Updated: Jan 16
Bretton Woods is a hotel in New Hampshire and it’s famously known for the political and economic activity that made history after two weeks of meetings with more than 40 different country representatives to determine the new economic system that the world would abide by after the interwar period. An international monetary system can be defined as the institutional framework within which international payments are made, movements of capital are accommodated, and exchange rates among currencies are determined. Having a monetary system that works is really important particularly when the main focus of countries is to expand their economic development. Trade allows countries to focus on producing whatever gives them a competitive advantage and still have a steady supply of raw materials to produce those goods they are best at. This paper will mainly answer the question of why was the Bretton Woods system created and why did it not work and collapsed in 1971. It will briefly examine the previous monetary systems and understand the important interwar period that led to the creation of Bretton Woods that ultimately was the transition from a commodity standard payment system to fiat money.
Brief history of the other monetary systems
Throughout history there have been a myriad of goods that perform monetary functions (cattle, salt, shells etc.) All of these goods used for transactions eventually transitioned into metal. This shift was conditioned with the advancement of technology, in particularly metallurgy. After this new discovery, civilizations started minting coins. Another major advancement in technology was the development of paper money in China after the discovery of paper, ink and printing.
Previous international monetary systems that the world used include bimetallism prior to 1875 and the classical gold standard from 1875-1914 where most countries fixed the value of their currencies in terms of a specific amount of gold. In this system, each bank note represented an amount of gold that the bank would be obligated to give if a client requested it. Countries could not print more money without increasing their supply of gold. This allowed the purchasing power to be very stable. Compared to today’s monetary system, where fiat money is not pegged to the gold, anyone that changes a bill at the bank can only get more bills but no gold. Not having currencies pegged to a commodity or in this case gold, allows for mild to high levels of inflation to form like the case of hyperinflation in Germany after World War 1.
The gold standard was never created or designed by economists, it emerged in Britain in the early 19th century by trial and error over centuries. Government didn’t agree to the gold standard until much later only when it had been proved that the system could help local and global commerce. It’s interesting to point out that the gold standard functioned largely because Britain was the dominant commercial and financial power during the period of 1815 and 1914, they were the hegemon (most powerful actor) some recognize that era as Pax Britannica. London managed the gold standard, defined the informal rules and obligations, and controlled access to the most important capital markets. As this paper will go in detail, Washington became the London during the international Bretton Woods monetary system.
One of the fundamental reasons why the US and most countries stepped away from the gold standard is that it constrained the governments since the obligation to redeem gold for money limited the amount of money printing available. More gold needed to be collected before printing money.
The interwar period followed the gold standard and preceded the Bretton Woods system. This period experienced both World Wars and the Great Depression, major history episodes that had never had such a drastic impact among countries. The interwar period was a moment where there was no clear international monetary system, some countries sticked to the gold standard while others left it and then came back to it to to later find that it would not work given the amount of inflation their currency had gone through like the case of England.
The Treaty of Versailles signed by many of the nations involved in the first World War contained an article that required Germany to disarm their country and pay an enormous sum of money in reparations. This led to a series of problems including Germany defaulting on its debt with France in the early 1920s and France invading the Ruhr region an important economic area for Germany. Since there was higher unemployment, factories falling and less tax money, the German government decided to print more money leading to a hyperinflation.
Another important episode that had an impact in the world as a whole was the Great Depression in 1929. Some of the reasons that caused this episode were the stock market crash after the great years it had gone up, bank runs, lack of confidence and the lack of money supply due to the gold standard system. There were terrible repercussions for the US since half banks failed and international trade fell by 60%. The world was to be impacted by the catastrophic collapse of the American economy particularly because the investments of the US would stop arriving into Europe. Germany for example was rebuilding their economy with a lot of loans that came from the US, after they stopped receiving the money, unemployment soared, impacting a lot of people.
In September of 1931, the Britain that had pioneered the gold standard would abandon it, due to the hard economic crisis the world including themselves where going through. Inflationary and deflation implications where very common throughout those times. After Britain left the gold standard, 25 other nations followed. The United States did not decide to leave the gold standard until Roosevelt took office in 1933. Other countries had decided to leave the gold standard even before to be able to print more money and finance their war efforts (World War 1).
In 1934 Roosevelt instituted the US Gold Reserve Act that required all gold and gold certificates held by the Federal Reserve or citizens to be surrendered and vested in the sole title of the United States Department of treasury, this made anyone in possession of gold a criminal activity. The government purchase each ounce of gold at a price of $20.67 and not long after that devalued the coin to $35 per ounce of gold. This gold reserve act, allowed the US government to hold more than ⅔ of the gold, increase their money supply and solidify their vast economic power as a nation. The dollar would served as the reserve currency and all non-reserve nations that were members of the “gold-exchange standard” agreed to fix their exchange rates to the reserve at a specific rate. Only members would be able to buy gold through central bank transactions, similar to what would become the international Bretton Woods system.
Why was the Bretton Woods created?
The Bretton Woods system was mainly led by Harry Dexter White, US secretary of Treasury, alongside with Sir. John Maynard Keynes representing Britain as an economist and adviser rather than a political figure. Hans Morgenthau was the Federal Reserve Chairman at the time and Franklin D. Roosevelt was the president of the United States.
It’s important to point out and understand the global setting in which the Bretton Woods system was created. It was during World War 2 while Hitler and the axis countries attacked the allies that Britain requested urgent help from the United States since their financial reserves had been mostly consumed by the war efforts and they were in need of weapons and resources to fight the war. Hard negotiations between US and Britain happened and the Lend-Lease bill was signed that made Britain financially liable for everything that they receive from the US. As this war was being fought in Europe, Morgenthau asked White to prepare a memorandum on the establishment of an “inter-Allied stabilization fund” which would “provide the basis for postwar international monetary agreements, it was clear that many countries would need financial support after a devastating war.
White created the “White plan” in 1942. He was looking past the war, looking at the economic challenges that countries would have if there was no system for trade. White thought that if there was no fast action around resolving the international economic system after the war it would be a catastrophe. “A period of chaotic competition, monetary disorders, depressions, political disruption, and finally… new wars within as well as among nations … the absence of a high degree of economic collaboration among the leading nations will, during the coming decade, inevitably result in economic warfare”.
White’s plan involved no mechanism to make sure that the United States would not run out of gold stocks. He actually envisioned to print more and more dollars without having to increase the gold reserves. This limited vision missed realizing that at some point countries that held dollars would get scared and exchange their dollars for gold. White’s plan also consisted of a fund (IMF) that strictly regulated the international marketplace for currencies, in other words exchange rates to the dollar would have a fixed price. White argued that this fund would bring more control and allow governments to manage their rates more freely compared to the pre-1914 gold standard.
At the same time, John Maynard Keynes drafted his own system known as “Keynes Plan”. Keynes ideas were different than Whites. The English economist wanted to create a system where there was one central banc that didn’t belong to anyone and held the gold called Bancor. This bank would regulate transactions and have a fixed exchange rate with all member currencies and gold. However, currencies would not be allowed to be redeemed for gold. Exports from every member would be captured and compared to the imports to get a balance sheet. There plan included limits to what a country could accumulate in trade surplus, members would have to import more with their earnings or pay a penalty. On a regular basis currencies would devalue or appreciate depending on their net exports, the deficit countries would have their currencies devalued so they could be more competitive in the market and surplus countries would have their currencies appreciate so other countries could have a chance to expand economically.
But of course White would not accept Keynes ideas since the US was the leading country and they were a surplus economy hence it was not convenient for them in any way. Since the meeting would be held in the US where all the gold reserves where held, Keynes would not be able to use his well thought out system. As a result, the new monetary system would mostly be based on US interests.
Interestingly, in 1933, there had been another meeting held in London called the London Economic Conference, this had been organized by the League of Nations the first intergovernmental organization created after the first World War to maintain world peace. In the London Economic Conference, the main intent was to get rid of the obstacles of trade with the use of tariffs, import quotas, and exchange controls. Unfortunately, this conference did not have any results since Roosevelt sent a message known as the “bombshell” where he said that he was dismayed by the direction the discussions had taken. He would argue that there was too much emphasis on short run exchange rates stabilization and not enough on commodity prices and recovery. He declared that the main aim of the conference should have been to generate mechanisms for “controlled inflation”. Although nothing happened in the London Economic conference, it’s clear that a new conversation towards a world where countries engage in trade with one another instead of holding individualist and nationalist approaches was the new mission.
The Bretton Woods conference itself was not only a test of support for monetary cooperation but it also represented a test if the Soviets and British would willingly collaborate with the United States in postwar enterprises. It was clear by US officials (White and Morgenthau) that if either one of those two countries decided to not cooperate, the Bretton Woods conference would have to be postponed since both countries represented big power and influence in the global scheme. Although Britain had the lower hand in the negotiations, they still had the power of choosing if they were willing to cooperate and attend the meeting.
The intention behind White’s plan were, a new monetary policy that would “promote trade and finance” as a key criteria, but it also allowed “sovereignty in shaping domestic policies.” His proposed monetary policy had to take the best from the gold standard and national monetary standards but avoid the biggest disadvantages of each. A so called “managed currency standard.” It’s clear that this new system would elevate the US dollar and it’s power around the world a move that was very convenient for the US at the time.
Keynes had a few important points that where necessary to clarify for Britain’s participation in this new monetary system. One of them was “the articles of agreement must indicate that each fund member retained “ultimate freedom” over its exchange rate. A second point was that there could be no hint that a nation’s domestic economic policies could be dictated from an outside group, for example bankers.
It’s very clear that most delegations in the Bretton Woods meetings where looking to promote trade and sovereignty on the exchange rates. The main interest was to end the long period of nationalism and to stop relying on ineffective government to government negotiations on exchange rates. For proper function of the international monetary system, there had to be an outside institution (fund). The International Monetary Fund would serve as a mediator and impartial judge overseeing agreements with its members regarding the international monetary system, exchange rates and international payments that enable countries (and their citizens) to transact with each other.
The actual structure for the conference included four committees and each one was composed with members of different countries and only 1 voting member from each country could participate in the final decision.
Committee A: Dealt with the purposes and policies and quotas of the funds
Committee B: With the operations of the fund
Committee C: With the organization and management
Committee D: With the foreign status of the fund
It was decided that both institutions headquarters (IMF and World Bank) would be in Washington DC and that the president would be whoever was the highest contributor to the fund. In this case the United States.
In addition to creating the IMF and the International Bank for Reconstruction and Development (IBRF) intended to help Europe rebuild after World War 2, the dollar was pegged to the gold at $35 per gold ounce and the other currencies were pegged to the dollar at a specific exchange rate.
Why did it not work?
The Bretton Woods system accomplished it’s main goal: trade. More countries around the globe would participate in trade between one another. Exports and capital flows from non communist countries increased vastly. For instance, United States in 1950 sold only 9.1% of production abroad but in 1970, this figure had raised to 12.8%. West Germany went from 17.3% to 37% or Japan had increased their trade from 18.3% to 30.1%. However, as economies grew more interdependent on each other, new problems would arise. Governments required to pay more attention to the repercussions of their policy decisions on change in unemployment, inflation or calibrating their balance sheets (deficits and surplus).
An action taken by one country can impact another negatively, fluctuations in interest rates could cause major depreciation or appreciation on a countries currencies since investment is related to interest rates. There was no criteria created during the Bretton Woods meetings for periodic parity alterations. And a lot of times, since banks would not lend devalued currencies, governments tended to avoid sharing economic errors. Countries like Israel, Yugoslavia, Uruguay all devalued more than 90%
The agreement of redemption of $35 dollars per ounce of gold gave confidence to the world about the monetary system. In 1953 possession of US dollars by foreign governments was equivalent to 57% of gold reserves, however, by 1958 the ratio was 86% and eventually, the dollar reserves in the world were higher than what the US gold holdings could back up. If all the countries decided to exchange their dollars for gold, the US would not be able to keep their promise, this meant that countries had to trust on the strength of the dollar from now on. By 1971, the US gold holdings had dropped from $17.8 billion to $10.7 billion, this clearly impacted the confidence in the dollar-exchange standard and decreased the US international position as a power nation.
The years while the dollar was used and there was the so called Pax Americana, there was a massive shift in powers. Prior to this systems creation, the United States accounted for 39.3 percent of world GDP while Britain contributed another 5 percent. During the years of 1960’s other countries starting with the recovery of Europe started to expand economically and there was a relative decline of the United States and Britain.
For example, Japan’s real gross national product increased by 187 percent, 59 percent in Germany, 48 percent in the United States and only 30 percent in Britain. In addition, the value of world trade had a radical increase from $130 billion to $310 billion in
1970, this meant that less influential or powerful countries had been growing while the US and Britain had not.
The US constant budget deficits were not sustainable, more dollars out in the world and more countries requesting to trade their dollars for gold was a major reason why this financial system didn’t work.
On Sunday August 15th, 1971 president Nixon made a national announcement, it was a bold action to create more and better jobs for americans, stop the rise of cost of living and protect the attack on the dollar from international speculators. This New Economic Policy included a wage price freeze, suspension of the dollar convertible into gold and other reserve assets and a tariff of 10% on certain products until the “unfair treatment from other nations ended”. This was the end of the Bretton Woods system.
Although this system didn’t work, it’s clear that Bretton Woods can be viewed as the final stage in the transition from commodity money to fiat money, setting the monetary system on a new foundation.
As mentioned earlier, the reason why the gold standard was successful is because the hegemony Britain held. In the case of the Bretton Woods system, the United States held a similar position as Britain back in the day. Washington was bringing stability in the world economy but when the power of that country falls, the international monetary system must fall since they go hand by hand. What’s clear is that, as other European and Asian nations became economically powerful, the less political and economical influence the US had.
This paper points out how a nation with gold (money) is a nation with power, it can set the rules and control others. White said “International agreement is not a substitute for gold” as it’s shown in history, the moment the United States gold stocks decreased to a significant extent, the collapse of the international monetary system came behind it.
History shows how every state looks out for themselves, Keynes and White both had a plan for how to design the monetary system based on their countries circumstances at that time and what would have been more convenient for each. The winner in this case of course was the US system. What would have happened If the United States had not been so greedy and wanted to take so much control on the financial system? What would have happened if Keyne’s plan was to be used?
Economics, politics and peace are all tied together, without a solid and stable international economic system it is hard if not impossible to maintain peace.
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