Post World War Rebuilding
In July 1944 outside of the small town of Bretton Woods, New Hampshire, representatives from forty four of the allied nations fighting in World War II met to discuss the impending post-war world order, especially as it pertained to economics. The result of that conference was the implementation of a new world-wide economic system, which became known as the Bretton Woods System, or regime, that sought to bring stability to the world in a period of world history when stability was desired more than anything. The Bretton Woods regime operated under the auspices of the United Nations and served as an important part of the Cold War era global economy. Despite collapsing in the early 1970s, the Bretton Woods regime was one of the most influential monetary systems of the modern world as it continues to influence the global economy in many ways.
The United States and most of the industrialized, non-communist nations of the world took part in the Bretton Woods regime, which meant that the entire world was at least indirectly affected in many ways by those who ran the system. The International Bank for Reconstruction and Development – colloquially known as the World Bank – and the International Monetary Fund (IMF) were two institutions installed during the Bretton Woods Regime that still exist today. The organization of the most industrialized nations of the world – known today as the G-20, or “Group of 20” – can also trace its origins back to the Bretton Woods regime, which has led many economists to look at the system as the last great period of global economics. Bretton Woods was the last system to use a gold standard and for the most part, global economic stability and equilibrium were achieved during the Bretton Woods regime; but despite all of the apparent economic benefits that Bretton Woods gave to the global economy a number of its inherent qualities ultimately led to its decline.
The Origins of the Bretton Woods Regime
As noted above, Bretton Woods was born at the end of the Second World War out of a combination of hope and fear for the future. As the British Empire and the old colonial world order crumbled many of the world’s leaders and economists were optimistic that a new economic order would bring more stability and wealth to a greater part of the population, but there was also a considerable amount of fear that accompanied the optimism. As the fascist regimes of Europe were being toppled, many saw Joseph Stalin and the Soviet Union as an equally big threat to world peace and stability and so believed that a stable, but prosperous, world economic system would be the best deterrent to the communist menace. These hopes and fears were articulated by some of the leading economic minds of the era at the Bretton Woods conference in 1944, which then ultimately produced the Bretton Woods regime.
Among the numerous economists who influenced the nascent Bretton Woods regime, the most impactful was the Englishman John Maynard Keynes (1883-1946). Keynes saw the previous global economic system, the Classical Gold Standard, as too unstable for the new era and so envisaged an economic system where governments, or the system itself, could intervene in the market in order to limit what became known as “disequilibrating” capital flows and obtain near full-employment in member countries. Economist Johnathon Kirshner later described the Bretton Woods regime as a “compromise of market forces and social contract.” In some ways the Bretton Woods regime borrowed ideas from the previous Classical Gold Standard but was for the most part a truly unique economic system.
The Form and Implementation of Bretton Woods
The most important similarity between the Classical Gold Standard and the Bretton Woods Regime was the use of gold as part of the standard exchange rate. Although during Bretton Woods the U.S. dollar was used as the reserve currency for the basis of exchange, member countries could exchange their dollars for gold at a fixed rate of $35 per ounce of gold. Despite the importance of gold in the Bretton Woods regime, the commodity could not be converted for dollars by companies or individuals, which was a striking difference from the Classical Gold Standard. The exchange rate was the heart of the Bretton Woods Regime as its successful implementation hinged on how successfully it was carried out.
The Bretton Woods exchange rate was what is termed as an “adjustable peg” against the U.S. dollar. For the most part the rate would only change by narrow margins, but could be changed when there was what is termed as a “fundamental disequilibrium.” A fundamental disequilibrium was when a member country could not achieve economic balance without restricting trade or deflating output. The system then acted in a Keynesian way to adjust the problem before it got worse. The European members usually kept their currencies within three-fourths of one percent (.75) on either side of the dollar. Along with the exchange rate and directly related to it, another key component of the Bretton Woods regime was the idea of balance of payment adjustments. As already noted, the exchange rates were changed when there were noticeable imbalances in the system at which time reserves held in the World Bank would be used to avoid external balance, which proved to be one of the more delicate aspects of the Bretton Woods Regime.
The “reserve regime” aspect of Bretton Woods proved to be one of the system’s strengths when all members cooperated, but also in the end one of its weaknesses. In theory, member countries were expected to restrict their deficits to the sums that could be financed by their own reserves, or if not possible, by reserves supplemented by the IMF. Obviously this aspect of Bretton Woods would benefit countries that ran deficits, while not necessarily hurting those that ran surpluses. The more obvious problems with the reserve aspect of Bretton Woods were liquidity, or lack of it, and currency speculation, which will be discussed more thoroughly below. In many ways the Bretton Woods Regime was actually quite simple, but how well did it work?
If one examines the history of countries in the Bretton Woods regime then it quickly becomes obvious that no major bust cycles took place during the period. Yes, there were recessions in many Bretton Woods countries, but nothing along the lines of what took place before, during the Great Depression, or since, such as the most recent world-wide recession. In fact, during the Bretton Woods regime the world witnessed the most widely distributed and fastest economic growth; unemployment was low and prices were stable, especially at the beginning and towards the end of the regime. Despite these facts not all economists are convinced that Bretton Woods was the sole reason for the economic stability of the 1950s and ‘60s as they argue that market forces were more responsible for economic success. Although other factors may have influenced economic boom periods during the 1950s and ‘60s, the very composition of the Bretton Woods regime probably stopped more than one recession from getting out of hand. The Bretton Woods regime may have served the world admirably for nearly thirty years, but cracks in its foundations eventually became fissures that could not be fixed.
The Collapse of the Bretton Woods Regime
An examination of the downfall of the Bretton Woods regime reveals that some of the aspects that made it strong and unique also contributed to its eventual demise. One of the core problems with Bretton Woods was liquidity, particularly as it related to the United States. Liquidity in the Bretton Woods regime related to how many dollars were available for members to use, which ultimately hinged on how much, or little, the United States had and/or was willing to part with. For example, the United States would have to run a deficit in order to create international liquidity, which then would result in the erosion of confidence in the dollar’s convertibility into gold. Conversely, if the United States sought to reduce its deficit then the world’s liquidity would decrease – the liquidity problem proved to be a “Catch-22” for the Bretton Woods regime. But as much of a problem that liquidity proved to be for Bretton Woods, other inherent issues proved to be worse.
As much as the fixed exchange rate seemed logical and appeared to work for so many years, it had inherent problems that contributed to the decline of Bretton Woods. The exchange rate sought to eliminate or at least alleviate “disequilibrium”, but it actually created imbalance between consistent surplus states in Europe and deficit states like the United States and United Kingdom. If the exchange rate was allowed to fluctuate more, then the imbalances may have evened out, but the rigidity, which was institutionalized after the British sterling crisis of 1947, helped to keep a firm line between deficit and surplus states. The Bretton Woods regime was a system created by humans who were unable to foresee some of its inherent problems, but one problem that any good economist should have seen was the rampant speculation on currency.
Although most economists are quick to point out that currency speculation was not one of the root problems in Bretton Woods, it was a problem nonetheless. As Bretton Woods lurched towards it death in the late 1960s and early 1970s a number of speculative “attacks” took place on the dominant currencies of the time. Member nations sought to assuage the effects of the speculation attacks by creating a combination of piecemeal international agreements and capital controls. Debtor nations used capital controls to protect their domestic expansion policies from capital flight, while creditor countries sought buttress their economies from the inflationary effects of excess capital. Speculation on currency also resulted in capital mobility, which then created fiat money. As none of these solutions worked, the late 1960s saw even more events take place that marked the end of the Bretton Woods regime.
The Gold Pool, which was the accumulated sum of all member nations’ gold supply, was eliminated in 1968. The elimination of the Gold Pool meant that none of the world’s currencies were backed by gold, but more importantly it adversely affected the Bretton Woods regime. The Gold Pool gave reserve constraint to the Bretton Woods member nations and a sense of monetary discipline to the overall system. Reserves could be tapped only as long as there was gold to back any loans, but once gold was eliminated from Bretton Woods it was replaced by the printing press. Member nations began to print more fiat money and it was no coincidence that the world then entered into a major inflationary cycle during the 1970s. As the world entered the 1970s the Bretton Woods regime was a shell of its former self, but American president Richard Nixon would perform the coup de grâce that ended the system for good.
When Nixon became president in 1968 he inherited a host of social, political, and economic problems from his predecessor, which he intended to rectify with vigorous measures. Although the Gold Pool was eliminated in 1968, the dollar was still technically convertible to gold, which Nixon ended in August 1971. Later that same year, Bretton Woods members attempted to reorganize the regime as they devised the “Smithsonian Agreement,” which adjusted the exchange rate to a plus or minus 2.25% to the dollar and officially abolished convertibility to gold. Despite these efforts the Bretton Woods regime officially ended in 1973.