What it means
In August 1971 the United States closed the gold window, and the fixed-exchange-rate world lost its anchor overnight. Four months of chaos later, the major powers met in Washington to rebuild it.
The Smithsonian Agreement, signed at the castle-like institution building in December 1971, was the rebuild: currencies were re-pegged, the dollar devalued against gold, and trading bands widened. The Federal Reserve's history of the episode records the terms and the mood: President Nixon called it the greatest monetary agreement in the history of the world.
The agreement's arithmetic was genuine compromise: the dollar fell about eight percent against gold, other currencies revalued against the dollar, and bands of two and a quarter percent replaced the old narrow ones. What it could not supply was discipline: the old system's glue, dollar convertibility into gold, was gone, and nothing in the new pegs replaced it.
The collapse came fast: speculative pressure battered the new parities through 1972, Britain floated the pound that June, and by March 1973 the major currencies floated for good. The Smithsonian thus became the bridge between eras: the last attempt to save fixed rates, and the event whose failure made floating the permanent regime.
For a non-finance reader, it is the treaty that proves rules need backing: the pegs were agreed, announced, and celebrated, and the markets tested them for fifteen months and won. The gold price at the heart of the deal was symbolic: $38 an ounce replaced 35, but the window stayed shut, so the new parity governed nothing except the arithmetic of the revaluation.
Central banks bore the defence costs: holding a parity means buying your own currency with reserves when speculators sell it, and the fifteen months of the agreement drained reserves at a pace no treasury could sustain. The lesson shaped later crises: every defended peg since, from the European exchange-rate mechanism to currency boards, is measured against the Smithsonian question of what backs the promise.
Historians treat the agreement as an epitaph: the communique's confidence is quoted in textbooks beside the dates of its collapse, a pairing that teaches faster than any theory of exchange regimes.
In practice
Real-world examples.
Example
A dealing desk redraws every band in December 1971, then watches markets lean against the new pegs within months. The traders know the central bank must buy its own currency at the bottom of the band. That obligation is what speculators test first.
Example
Sterling floats out of the agreement in June 1972, the first crack in the rebuild. Britain stops defending its parity after reserves drain away. Other governments take note of how quickly a defended peg can fail.
Example
By March 1973 the major currencies float, and the fifteen-month agreement becomes the bridge to the modern regime. What had been planned as a repair turns into a permanent change. The floating system nobody agreed to outlasts the agreement everyone celebrated.
Formula
Calculation
No formula; the terms: the dollar devalued roughly 8% against gold to $38 per ounce, other major currencies revalued against the dollar, and permitted fluctuation bands widened to plus or minus 2.25% around the new parities.
The arithmetic is short. Raising the gold price from $35 to $38 an ounce lifted the gold price by 38 / 35 - 1 = 8.6%, which means the dollar's gold value fell by 1 - 35 / 38 = 7.9%, or roughly 8%. For an illustrative central rate of $2.60 per pound, a band of 2.25% is $2.60 x 0.0225 = $0.0585 either way, so the permitted range ran from $2.5415 to $2.6585, a total band width of 4.5%.Case study
Seen in the real world.
This case study is fictional and illustrative. A made-up currency dealer at a London bank keeps a diary through the period. December 1971 reads triumphant: the Smithsonian terms are on the wires, the pound has a new parity, and her desk redraws every dealing band in the building over a weekend. The middle entries record the quiet problem: nothing backs the new parities except promises, and every rumour, a trade deficit, an election, a dock strike, sends money leaning against the bands, with central banks buying their own currencies to defend numbers negotiated at a party.
June 1972 is her busiest week ever: sterling leaves the agreement and floats, and the desk learns that a defended peg is a subsidy to whoever bets against it. March 1973 ends the diary's theme: the remaining parities are abandoned, and her last entry observes that the greatest monetary agreement in history lasted fifteen months, while the float nobody agreed to has already lasted longer. Her trainee asks what the lesson is, and she points at the screen: prices that cannot be changed get changed by speculators instead, and the only question is who collects the difference.
Watch out
Common mistakes.
- Thinking it ended Bretton Woods; the gold window's closure in August 1971 did that, and Smithsonian was the failed attempt to save the fixed-rate system.
- Believing it created floating rates; floating was the unplanned residue after the agreement's pegs collapsed in 1973.
- Judging it a diplomatic failure; the terms were a real compromise, but no agreement could substitute for the lost gold anchor's discipline.
Questions
People also ask.
What was the Smithsonian Agreement?
A December 1971 deal re-pegging major currencies and devaluing the dollar after the US closed the gold window, with wider trading bands around new parities.
Why did it fail?
Without gold convertibility nothing disciplined the pegs, speculative pressure overwhelmed them, and the major currencies floated by March 1973.
What did it change?
It was the last stand of fixed exchange rates; its collapse ushered in the floating-rate system that still governs major currencies.
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