussions at Camp David, the NEP aimed to, among other goals, “protect the dollar from the attacks of international money speculators.” This would be achieved by suspending the convertibility of the dollar to gold and imposing a 10% tariff on imports to encourage trading partners to allow their currencies to appreciate.4 The Administration directed its diplomatic offensive principally at Japan and West Germany.3
Japanese authorities were strongly averse to an appreciation of the yen, intervening massively in some cases to control the yen’s rise through purchases of dollars. Japan’s growth was fueled by exports, and the country’s leaders hoped to preserve amicable trade relations with the U.S., taking preliminary steps towards trade liberalization in 1971 before Nixon’s announcement. Even though 90% of Japan’s exports to the U.S. were subject to the tariff, Japan remained largely unwilling to adjust the exchange rate that was established in 1949. In the aftermath of the shock, Japan purchased huge dollar reserves, but it was unable to prevent the depreciation of the dollar relative to the yen caused by market forces. Japan enacted a “dirty float” that was heavily supported by the government.3
Tariffs had a minimal effect on changing Japan’s exchange rate policy. Japan only partially relented to American demands when its central bank could no longer counter market pressures that forced the appreciation of the yen.
Would higher tariff rates have resulted in a more decisive change to Japanese policy? That’s unlikely: Japan would’ve diversified its trading partners. Japanese negotiators argued that America could devalue the dollar unilaterally and warned that America’s conduct risked starting a global trade war. Leaders of Japan’s ruling Liberal Democratic Party (LDP) called for Japan to maintain positive relations with the U.S. but recognize that the world had “entered a tri-polar, or a five polar era.” Already, major Japanese corporations accepted Chinese Premier Zhou Enlai’s “Four Conditions” for trade, including the severance of ties to Taiwan.5
West Germany exhibited similar indifference to the American tariff. In May 1971, the Germans established a floating exchange rate, and the mark appreciated relative to the dollar due to strong demand. However, Germany wanted other European countries to float their currency against the dollar, which they objected to. Most notably, Germany was afraid of losing competitiveness to France, which did not change policy due to the tariff. The French remained adamant that the U.S. had to raise the dollar value of gold. President Nixon eventually devalued the dollar against gold.3
The impasse came to an end on December 18th, 1971, when the Group of 10 (G-10) economies agreed to a new set of exchange rates in the Smithsonian Agreement. President Nixon subsequently lifted the tariff. The dollar was depreciated by slightly less than 8 percent against other OECD currencies, weighted by trade.3
The Nixon Administration successfully renegotiated exchange rates. However, the Smithsonian Agreement largely codified exchange rates that were set by speculative market pressures in the aftermath of the shock. Evidence suggests that Japanese business interests were growing uncomfortable with the tariff; however, market forces triggered by the closing of the gold window—not the tariff—ultimately brought about America’s desired outcome.3
Conclusion
Protectionism reared its head again in the 1980s to address concerns about Japanese automakers’ growing market share in America and the resultant struggles of the “Big 3” automakers and their employees. NPR reports that the Reagan Administration successfully used the threat of tariffs to persuade foreign carmakers to establish production facilities in America.6 As Scott Lincicome explains, however, the reality is more complicated. Foreign car manufacturers didn’t need the threat of tariffs to produce more vehicles in America: Japanese companies estimated that labor costs were lower in the U.S. than Japan, partially driving the 1990s wave of foreign investment in the American automobile industry. Volkswagen and Honda announced significant investments in Pennsylvania and Ohio that predated the Reagan Administration.7
Presidents should consider tariffs as a last resort instrument of trade policy. The Trump Administration has concurred with the traditional economic wisdom that tariffs hurt consumers. President Trump’s economic team should also reject the use of tariffs as a negotiating tool.
References
1 https://www.npr.org/2025/04/08/nx-s1-5355969/trump-trade-official-tariffs-congress
2 https://history.state.gov/milestones/1937-1945/bretton-woods
3 https://www.nber.org/system/files/working_papers/w17749/w17749.pdf
4 https://history.state.gov/milestones/1969-1976/nixon-shock