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The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States,Canada, Western Europe, Australia and Japan in the mid-20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate (± 1 percent) by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments. Also, there was a need to address the lack of cooperation among other countries and to prevent competitive devaluation of the currencies as well.

Preparing to rebuild the international economic system while World War II was still raging, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference, also known as the Bretton Woods Conference. The delegates deliberated during 1–22 July 1944, and signed the Bretton Woods agreement on its final day. Setting up a system of rules, institutions, and procedures to regulate the international monetary system, these accords established theInternational Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. The United States, which controlled two thirds of the world's gold, insisted that the Bretton Woods system rest on both gold and theUS dollar. Soviet representatives attended the conference but later declined to ratify the final agreements, charging that the institutions they had created were "branches of Wall Street."^[1] These organizations became operational in 1945 after a sufficient number of countries had ratified the agreement.

On 15 August 1971, the United States unilaterally terminated convertibility of the US dollar to gold, effectively bringing the Bretton Woods system to an end and rendering the dollar a fiat currency.^[2] This action, referred to as the Nixon shock, created the situation in which the US dollar became a reserve currency used by many states. At the same time, many fixed currencies (such as the pound sterling, for example) also became free-floating.

Origins[edit]

The political basis for the Bretton Woods system was in the confluence of two key conditions: the shared experiences of two World Wars, with the sense that failure to deal with economic problems after the first war had led to the second; and the concentration of power in a small number of states.

Interwar period[edit]

There was a high level of agreement among the powerful nations that failure to coordinate exchange rates during the interwar period had exacerbated political tensions. This facilitated the decisions reached by the Bretton Woods Conference. Furthermore, all the participating governments at Bretton Woods agreed that the monetary chaos of the interwar period had yielded several valuable lessons.

The experience of World War II was fresh in the minds of public officials. The planners at Bretton Woods hoped to avoid a repeat of the Treaty of Versailles after World War I, which had created enough economic and political tension to lead to WWII. After World War I, Britain owed the US substantial sums, which Britain could not repay because it had used the funds to support allies such as France during the War; the Allies could not pay back Britain, so Britain could not pay back the US. The solution at Versailles for the French, British, and Americans seemed to be "make Germany pay for it all." If the demands on Germany were unrealistic, then it was unrealistic for France to pay back Britain, and for Britain to pay back the US.^[3] Thus, many "assets" on bank balance sheets internationally were actually unrecoverable loans, which culminated in the 1931 banking crisis. Intransigent insistence by creditor nations for the repayment of Allied war debts and reparations, combined with an inclination toisolationism, led to a breakdown of the international financial system and a worldwide economic depression.^[4] The so-called "beggar thy neighbor" policies that emerged as the crisis continued saw some trading nations using currency devaluations in an attempt to increase their competitiveness (i.e. raise exports and lower imports), though recent research suggests this de facto inflationary policy probably offset some of the contractionary forces in world price levels(see Eichengreen "How to Prevent a Currency War").

In the 1920s, international flows of speculative financial capital increased, leading to extremes in balance of payments situations in various European countries and the US.^[5] In the 1930s, world markets never broke through the haphazardly constructed, nationally motivated and imposed barriers and restrictions on international trade and investment volume. The various anarchic and often autarkic protectionist and neo-mercantilist national policies – often mutually inconsistent – that emerged over the first half of the decade worked inconsistently and self-defeatingly to promote national import substitution, increase national exports, divert foreign investment and trade flows, and even prevent certain categories of cross-border trade and investment outright. Global central bankers attempted to manage the situation by meeting with each other, but their understanding of the situation as well as difficulties in communicating internationally, hindered their abilities.^[6] The lesson was that simply having responsible, hard-working central bankers was not enough.

Britain in the 1930s had an exclusionary trading bloc with nations of the British Empire known as the "Sterling Area." If Britain imported more than it exported to, say, South Africa, South African recipients of pounds sterling tended to put them into London banks. This meant that though Britain was running a trade deficit, it had a financial account surplus, and payments balanced. Increasingly, Britain's positive balance of payments required keeping the wealth of Empire nations in British banks. One incentive for, say, South African holders of rand to park their wealth in London and to keep the money in Sterling, was a strongly valued pound sterling. Unfortunately, as Britain deindustrialized in the 1920s, the way out of the trade deficit was to devalue the currency. But Britain couldn't devalue, or the Empire surplus would leave its banking system.^[7]

Nazi Germany also worked with a bloc of controlled nations by 1940. Germany forced trading partners with a surplus to spend that surplus importing products from Germany.^[8] Thus, Britain survived by keeping Sterling nation surpluses in its banking system, and Germany survived by forcing trading partners to purchase its own products. The US was concerned about a sudden drop-off in war spending which might return the nation to unemployment levels of the 1930s, and so wanted Sterling nations and everyone in Europe to be able to import from the US, hence the US supported free trade and international convertibility of currencies into gold or dollars.^[9]

Post war negotiations[edit]

When many of these same expert observers reared on the 1930s debacle became the architects of a new, unified, post-war system at Bretton Woods, their guiding principles became "no more beggar thy neighbor" and "control flows of speculative financial capital." Preventing a repetition of this process of competitive devaluations was desired, but in a way that would not force debtor nations to contract their industrial bases by keeping interest rates at a level high enough to attract foreign bank deposits. John Maynard Keynes, wary of repeating the Great Depression, was behind Britain's proposal that surplus nations be forced by a "use-it-or-lose-it" mechanism, to either import from debtor nations, build factories in debtor nations or donate to debtor nations.^[10][11] The US opposed Keynes' plan, and a senior official at the US Treasury, Harry Dexter White, rejected Keynes' proposals, in favor of an International Monetary Fund which would have enough resources to counteract destabilizing flows of speculative finance.^[12] However, unlike the modern IMF, White's proposed fund would have counteracted dangerous speculative flows automatically, with no political strings attached—i.e., no IMF conditionality.^[13] According to economic historian Brad Delong, on almost every point where he was overruled by the Americans, Keynes was later proved correct by events.^[14]

Today these key 1930s events look different to scholars of the era (see the work of Barry Eichengreen Golden Fetters: The Gold Standard and the Great Depression, 1919–1939 and How to Prevent a Currency War); in particular, devaluations today are viewed with more nuance. Ben Bernanke's opinion on the subject follows:

... [T]he proximate cause of the world depression was a structurally flawed and poorly managed international gold standard. ... For a variety of reasons, including a desire of the Federal Reserve to curb the US stock market boom, monetary policy in several major countries turned contractionary in the late 1920s—a contraction that was transmitted worldwide by the gold standard. What was initially a mild deflationary process began to snowball when the banking and currency crises of 1931 instigated an international "scramble for gold." Sterilization of gold inflows by surplus countries [the USA and France], substitution of gold for foreign exchange reserves, and runs on commercial banks all led to increases in the gold backing of money, and consequently to sharp unintended declines in national money supplies. Monetary contractions in turn were strongly associated with falling prices, output and employment. Effective international cooperation could in principle have permitted a worldwide monetary expansion despite gold standard constraints, but disputes over World War I reparations and war debts, and the insularity and inexperience of the Federal Reserve, among other factors, prevented this outcome. As a result, individual countries were able to escape the deflationary vortex only by unilaterally abandoning the gold standard and re-establishing domestic monetary stability, a process that dragged on in a halting and uncoordinated manner until France and the other Gold Bloc countries finally left gold in 1936. —Great Depression, B. Bernanke

In 1944 at Bretton Woods, as a result of the collective conventional wisdom of the time[citation needed], representatives from all the leading allied nations collectively favored a regulated system of fixed exchange rates, indirectly disciplined by a US dollar tied to gold[citation needed],—a system that relied on a regulated market economy with tight controls on the values of currencies. Flows of speculative international finance were curtailed by shunting them through and limiting them via central banks. This meant that international flows of investment went into foreign direct investment (FDI)—i.e., construction of factories overseas, rather than international currency manipulation or bond markets. Although the national experts disagreed to some degree on the specific implementation of this system, all agreed on the need for tight controls.

Economic security[edit]

 

Cordell Hull, US Secretary of State 1933–44

Also based on experience of the inter-war years, U.S. planners developed a concept of economic security—that a liberal international economic system would enhance the possibilities of postwar peace. One of those who saw such a security link was Cordell Hull, the United States Secretary of State from 1933 to 1944.^{[Notes 1]} Hull believed that the fundamental causes of the two world wars lay in economic discrimination and trade warfare. Specifically, he had in mind the trade and exchange controls (bilateral arrangements)^[15] of Nazi Germany and the imperial preference system practiced by Britain, by which members or former members of the British Empire were accorded special trade status, itself provoked by German, French, and American protectionist policies. Hull argued

[U]nhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war … if we could get a freer flow of trade…freer in the sense of fewer discriminations and obstructions…so that one country would not be deadly jealous of another and the living standards of all countries might rise, thereby eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.^[16]

Rise of governmental intervention[edit]

The developed countries also agreed that the liberal international economic system required governmental intervention. In the aftermath of theGreat Depression, public management of the economy had emerged as a primary activity of governments in the developed states.^{[citation needed]}Employment, stability, and growth were now important subjects of public policy.

In turn, the role of government in the national economy had become associated with the assumption by the state of the responsibility for assuring its citizens of a degree of economic well-being.^{[citation needed]} The system of economic protection for at-risk citizens sometimes called the welfare state grew out of the Great Depression, which created a popular demand for governmental intervention in the economy, and out of the theoretical contributions of the Keynesian school of economics, which asserted the need for governmental intervention to counter market imperfections.^{[citation needed]}

However, increased government intervention in domestic economy brought with it isolationist sentiment that had a profoundly negative effect on international economics.^{[citation needed]} The priority of national goals, independent national action in the interwar period, and the failure to perceive that those national goals could not be realized without some form of international collaboration—all resulted in "beggar-thy-neighbor" policies such as high tariffs, competitive devaluations that contributed to the breakdown of the gold-based international monetary system, domestic political instability, and international war. The lesson learned was, as the principal architect of the Bretton Woods system New DealerHarry Dexter White put it:

the absence of a high degree of economic collaboration among the leading nations will … inevitably result in economic warfare that will be but the prelude and instigator of military warfare on an even vaster scale.

— ^{[Notes 2]}

To ensure economic stability and political peace, states agreed to cooperate to closely regulate the production of their currencies to maintain fixed exchange rates between countries with the aim of more easily facilitating international trade.^{[citation needed]} This was the foundation of the U.S. vision of postwar world free trade, which also involved lowering tariffs and, among other things, maintaining a balance of trade via fixed exchange rates that would be favorable to the capitalist system.^{[citation needed]}

Thus, the more developed market economies agreed with the U.S. vision of post-war international economic management, which was to be designed to create and maintain an effective international monetary system and foster the reduction of barriers to trade and capital flows.^{[citation needed]} In a sense, the new international monetary system was in fact a return to a system similar to the pre-war gold standard, only using US dollars as the world's new reserve currency until the world's gold supply could be reallocated via international trade.^{[citation needed]}

Thus, the new system would be devoid (initially) of governments meddling with their currency supply as they had during the years of economic turmoil preceding WWII. Instead, governments would closely police the production of their currencies and ensure that they would not artificially manipulate their price levels.^{[citation needed]} If anything, Bretton Woods was a return to a time devoid of increased governmental intervention in economies and currency systems.^{[citation needed]}

Atlantic Charter[edit]

 

Roosevelt and Churchill during their secret meeting of 9–12 August 1941, inNewfoundland resulted in the Atlantic Charter, which the U.S. and Britain officially announced two days later.

The Atlantic Charter, drafted during U.S. President Franklin D. Roosevelt's August 1941 meeting with British Prime Minister Winston Churchill on a ship in the North Atlantic, was the most notable precursor to the Bretton Woods Conference. Like Woodrow Wilson before him, whose "Fourteen Points" had outlined U.S. aims in the aftermath of the First World War, Roosevelt set forth a range of ambitious goals for the postwar world even before the U.S. had entered the Second World War.

The Atlantic Charter affirmed the right of all nations to equal access to trade and raw materials. Moreover, the charter called for freedom of the seas (a principal U.S. foreign policy aim since Franceand Britain had first threatened U.S. shipping in the 1790s), the disarmament of aggressors, and the "establishment of a wider and more permanent system of general security."

As the war drew to a close, the Bretton Woods conference was the culmination of some two and a half years of planning for postwar reconstruction by the Treasuries of the U.S. and the UK. U.S. representatives studied with their British counterparts the reconstitution of what had been lacking between the two world wars: a system of international payments that would allow trade to be conducted without fear of sudden currency depreciation or wild fluctuations in exchange rates — ailments that had nearly paralyzed world capitalism during the Great Depression.

Without a strong European market for U.S. goods and services, most policymakers believed, the U.S. economy would be unable to sustain the prosperity it had achieved during the war.^{[citation needed]} In addition, U.S. unions had only grudgingly accepted government-imposed restraints on their demands during the war, but they were willing to wait no longer, particularly as inflation cut into the existing wage scales with painful force. (By the end of 1945, there had already been major strikes in the automobile, electrical, and steel industries.)^{[citation needed]}

In early 1945 Bernard Baruch described the spirit of Bretton Woods as: if we can "stop subsidization of labor and sweated competition in the export markets," as well as prevent rebuilding of war machines, "oh boy, oh boy, what long term prosperity we will have."^[17] The United States [c]ould therefore use its position of influence to reopen and control the [rules of the] world economy, so as to give unhindered access to all nations' markets and materials.

Wartime devastation of Europe and East Asia[edit]

United States allies—economically exhausted by the war—needed U.S. assistance to rebuild their domestic production and to finance their international trade; indeed, they needed it to survive.^[9]

Before the war, the French and the British realized that they could no longer compete with U.S. industries in an open marketplace.^{[citation needed]}During the 1930s, the British created their own economic bloc to shut out U.S. goods. Churchill did not believe that he could surrender that protection after the war, so he watered down the Atlantic Charter's "free access" clause before agreeing to it.^{[citation needed]}

Yet U.S. officials were determined to open their access to the British empire. The combined value of British and U.S. trade was well over half of all the world's trade in goods. For the U.S. to open global markets, it first had to split the British (trade) empire. While Britain had economically dominated the 19th century, U.S. officials intended the second half of the 20th to be under U.S. hegemony.^[18]

A Senior Official of the Bank of England commented:

One of the reasons Bretton Woods worked was that the US was clearly the most powerful country at the table and so ultimately was able to impose its will on the others, including an often-dismayed Britain. At the time, one senior official at the Bank of England described the deal reached at Bretton Woods as "the greatest blow to Britain next to the war", largely because it underlined the way in which financial power had moved from the UK to the US.

— ^[19]

A devastated Britain had little choice. Two world wars had destroyed the country's principal industries that paid for the importation of half of the nation's food and nearly all its raw materials except coal. The British had no choice but to ask for aid. Not until the United States signed an agreement on 6 December 1945 to grant Britain aid of $4.4 billion did the British Parliament ratify the Bretton Woods Agreements (which occurred later in December 1945).^[20]

For nearly two centuries, French and U.S. interests had clashed in both the Old World and the New World.^{[citation needed]} During the war, French mistrust of the United States was embodied by General Charles de Gaulle, president of the French provisional government.^{[citation needed]} De Gaulle bitterly fought U.S. officials as he tried to maintain his country's colonies and diplomatic freedom of action. In turn, U.S. officials saw de Gaulle as a political extremist.^{[citation needed]}

But in 1945 de Gaulle—the leading voice of French nationalism—was forced to grudgingly ask the U.S. for a billion-dollar loan.^{[citation needed]}Most of the request was granted; in return France promised to curtail government subsidies and currency manipulation that had given its exporters advantages in the world market.^{[citation needed]}

Design of the financial system[edit]

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