The roughly three decades that coincided with the monetary arrangements of the Bretton Woods system is often thought of as a time of relative stability, order, and discipline. Yet considering that it took nearly 15 years following the 1944 conference at Bretton Woods before the system was fully operational and that there were signs of instability throughout the era, perhaps not enough has been made of the relative difficulty in trying to maintain the system. Rather than seeing Bretton Woods as a period characterized by stability, it's more accurate to consider it as being a transitional stage that ushered in a new international monetary order that we're still living with today.
Divergent Interests at Bretton Woods
In July 1944, delegates from 44 Allied nations gathered at a mountain resort in Bretton Woods, NH, to discuss a new international monetary order. The hope was to create a system to facilitate international trade while protecting the autonomous policy goals of individual nations. It was meant to be a superior alternative to the interwar monetary order that arguably led to both the Great Depression and World War II.
Discussions were largely dominated by the interests of the two great economic superpowers of the time, the United States and Britain. But these two countries were far from united in their interests, with Britain emerging from the war as a major debtor nation and the U.S. poised to take on the role of the world’s great creditor. Wanting to open the world market to its exports, the U.S. position, represented by Harry Dexter White, prioritized the facilitation of freer trade through the stability of fixed exchange rates. Britain, represented by John Maynard Keynes and wanting the freedom to pursue autonomous policy goals, pushed for greater exchange rate flexibility in order to ameliorate balance of payments issues.
Rules of the New System
A compromise of fixed-but-adjustable rates was finally settled upon. Member nations would peg their currencies to the U.S. dollar, and to ensure the rest of the world that its currency was dependable, the U.S. would peg the dollar to gold, at a price of $35 an ounce. Member nations would buy or sell dollars in order to keep within a 1% band of the fixed-rate and could adjust this rate only in the case of a “fundamental disequilibrium” in the balance of payments.
In order to ensure compliance with the new rules, two international institutions were created: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD; later known as the World Bank). The new rules were officially outlined in the IMF Articles of Agreement. Further provisions of the Articles stipulated that current account restrictions would be lifted while capital controls were allowed, in order to avoid destabilizing capital flows.
What the Articles failed to provide, however, were effective sanctions on chronic balance-of-payments surplus countries, a concise definition of “fundamental disequilibrium,” and a new international currency (a Keynes proposal) to augment the supply of gold as an extra source of liquidity. Further, there was no definitive timeline for implementing the new rules, so it would be close to 15 years before the Bretton Woods system was actually in full operation. By this time, the system was already showing signs of instability.
The Early Years of Bretton Woods
While the U.S. pushed for immediate implementation of Articles provisions, poor economic conditions in much of the post-war world made remedying balance-of-payments issues in a fixed exchange rate regime difficult without some current account exchange controls and external sources of funding. With no international currency created to provide supplemental liquidity, and given the limited loan capacities of the IMF and IBRD, it soon became evident that the U.S. would have to provide this external source of funding to the rest of the world while allowing for gradual implementation of current account convertibility.
From 1946 to 1949, the U.S. was running an average annual balance-of-payments surplus of $2 billion. In contrast, by 1947, European nations were suffering from chronic balance-of-payments deficits, resulting in the rapid depletion of their dollar and gold reserves. Rather than considering this situation advantageous, the U.S. government realized it seriously threatened Europe’s ability to be a continuing and vital market for American exports.
Within this context, the U.S. administered $13 billion of financing to Europe through the Marshall Plan in 1948, and some two dozen countries, following Britain’s lead, were permitted to devalue their currencies against the dollar in 1949. These moves helped alleviate the shortage of dollars and restored competitive balance by reducing the U.S. trade surplus.
The Marshall Plan and more competitively-aligned exchange rates relieved much of the pressure on European nations trying to revive their war-torn economies, allowing them to experience rapid growth and restore their competitiveness vis-à-vis the U.S. Exchange controls were gradually lifted, with full current account convertibility finally achieved at the end of 1958. However, during this time the U.S. expansionary monetary policy that increased the supply of dollars, along with increased competitiveness from other member nations, soon reversed the balance of payments situation. The U.S. was running balance-of-payments deficits in the 1950s and had a current account deficit in 1959.
Increasing Instability in the High Bretton Woods Era
The depletion of U.S. gold reserves accompanying these deficits, while remaining modest due to other nations' desire to hold some of their reserves in dollar-denominated assets rather than gold, increasingly threatened the stability of the system. With the U.S. surplus in its current account disappearing in 1959 and the Federal Reserve’s foreign liabilities first exceeding its monetary gold reserves in 1960, this bred fears of a potential run on the nation’s gold supply.
With dollar claims on gold exceeding the actual supply of gold, there were concerns that the official gold parity rate of $35 an ounce now overvalued the dollar. The U.S. feared that the situation could create an arbitrage opportunity whereby member nations would cash in their dollar assets for gold at the official parity rate and then sell gold on the London market at a higher rate, consequently depleting U.S. gold reserves and threatening one of the hallmarks of the Bretton Woods system.
But while member nations had individual incentives to take advantage of such an arbitrage opportunity, they also had a collective interest in preserving the system. What they feared, however, was the U.S. devaluing the dollar, thus making their dollar assets less valuable. To allay these concerns, presidential candidate John F. Kennedy was compelled to issue a statement late in 1960 that if elected he would not attempt to devalue the dollar.
In the absence of devaluation, the U.S. needed a concerted effort by other nations to revalue their own currencies. Despite appeals for a coordinated revaluation to restore balance to the system, member nations were reluctant to revalue, not wanting to lose their own competitive edge. Instead, other measures were implemented, including an expansion of the IMF’s lending capacity in 1961 and the formation of the Gold Pool by a number of European nations.
The Gold Pool brought together the gold reserves of several European nations in order to keep the market price of gold from significantly rising above the official ratio. Between 1962 and 1965, new supplies from South Africa and the Soviet Union were enough to offset the rising demand for gold, any optimism soon deteriorated once demand began outpacing supply from 1966 through 1968. Following France’s decision to leave the Pool in 1967, the Pool collapsed the following year when the market price of gold in London shot up, pulling away from the official price.
The Collapse of the Bretton Woods System
Another attempt to rescue the system came with the introduction of an international currency—the likes of what Keynes had proposed in the 1940s. It would be issued by the IMF and would take the dollar’s place as the international reserve currency. But as serious discussions of this new currency—given the name of Special Drawing Rights (SDR)—only began in 1964, and with the first issuance not occurring until 1970, the remedy proved to be too little, too late.
By the time of the first issuance of the SDRs, total U.S. foreign liabilities were four times the amount of U.S. monetary gold reserves, and despite a brief surplus in the merchandise trade balance in 1968-1969, the return to deficit thereafter was enough pressure to initiate a run on the U.S. gold reserves. With France leaking its intentions to cash in its dollar` assets for gold and Britain requesting to exchange $750 million for gold in the summer of 1971, President Richard Nixon closed the gold window.
In a final attempt to keep the system alive, negotiations took place in the latter half of 1971 that led to the Smithsonian Agreement, by which the United States agreed to devalue the dollar against gold by approximately 8.5% to $38 per ounce and other countries offered to revalue their currencies relative to the dollar. But despite these revaluations, another run on the dollar occurred in 1973, creating inflationary flows of capital from the U.S. to the Group of Ten. Pegs were suspended, allowing currencies to float and bringing the Bretton Woods system of fixed-but-adjustable rates to a definitive end.
The Bottom Line
Far from being a period of international cooperation and global order, the years of the Bretton Woods agreement revealed the inherent difficulties of trying to create and maintain an international order that pursued both free and unfettered trade while also allowing nations to pursue autonomous policy goals. The discipline of a gold standard and fixed exchange rates proved to be too much for rapidly-growing economies at varying levels of competitiveness. With the demonetization of gold and the move to floating currencies, the Bretton Woods era should be regarded as a transitional stage from a more disciplinary international monetary order to one with significantly more flexibility.