A Bit on Bretton Woods, 1951 – 1971

The Bretton Woods System is an interesting creature. It is often stressed that the system looked very different than the way its founders originally intended in 1944. It ushered in a period of rapid economic growth on a scale never seen before or even after. While the system itself should be credited for some portion of the success, the larger context of a post-war boom must be kept in mind too.

The international monetary order as it existed prior to Bretton Woods, from 1914 to 1945, was such a disturbed period in human history that Winston Churchill referred to it as the “Next 30 Years War.” Calling it a kind of monetary “order” is probably an exaggeration. Prior to WWI, the monetary order referred to as the Classical Gold Standard was literally destroyed. Countries not only destroyed each other, but also their own economies and currencies in patriotic fervor.

The Bretton Woods System was a platform on which the unprecedented rise in the standard of living prior to WWI might resume. Who would have guessed that a system of fixed exchange rates and a world of immobile capital might yield such favorable results? (Since the late nineteenth-century, no period was characterized by such high degrees of capital immobility as that of Bretton Woods) Nonetheless, even this system was wrecked by political considerations. This time it was American fiscal exigencies.

The monetary order was, nominally, underpinned by gold. After a round of devaluations of around 30% in the late 1940s, the fixed exchange rate system was born. The Sterling was revalued in terms of the Dollar, from $4 to $2.80 to the pound. This was the opposite of what happened in 1925, when the British refused to devalue the Sterling. One of the effects was that an overvalued Pound reinforced existing structural unemployment by making exports less competitive.

However, the problem lay with the new hegemonic status commanded by the dollar. In the system, the dollar was pegged to gold at $35 an ounce. Every other currency was pegged to the dollar. By anchoring the dollar to gold and the Rest of the World’s currencies to the dollar, it was hoped that the new monetary order would bring international monetary stability. And for a time, it did.

The dollar became the world’s new international medium of exchange, not gold. It was simply assumed that dollar denominated liabilities, bonds issued by the federal government, were all backed by the gold amassed at Fort Knox. While cashing in American paper for gold was allowed (imagine the consequences if it was not!), American debt largely served as collateral, an asset base, on the balance sheets of foreign central banks.

What if everybody might want to cash in on these dollar denominated securities? Would Fort Knox be able to accommodate everybody? Hypothetically, Robert Triffin postulated, no. Hence, this particular issue was eventually termed the “Triffin Problem.”

In hindsight, it is easy to see that a little “benign neglect” by the American government might have produced some unintended inflation, while the spillover effects extended into other countries. Professor Nick Crafts calls these countries “inflation takers.” At first, the expansion of the dollar served as a source of liquidity for Europe – the point Professor Crafts makes in reference to the Marshall Plan. However, the inflationary pressure originating from the dollar eventually came to be known as “malign neglect,” because it was no longer in the new monetary order’s interests that justified dollar expansion, but in the American government’s interest.

The evidence speaks for itself. The amount of monetary gold held as reserves in 1950 stood at $35.3 billion. By 1973, it rose to only 43.1 billion. (At $35 an ounce, this is not really a surprise. Then again, it did still provide the anchor for the whole system) Another potential source of liquidity, the IMF’s Special Drawing Rights, also saw a comparatively small expansion over the same period, from $1.7 billion to $7.4 billion. A clue is in the figures representing foreign exchange reserves, which were held in dollars (of course). Between only 1969 and 1973 this figure nearly quadrupled – standing at $32.4 billion in 1969 and exploding to $123.1 billion in 1973.

While general external dollar liabilities increased substantially as early as 1967, external dollar liabilities held by monetary authorities (foreign central banks) skyrocketed in 1970. So why did the United States break the post-war monetary order? The War in Vietnam is the most obvious candidate, with the bombing of the North Vietnam beginning in 1965. Additionally, I hypothesize that funding NASA during this time period wasn’t cheap either. After all, the first moon landing was in 1969.