Bretton Woods System and Post Bretton Woods System
[Entry in The Encyclopedia of Political Economy, edited by Philip O'Hara, London: Routledge (forthcoming).]
In July 1944, in Bretton Woods, New Hampshire, representatives of 44 nations met to establish the standards by which international trade and finance would be conducted once the Second World War had ended. This included not only specification of the exchange rate and payments system that would prevail, but also of provisions for helping the "third world" nations develop in the post-colonial era. In its final form the plan was something less than its primary architects, Harry Dexter White and John Maynard Keynes, had hoped. Nonetheless, the stability it lent to the post-war period helped create an environment conducive to recovery. But the tranquility was not to last, however. In the end, it appears that the exchange rate and payments mechanism contained the seeds of its own destruction, allowing, even encouraging, developments to take place that led to its demise. Meanwhile, many argue that the efforts to develop emerging economies has done more harm that good [Danaher 1994]. From those events, especially the massive INTERNATIONALISATION OF CAPITAL, evolved the modern international monetary system.
Independently, White, in the United States, and Keynes, in Great Britain, had been developing ambitious plans for the post- war international economy since the early 1940's [Shelton 1994, pp.24-28]. Both had conceived of a system wherein EXCHANGE RATE stability was a prime goal, and they shared an intense desire to engineer an arrangement that promoted cooperation and humanitarian goals. Neither of them favored a return to a classical gold standard. The most significant difference between their approaches was that White's scheme tended to favor incentives designed to create price stability within the world's economies, while Keynes' wanted a system that encouraged economic growth. In the end, though true compromise was achieved on some points, the overwhelming economic and military power of the United States led to the adoption of a largely American plan.
The international monetary system that emerged was a gold- exchange standard. The U.S. dollar was fixed to gold and convertible on demand (at $35 per ounce). All other currencies were fixed to the dollar (and therefore to gold) and were allowed to fluctuate around that value only within a narrow band. Central banks were expected to intervene in the event that their home currency moved or threatened to move outside that band. If a currency's value appeared to have permanently shifted well beyond the par rate, that country had the right under the articles of agreement to declare that a fundamental disequilibrium existed. The rules of the system were then supposed to allow that country some recourse (either revaluation or devaluation of their money). In addition to these exchange- rate specific regulations, Bretton Woods also established a fund from which countries could draw when facing temporary payments difficulties. At the same time, the World Bank was established to help integrate the less-developed economies into the world capitalist economy. This was to be achieved through a combination of advice, direct loans, and guarantees of third-party loans.
The spectacular growth of the former combatants after the war is well known. Bretton Woods was certainly not the only reason for this "miracle," especially in light of the fact that not all of its provisions (in particular, the convertibility obligations) were in full force until 1958 and that the impact of U.S. policy, especially the Marshall Plan, was undoubtedly greater than that of the World Bank. Nonetheless, their stabilizing presence in this particularly unpredictable period must have encouraged international trade and investment. But by the late 1960's flaws in the exchange rate and payments system were becoming evident.
To begin, the par rates set after the war assumed an overwhelmingly dominant U.S. economy. At first, this proved an accurate assumption, as the U.S. ran large balance-of-payments surpluses until 1950. But as the European economies recovered, the U.S. payments balance slipped into deficit. This was relatively small until 1958, when it began to increase sharply. Given the worldwide shortage of dollars, this was a not unwelcome development. However, as it continued well into the 1960's, and especially when the U.S. current account went into deficit in 1968, it was soon clear that a devaluation of the dollar was necessary.
Unfortunately, a mechanism for dealing with chronic payments imbalances and adjustments of the peg was never really finalized. As suggested above, Keynes had preferred arrangements that encouraged world growth. Consequently, his recommendations for reducing imbalances were aimed every bit as much (perhaps more so) at surplus countries as at deficit ones. He believed that the accumulation of surplus affected the world economy in the same way that savings reduced demand in a domestic one. But the U.S., as a likely creditor nation, balked at Keynes' plan. While White was sensitive to the problem that placing too much of the burden on the deficit country would be deflationary, it was widely believed by the U.S. contingent that the post-war economy was likely to be very inflationary [Bernstein 1989, p.30 and Walter 1991, pp.155-156]. The inability to arrive at a satisfactory compromise left them with no systematic means of addressing the issue [Walter 1991, pp.154-156].
Thus, when "fundamental disequilibria" did occur, there was no automatic provision for dealing with them. And even though deficit countries were allowed considerable latitude to simply declare devaluations, in practice the political implications of this kept it to a minimum (at least among the developed countries). Meanwhile, surplus countries were content to accumulate reserves. To complicate matters, the U.S. was very reluctant to devalue given the status of the dollar as the international currency. Though an attempt was made to save Bretton Woods in 1971 (the Smithsonian Agreement), by 1973 the inability to agree on par rates led to its collapse. The reasons for its disintegration went beyond the inability to efficiently address payments imbalances. The massive internationalisation of capital that had been taking place since the late 1950's and early 1960's had placed tremendous pressure on the fixed-rate system. Keynes had already warned that capital controls would be necessary if central banks were to have the power to defend the parities set under Bretton Woods [Krause 1991, pp.62-65]. He recommended, "Not merely as a feature of the transition, but as a permanent arrangement...the right to control all capital movements" [Bryant 1987, pp.61-62]. As part of this policy, he submitted that all currency be converted through central banks.
Though market convertibility was substituted for official, Keynes' sentiment is reflected in the articles of agreement. Under Bretton Woods, pure capital flows could be, and were, controlled [Fraser 1987, pp.19-28]. In practice, each country put in place regulations intended to "balkanize" the various national capital markets [Krause 1991, p.64]. But as U.S. payments deficits caused dollars to accumulate in Europe, a combination of investors' desire to avoid the balkanizing controls along with other considerations (like U.S. limits on deposit interest and the growth of multinational industry and finance) led to the rise of the Eurodollar market. From 1964 (the first year for which figures are available) to 1973, the Eurodollar market grew from the equivalent of $20 billion to $305 billion [Sarver 1988, 6-7]. The changing importance of the U.S. economy relative to Europe was already making the old par rates obsolete. The growing size of capital flows was now making actual and potential movements in exchange rates much larger, unpredictable, and uncontrollable. With such capital available for SPECULATION, apparent exchange rate problems could quickly become crises. By 1973, speculators had challenged and defeated every central bank, including the Federal Reserve [Moffitt 1983, 71-92]. The internationalisation of capital had the potential to both cause and exacerbate fundamental disequilibria and with no practical means of resolving these problems, Bretton Woods failed.
The failure of the World Bank to answer the challenge of world poverty, while less spectacular than the collapse of the Bretton Woods, has been far more tragic. The political ideology and economic approach of that institution has been so far removed from the realities of those struggling with underdevelopment that Bank plans typically focus more on controlling inflation and introducing austerity plans than they do addressing hunger and powerlessness [Danaher 1994]. The additional burden placed on so many in the third world by the debts created during the OPEC oil embargoes makes their future even more bleak. It does not appear that there is much about which to be encouraged regarding the policies that we may expect to see emerging from the World Bank in the near future.
Regarding international payments and exchange rates, immediately following the collapse of Bretton Woods the stage was set for the continued growth and domination of the international capital market. Today the overwhelming majority of currency transactions are related to capital. As a consequence, policymakers are forced to consider the reaction of international financial markets to each and every policy move, lest they by "punished" by capital outflows and currency depreciation or "rewarded" with inflows and appreciation. This has meant that not only has the volume of capital led to excessive exchange rate volatility and chronic misalignment [Harvey 1995], but it has also created a deflationary bias in the system through the necessity of pleasing international investors with high interest rates and conservative economic policies [Davidson 1992-93 and Grabel 1993].
No true system has evolved to take the place of Bretton Woods. Instead, most developed-country currencies float against one another (with one major exception, as explained below) while those of developing nations are pegged, most often to the dollar. For the developed countries, who continue to dominate trade and finance, the post Bretton Woods era has been a managed float within which currency prices are set primarily by market forces but central bank intervention still exists. What triggers intervention depends on the economic and political objectives of the nation in question. One would think that this might create the potential for a great deal of conflict, but generally speaking there have been more problems associated with market- initiated movements of the exchange rates, especially those associated with capital flows and speculation. In fact, beginning with the Plaza Agreement in 1985, the central banks of France, Germany, Japan, Great Britain, and the United States have worked within broad guidelines to cooperate in introducing some stability into foreign exchange markets. These measures have been far short of the kind that one would expect in a fixed-rate regime, but they are nonetheless indicative of the sort of disruption of which policymakers believe international capital flows are capable.
The major exception to market-determined rates among the developed countries has been the European Monetary System. It has operated as a mini-pegged system anchored to the Deutsche Mark since 1979, and appeared to be moving toward a single- currency area until developments in 1992. Just as in Bretton Woods, events made it clear that fundamental disequilibria existed and that changes in either macroeconomic policies or pegged rates were necessary. Again similar to events in the early 1970's, agreement over what should be done was not easily had, and soon the massive force of speculation forced policymakers to quickly choose which paths they would follow. By 1993 this had included extensive realignments, periods of floating, and exchange rate bands so wide they are "nearly tantamount to floating" [Henning 1994, p.242]. Whether this can be considered a success only time will tell.
Ironically, the major issues that have plagued international monetary systems and agreements in the fifty years since the end of the Second World War have been precisely those feared by Keynes in the early 1940's. In fixed-rate regimes, efficient means of realigning currencies remain elusive. Either the solutions tend to be deflationary, when they force deficit countries to contract their economies, or politically unpalatable, when they require currency devaluation. Perhaps he was correct when he saw the only viable means as placing the burden of adjustment on the surplus economy (a solution today urged by Paul Davidson [1992-93]). Meanwhile, capital flows have proven to be disruptive in both fixed and flexible rate systems, their "discipline" severely limiting policy choices in both circumstances. Success has been just as elusive regarding the World Bank and its work with less-developed nations' economies. Not surprisingly, the failures in both arenas have their roots in economic theory. Modern policymakers are convinced that market liberalization is the key to economic growth, so that efforts to directly control capital flows or to plan or protect the economies of emerging states are unlikely to be forthcoming.
See also: Exchange Rates; International Finance; Monetary/Customs Unions.
Selected References
Bernstein, Edward M. (1989) "The Search for Exchange Stability: Before and After Bretton Woods." In _The Future of the International Monetary System: Change, Coordination or Instability?_, Omar F. Hamouda, Robin Rowley, and
Bernard M. Wolf, eds., Armonk, New York: M.E. Sharpe, Inc.: pp.27-34.
Bryant, Ralph C. (1987) _International Financial Intermediation_.Washington, D.C.: The Brookings Institution.
Danaher, Kevin. _50 Years is Enough: The Case against the World Bank and the International Monetary Fund_. Boston: South End Press, 1994.
Davidson, Paul. (1992-93) "Reforming the World's Money," _Journal of Post Keynesian Economics_, vol.15, no.2: pp.153-179.
Grabel, Ilene. (1993) "Crossing Borders: A Case for Cooperation in International Financial Markets," in _Creating a New World Economy: Forces of Change and Plans of Action_, edited by Gerald Epstein, Julie Graham, and Jessica Nembhard, Philadelphia, Pennsylvania: Temple University Press: pp.64- 83.
Harvey, John T. (1995) "The International Monetary System and
Exchange Rate Determination: 1945 to the Present." _Journal of Economic Issues_, vol.29, no.2: pp.493-502.
Henning, C. Randall. (1994) _Currencies and Politics in the United States, Germany and Japan_, Washington, D.C.: Institute for International Economics.
Keynes, John Maynard. (1964) _The General Theory of Employment, Interest, and Money_, San Diego: Harcourt Brace Jovanovich, Publishers.
Krause, Laurence A. (1991) _Speculation and the Dollar: The Political Economy of Exchange Rates_, Boulder, Colo.: Westview Press.
Sarver, Eugene. (1988) _The Eurocurrency Market Handbook: The Global Eurodeposit and Related Markets_, New York: New York Institute of Finance (Prentice-Hall).
Shelton, Judy. (1994) _Money Meltdown: Restoring Order to the Global Currency System_, New York: The Free Press (A Division of Macmillan, Inc.).
Walter, Andrew. (1991) _World Power and World Money: The Role of Hegemony and International Monetary Order_. New York: St. Martin's Press.
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