Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial relations among the United States, Canada, Western European countries, and Australia as well as 44 other countries[1] after the 1944 Bretton Woods Agreement. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent states. The Bretton Woods system required countries to guarantee convertibility of their currencies into U.S. dollars to within 1% of fixed parity rates, with the dollar convertible to gold bullion for foreign governments and central banks at US$35 per troy ounce of fine gold (or 0.88867 gram fine gold per dollar). It also envisioned greater cooperation among countries in order to prevent future competitive devaluations, and thus established the International Monetary Fund (IMF) to monitor exchange rates and lend reserve currencies to nations with balance of payments deficits.[2]
Preparing to rebuild the international economic system while World War II was still being fought, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference, also known as the Bretton Woods Conference. The delegates deliberated from 1 to 22 July 1944, and signed the Bretton Woods agreement on its final day. Setting up a system of rules, institutions, and procedures to regulate the international monetary system, these accords established the IMF and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. The United States, which controlled two-thirds of the world's gold, insisted that the Bretton Woods system rest on both gold and the US dollar. Soviet representatives attended the conference but later declined to ratify the final agreements, charging that the institutions they had created were "branches of Wall Street".[3] These organizations became operational in 1945 after a sufficient number of countries had ratified the agreement. According to Barry Eichengreen, the Bretton Woods system operated successfully due to three factors: "low international capital mobility, tight financial regulation, and the dominant economic and financial position of the United States and the dollar."[4]
On 15 August 1971, the United States "temporarily" suspended the convertibility of the US dollar to gold, effectively bringing the Bretton Woods system to an end and rendering the dollar a fiat currency.[5] Shortly thereafter, many fixed currencies (such as the pound sterling) also became free-floating,[6] and the subsequent era has been characterized by floating exchange rates.[7] The end of Bretton Woods was formally ratified by the Jamaica Accords in 1976.
Origins[edit]
Interwar period[edit]
There was a high level of agreement among the powerful nations that failure to coordinate exchange rates during the interwar period had exacerbated political tensions. This facilitated the decisions reached by the Bretton Woods Conference. Furthermore, all the participating governments at Bretton Woods agreed that the monetary chaos of the interwar period had yielded several valuable lessons.
The experience of World War I was fresh in the minds of public officials. The planners at Bretton Woods hoped to avoid a repetition of the Treaty of Versailles after World War I, which had created enough economic and political tension to lead to WWII. After World War I, Britain owed the U.S. substantial sums, which Britain could not repay because it had used the funds to support allies such as France during the War; the Allies could not pay back Britain, so Britain could not pay back the U.S. The solution at Versailles for the French, British, and Americans seemed to entail ultimately charging Germany for the debts. If the demands on Germany were unrealistic, then it was unrealistic for France to pay back Britain, and for Britain to pay back the US.[8] Thus, many "assets" on bank balance sheets internationally were actually unrecoverable loans, which culminated in the 1931 banking crisis. Intransigent insistence by creditor nations for the repayment of Allied war debts and reparations, combined with an inclination to isolationism, led to a breakdown of the international financial system and a worldwide economic depression.[9]
The so-called "beggar thy neighbor" policies that emerged as the crisis continued saw some trading nations using currency devaluations in an attempt to increase their competitiveness (i.e. raise exports and lower imports), though recent research suggests this de facto inflationary policy probably offset some of the contractionary forces in world price levels (see Eichengreen "How to Prevent a Currency war").
In the 1920s, international flows of speculative financial capital increased, leading to extremes in balance of payments situations in various European countries and the US.[10] In the 1930s, world markets never broke through the barriers and restrictions on international trade and investment volume – barriers haphazardly constructed, nationally motivated and imposed. The various anarchic and often autarkic protectionist and neo-mercantilist national policies – often mutually inconsistent – that emerged over the first half of the decade worked inconsistently and self-defeatingly to promote national import substitution, increase national exports, divert foreign investment and trade flows, and even prevent certain categories of cross-border trade and investment outright. Global central bankers attempted to manage the situation by meeting with each other, but their understanding of the situation as well as difficulties in communicating internationally, hindered their abilities.[11] The lesson was that simply having responsible, hard-working central bankers was not enough.
Britain in the 1930s had an exclusionary trade bloc with nations of the British Empire known as the "Sterling Area". If Britain imported more than it exported to such nations, recipients of pounds sterling within these nations tended to put them into London banks. This meant that though Britain was running a trade deficit, it had a financial account surplus, and payments balanced. Increasingly, Britain's positive balance of payments required keeping the wealth of Empire nations in British banks. One incentive for, say, South African holders of rand to park their wealth in London and to keep the money in Sterling, was a strongly valued pound sterling. In the 1920s, imports from the US threatened certain parts of the British domestic market for manufactured goods and the way out of the trade deficit was to devalue the currency. But Britain could not devalue, or the Empire surplus would leave its banking system.[12]
Nazi Germany also worked with a bloc of controlled nations by 1940. Germany forced trading partners with a surplus to spend that surplus importing products from Germany.[13] Thus, Britain survived by keeping Sterling nation surpluses in its banking system, and Germany survived by forcing trading partners to purchase its own products. The U.S. was concerned that a sudden drop-off in war spending might return the nation to unemployment levels of the 1930s, and so wanted Sterling nations and everyone in Europe to be able to import from the US, hence the U.S. supported free trade and international convertibility of currencies into gold or dollars.[14]
Post-war negotiations[edit]
When many of the same experts who observed the 1930s became the architects of a new, unified, post-war system at Bretton Woods, their guiding principles became "no more beggar thy neighbor" and "control flows of speculative financial capital". Preventing a repetition of this process of competitive devaluations was desired, but in a way that would not force debtor nations to contract their industrial bases by keeping interest rates at a level high enough to attract foreign bank deposits. John Maynard Keynes, wary of repeating the Great Depression, was behind Britain's proposal that surplus nations be forced by a "use-it-or-lose-it" mechanism, to either import from debtor nations, build factories in debtor nations or donate to debtor nations.[15][16] The U.S. opposed Keynes' plan, and a senior official at the U.S. Treasury, Harry Dexter White, rejected Keynes' proposals, in favor of an International Monetary Fund with enough resources to counteract destabilizing flows of speculative finance.[17] However, unlike the modern IMF, White's proposed fund would have counteracted dangerous speculative flows automatically, with no political strings attached—i.e., no IMF conditionality.[18] Economic historian Brad Delong writes that on almost every point where he was overruled by the Americans, Keynes was later proved correct by events.[19]
Today these key 1930s events look different to scholars of the era (see the work of Barry Eichengreen Golden Fetters: The Gold Standard and the Great Depression, 1919–1939 and How to Prevent a Currency War); in particular, devaluations today are viewed with more nuance. Ben Bernanke's opinion on the subject follows:
Readjustment[edit]
Dollar shortages and the Marshall Plan[edit]
The Bretton Woods arrangements were largely adhered to and ratified by the participating governments. It was expected that national monetary reserves, supplemented with necessary IMF credits, would finance any temporary balance of payments disequilibria. But this did not prove sufficient to get Europe out of its conundrum.
Postwar world capitalism suffered from a dollar shortage. The United States was running large balance of trade surpluses, and U.S. reserves were immense and growing. It was necessary to reverse this flow. Even though all nations wanted to buy U.S. exports, dollars had to leave the United States and become available for international use so they could do so. In other words, the United States would have to reverse the imbalances in global wealth by running a balance of trade deficit, financed by an outflow of U.S. reserves to other nations (a U.S. financial account deficit). The U.S. could run a financial deficit by either importing from, building plants in, or donating to foreign nations. Speculative investment was discouraged by the Bretton Woods agreement, and importing from other nations was not appealing in the 1950s, because U.S. technology was cutting edge at the time. So, multinational corporations and global aid that originated from the U.S. burgeoned.[36]
The modest credit facilities of the IMF were clearly insufficient to deal with Western Europe's huge balance of payments deficits. The problem was further aggravated by the reaffirmation by the IMF Board of Governors of the provision in the Bretton Woods Articles of Agreement that the IMF could make loans only for current account deficits and not for capital and reconstruction purposes. Only the United States contribution of $570 million was actually available for IBRD lending. In addition, because the only available market for IBRD bonds was the conservative Wall Street banking market, the IBRD was forced to adopt a conservative lending policy, granting loans only when repayment was assured. Given these problems, by 1947 the IMF and the IBRD themselves were admitting that they could not deal with the international monetary system's economic problems.[37]
The United States set up the European Recovery Program (Marshall Plan) to provide large-scale financial and economic aid for rebuilding Europe largely through grants rather than loans. Countries belonging to the Soviet bloc, e.g., Poland were invited to receive the grants, but were given a favorable agreement with the Soviet Union's COMECON.[38] In a speech at Harvard University on 5 June 1947, U.S. Secretary of State George Marshall stated:
Late application[edit]
U.S. balance of payments crisis[edit]
After the end of World War II, the U.S. held $26 billion in gold reserves, of an estimated total of $40 billion (approx 65%). As world trade increased rapidly through the 1950s, the size of the gold base increased by only a few percentage points. In 1950, the U.S. balance of payments swung negative. The first U.S. response to the crisis was in the late 1950s when the Eisenhower administration placed import quotas on oil and other restrictions on trade outflows. More drastic measures were proposed, but not acted upon. However, with a mounting recession that began in 1958, this response alone was not sustainable. In 1960, with Kennedy's election, a decade-long effort to maintain the Bretton Woods System at the $35/ounce price began.
The design of the Bretton Woods System was such that nations could only enforce convertibility to gold for the anchor currency—the United States dollar. Conversion of dollars to gold was allowed but was not required. Nations could forgo converting dollars to gold, and instead hold dollars. Rather than full convertibility, the system provided a fixed price for sales between central banks. However, there was still an open gold market. For the Bretton Woods system to remain workable, it would either have to alter the peg of the dollar to gold, or it would have to maintain the free market price for gold near the $35 per ounce official price. The greater the gap between free market gold prices and central bank gold prices, the greater the temptation to deal with internal economic issues by buying gold at the Bretton Woods price and selling it on the open market.
In 1960 Robert Triffin, a Belgian-American economist, noticed that holding dollars was more valuable than gold because constant U.S. balance of payments deficits helped to keep the system liquid and fuel economic growth. What would later come to be known as Triffin's Dilemma was predicted when Triffin noted that if the U.S. failed to keep running deficits the system would lose its liquidity, not be able to keep up with the world's economic growth, and, thus, bring the system to a halt. But incurring such payment deficits also meant that, over time, the deficits would erode confidence in the dollar as the reserve currency created instability.[40]
The first effort was the creation of the London Gold Pool on 1 November 1961 between eight nations. The theory behind the pool was that spikes in the free market price of gold, set by the morning gold fix in London, could be controlled by having a pool of gold to sell on the open market, that would then be recovered when the price of gold dropped. Gold's price spiked in response to events such as the Cuban Missile Crisis, and other less significant events, to as high as $40/ounce. The Kennedy administration drafted a radical change of the tax system to spur more production capacity and thus encourage exports. This culminated with the 1963 tax cut program, designed to maintain the $35 peg.
In 1967, there was an attack on the pound and a run on gold in the sterling area, and on 18 November 1967, the British government was forced to devalue the pound.[41] U.S. President Lyndon Baines Johnson was faced with a difficult choice, either institute protectionist measures, including travel taxes, export subsidies and slashing the budget—or accept the risk of a "run on gold" and the dollar. From Johnson's perspective: "The world supply of gold is insufficient to make the present system workable—particularly as the use of the dollar as a reserve currency is essential to create the required international liquidity to sustain world trade and growth."[42]
While West Germany agreed not to purchase gold from the U.S., and agreed to hold dollars instead, the pressure on both the dollar and the pound sterling continued. In January 1968 Johnson imposed a series of measures designed to end gold outflow, and to increase U.S. exports. This was unsuccessful, however, as in mid-March 1968 a dollar run on gold ensued through the free market in London, the London Gold Pool was dissolved, initially by the institution of ad hoc UK bank holidays at the request of the U.S. government. This was followed by a full closure of the London gold market, also at the request of the U.S. government, until a series of meetings were held that attempted to rescue or reform the existing system.[43]
All attempts to maintain the peg collapsed in November 1968, and a new policy program attempted to convert the Bretton Woods system into an enforcement mechanism of floating the gold peg, which would be set by either fiat policy or by a restriction to honor foreign accounts. The collapse of the gold pool and the refusal of the pool members to trade gold with private entities—on 18 March 1968 the Congress of the United States repealed the 25% requirement of gold backing of the dollar[44]—as well as the U.S. pledge to suspend gold sales to governments that trade in the private markets,[45] led to the expansion of the private markets for international gold trade, in which the price of gold rose much higher than the official dollar price.[46][47]
U.S. gold reserves remained depleted due to the actions of some nations, notably France,[47] which continued to build up their own gold reserves.
The Bretton Woods system in the 21st century[edit]
2008 crisis[edit]
In the wake of the Global financial crisis of 2008, some policymakers, such as Chace[52] and others have called for a new international monetary system that some of them also dub Bretton Woods II. On the other side, this crisis has revived the debate about Bretton Woods II.[Notes 5]
On 26 September 2008, French President Nicolas Sarkozy said, "we must rethink the financial system from scratch, as at Bretton Woods."[53]
In March 2010, Prime Minister Papandreou of Greece wrote an op-ed in the International Herald Tribune, in which he said, "Democratic governments worldwide must establish a new global financial architecture, as bold in its own way as Bretton Woods, as bold as the creation of the European Community and European Monetary Union. And we need it fast." In interviews coinciding with his meeting with President Obama, he indicated that Obama would raise the issue of new regulations for the international financial markets at the next G20 meetings in June and November 2010.
Over the course of the crisis, the IMF progressively relaxed its stance on "free-market" principles such as its guidance against using capital controls. In 2011, the IMF's managing director Dominique Strauss-Kahn stated that boosting employment and equity "must be placed at the heart" of the IMF's policy agenda.[54] The World Bank indicated a switch towards greater emphases on job creation.[55][56]
2020 crisis[edit]
Following the 2020 Economic Recession, the managing director of the IMF announced the emergence of "A New Bretton Woods Moment" which outlines the need for coordinated fiscal response on the part of central banks around the world to address the ongoing economic crisis.[57]
General: