The Bretton Woods System

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Podcast Transcript

Barely a month after the Normandy Landing in 1944, the allied powers were already thinking of what the post-war world would look like.

One of the big issue was the creation of a monetary system which could replace the then abandoned gold standard. 

So, in at a resort in New Hampshire, representatives from 44 countries hammered out a new international monetary system which would govern the world for the next 25 years.

Learn more about the Bretton Woods System, and how parts of it still influence the world today, on this episode of Everything Everywhere Daily.

You’ve probably heard the expression that history repeats itself. 

Well, many of the powers that be, to their credit, actively tried to make sure that the end of the second world war wasn’t a repeat of the first world war. 

The extreme sanctions which were placed upon Germany were largely responsible subsequent hyperinflation in the Weimar Republic, and the rise of the Nazi Party.

Moreover, during the Great Depression, many countries began a currency war where they devalued their currencies to gain an economic advantage. 

You might wonder why a country would purposely devalue their currency?

By devauling your currency, you make imported items more expensive, and exported items cheaper. During the depression, many countries used this strategy to try to boost employment. 

However, when everyone does it, it can reduce total global trade which just hurts all parties.

If you remember back to my episode on the gold standard, it wasn’t a planned system. Its creation was sort of an accident, and it grew organically.

Many economists complained that the gold standard was too inflexible, which didn’t give governments enough latitude to solve the problems during the depression. 

So, the idea was that after the conclusion of the war, things would be different. 

The idea for a new, organized global financial system was hatched by the British economist John Maynard Keynes and American Harry Dexter White, the Assistant US Secretary of the Treasury.

Keynes’s initial idea was something called the International Clearing Union. This would be an international bank that would work as a cleaning house between countries. He also proposed that there would be a currency that would be used between countries that he called the “bancor”.

A series of negotiations between British, American, and other allied countries in April resulted in the “Joint Statement by Experts on the Establishment of an International Monetary Fund”.

With that, invitations were sent to representatives from 44 countries to meet from July 1 to 22, 1944, at the Mount Washington Hotel in Breton Woods, New Hampshire. The event was formally known as the United Nations Monetary and Financial Conference.

Note: the term “United Nations” was used generically during World War II to refer to all the allied countries and wasn’t referring to the international organization which later bore the name. 

The simple fact looming over everything at the conference was the United States was running the show and was going to be the center of the new international monetary system. 

This was just the reality of things in 1944. The United States was home to half of the world’s industrial capability at this time. Moreover, the United States alone guaranteed that the world couldn’t go back to the gold standard because over 75% of the world’s gold reserves were now in the United States. 

There just wasn’t enough gold for the rest of the world.

The 730 delegates in attendance broke into three groups.

The first was led by Harry Dexter White and was tasked with the creation of an International Monetary Fund, which had as its purpose the stability of exchange rates. 

John Maynard Keynes led the second group, and it dealt with the creation of an International Bank for Reconstruction and Development. 

The final group was led by Eduardo Suárez, the Mexican Minister of Finance, and it covered everything not included in the other two groups. 

In the end, several major agreements were signed that outlined the new international monetary order. 

The system envisioned by Keynes didn’t pan out.  

Instead of an international currency used between countries, the decision was made to use the US Dollar as the international reserve currency. 

All of the countries which took part would peg their currency to the US Dollar and hold dollars in reserve.

The US Dollar would then be backed by gold at a set price of $35 an ounce. 

This was by far the biggest thing to come out of Bretton Woods. 

The ban on private ownership of gold bullion which FDR established, was still in effect in the United States, so this gold convertibility was only good for other countries. 

This system allowed for more flexibility than the gold standard did. After joining the system, a country could adjust its exchange rate by as much as 10% on a one-time basis without penalty and then by 1% every year thereafter. 

Countries would maintain their currency peg by buying and selling US dollars. 

If their currency was overvalued, they would buy US dollars, thus putting more of their currency out into the economy. If their currency was undervalued, they could sell US dollars, thus taking their currency out of circulation and driving up the price. 

This system was overseen by one of the two major institutions to come out of the Bretton Woods Agreement: the International Monetary Fund or the IMF.

The IMF sort of served as the bank for the world’s central bank, but without the power of a central bank itself. They were the institution that monitored global exchange rates and helped countries bring their currencies back to the peg. 

The other institution which came out of the conference was the International Bank for Reconstruction and Development, which is better known today as the World Bank. 

The World Bank served as a lending organization for developing countries, but its first loan recipients were actually European countries that were rebuilding after the war. 

Today the World Bank is actually the World Bank Group which consists of five different organizations, four of which were founded after Bretton Woods. The International Development Association, the International Finance Corporation, the Multilateral Investment Guarantee Agency, and the International Centre for Settlement of Investment Disputes.

Both the IMF and all of the World Bank organizations are headquartered in Washington DC, which reflects the influence that the United States had on the Bretton Woods System. 

Underlying all of the Bretton Woods agreements was the desire to facilitate free and open trade around the world and to end economic nationalism, which had plagued the first half of the 20th century and led to disastrous trade wars.

Another underlying assumption that was understood but not part of any of the formal agreements was that the United States would guarantee the peaceful movement of ships and cargo on the high seas with its navy.

One thing which was lacking in the Bretton Woods Accord was the creation of an International Trade Organization. 

From November 1947 to March 1948, negotiators hammered out the terms for an International Trade Organization in Cuba. The final document, known as the Havana Charter, never amounted to anything because the US Congress refused to ratify the treaty. 

The currency system which the IMF managed didn’t come into full effect until 1958, but it had been in limited effect before that. 

The system managed to work reasonably well. Through the 1950s and 1960s, more countries were added to the system as they became independent after decolonization. 

The Soviet Union actually took part in the Bretton Woods Conference and signed the final document but didn’t end up actually participating because…..communism. 

The flaw in the Bretton Woods system was, not surprisingly, the United States. 

Every other country had to keep US dollars in reserve, which was relatively easy enough. The US, however had to keep gold in reserve. 

While they had the majority of the world’s bullion reserves when the Bretton Woods system started, their reserves eventually started to decline. 

If you remember back to my episode on the Gold Standard, I mentioned that the successor system to the gold standard wasn’t a gold standard, but in part, it was. That part was the United States gold reserves.

In the late 60s, the US had a hard time keeping up its end of the bargain. The main problem was increased spending due to the Vietnam War and Great Society social programs. Another problem was that the United States didn’t have the same economic advantage it held in 1944. 

Japan and countries in Europe had been able to rebuild from the war and had become much wealthier, and they were amassing dollars in their reserves.

There were more US dollars floating around than could be backed up by American gold reserves. This resulted in a run on gold by countries that wanted to convert their dollars into gold bullion that was being held in Fort Knox, Kentucky.

This resulted in President Richard Nixon closing the gold window by ending the convertibility of gold on August 15, 1971.

This marked the end of the Bretton Woods System. 

After this point, foreign currencies would float freely in international exchanges. 

Also, the US Dollar, and many other currencies, broke their last tenuous link to gold and became full fiat currencies. 

A fiat currency is just a currency that isn’t backed by anything. Previously, this was something that had only been done during times of war to pay for military expenditures. 

Now, it is the permanent state of affairs for most of the world. 

As for Bretton Woods, there are still legacies of it that exist today. The IMF and the World Bank are still around, albeit with a slightly different mission for the IMF.

In the end, putting all of the weight for the world monetary system on the shoulders of the United States wasn’t feasible in the long run. The entire Bretton Woods system only ended up lasting about 25 years. 

There have been calls for a new Bretton Woods type approach to international monetary policy, but as of now, nothing has been done. 

The end of Bretton Woods wasn’t the end of a global monetary system. A new system was soon in place within a few years, but it wasn’t based on decisions made in conferences and ratified in multilateral treaties.

It was an informal arrangement between the United States and a handful of countries, and that system is still in place today. It will be the subject in the next episode in my series on monetary policy: the Petrodollar system.

Everything Everywhere Daily is an Airwave Media Podcast. 

The executive producer is Darcy Adams.

The associate producers are Thor Thomsen and Peter Bennett.

Today’s review comes from listener frankcutronijr over at Podcast Addict. He writes:

Ponzi episode was really good to find out where the phrase Pozi scheme comes from.

Thanks, Frank! There are actually lots of words and phrases that have interesting origins, and I might just to some episodes on them in the future. 

Remember, if you leave a review or send me a boostagram, you too can have it read the show.