75 years ago, from July 1 to 22, 1944, representatives from 44 nations met in the Mount Washington Hotel in Bretton Woods, New Hampshire, to design what later became known as the “Bretton Woods System”. The “Articles of Agreement” of this conference established the World Bank and the International Monetary Fund and proposed an international monetary system based on fixed but adjustable exchange rates with the US-dollar as its center and gold as its backing.
Delegations from 44 Allied countries participated in the conference. The Soviet Union did not ratify the treaty, and the United States had an easy game persuading most of the other participants to accept its counterproposal over the British proposal. From the outset, the United States left no doubt about where the new power center was. The leader in charge of the U.S. delegation, Harry Dexter White from the Treasury Department, played cat and mouse with the British and their main negotiator, the famous economist John Maynard Keynes.
The Americans used to their advantage the fact that the United Kingdom depended on new loans from the United States. In contrast to the massive delivery of goods to the Soviet Union during the Second World War, for which the United States hardly had received any compensation, the British were burdened with external debt at the end of the war.
The Bretton Woods Conference ensured the end of Britain’s global financial dominance. As soon as the other potential competitors to global leadership, Germany and Japan, were no longer a threat, the world conflict shifted to the Cold War between the United States and its allies on the one side and the Soviet Union and its satellites on the other side.
Dethroning the British
When the United States terminated the lend-lease program on August 21, 1945, Britain had to take out additional loans. The debt burden led the United Kingdom into its postwar financial ruin and provoked the loss of its colonial empire in the ’50s and ’60s. The last installment of the payments made by Great Britain for U.S. aid during the Second World War took place on December 29, 2006.
Harry Dexter White, who led the negotiations for the United States at the Bretton Woods Conference, was a spy for the Soviet Union. He pursued the plan to eliminate the United Kingdom as a financial rival and as a sea power, Germany as a Continental power, and Japan in the Pacific to establish a new Communist world order together with the Soviet Union.
In line with the views of the U.S. Treasury under the leadership of Henry Morgenthau, who promoted a plan to relegate Germany to an agricultural economy after the end of the Second World War, Bretton Woods set the stage for the role of the United States as the main superpower.
Structure of the System
The Bretton Woods system defined the dollar in gold and obliged the other countries to tie their currencies within a range from −1 to +1 percent to the dollar.
Up to the present day, the United States has benefited from the role of the dollar as the most important international currency. So long as the dollar has that role, the U.S. government need not worry about its foreign debt or about the size of its current account deficit. The United States can import more than it exports as long as the dollar is in demand around the world.
With the dollar as the main international reserve currency, the American government has unlimited international payment ability. This is a boon and a curse at the same time. Americans balance their current account deficit with capital imports, which, from the perspective of foreign countries, serve as international currency reserves. In contrast to other countries, the United States can accumulate foreign debt without worrying about servicing the debt, and in fact the United States has become the world’s largest debtor in absolute terms.
The American government has sovereignty over its currency and therefore can produce as many dollars as it wants. The position of the United States as the issuer of the international reserve currency is an essential correlate to the global military position of the United States.
Nevertheless, the dollar privilege has its price. The U.S. economy becomes dependent on imports. In contrast to a country with a balanced trade position, the United States’ persistent current account deficits distort its structure of production and atrophy its industrial basis. The troubles of the U.S. economy at the beginning of the 21st century are not caused by free trade, but the role of the dollar as the major international reserve currency.
With a common European currency, the euro, the countries that form the Eurozone have withdrawn from paying tributes to the United States inasmuch as their need to hold dollar reserves has diminished. Internationally, the dollar still dominates the trade in oil and other commodities.
The Bretton Woods Agreement established a fixed exchange rate system whereby the parties to the agreement set their exchange rates in dollars and only could change them in negotiations with the International Monetary Fund.
The system operated as an inverted pyramid. The gold base would serve to maintain confidence in the dollar and prevent an inflationary expansion of the money supply. In fact, however, the U.S. gold stock declined, and the volume of circulating dollars increased, leading to the collapse of the system in the early 1970s.
Bretton Woods stipulated that the countries with a surplus of dollar deposits could redeem them for gold from the U.S. Treasury. The mechanism foresaw that in line with these redemptions, the quantity of dollars in circulation would diminish and make the U.S. economy competitive again because of a lower price level. While the system was supposed to work like the traditional gold standard, the United States did not stick to the agreement and the U.S. money supply expanded despite the shrinking gold base. A wide discrepancy emerged between money and the shrinking volume of gold. The creation of fiat money has continued. While the monetary stock (M1) stands at around $3.7 trillion in October 2018, U.S. gold holdings amount to 261.5 million troy ounces (8,133 tons), equivalent to about $330 billion.
Soon after the inception of the Bretton Woods System in 1949, the exchange rates required adjustments. The deutschmark revalued, while the franc and the pound devalued. However, the changes in exchange rates remained modest when compared to the shifts that occurred after the end of the Bretton Woods System in the early 1970s.
In the late 1960s, the international monetary system had transmogrified into a source of global liquidity creation that originated in the United States but also forced other nations to import this inflation. Inflation-fighting central banks could not practice a restrictive monetary policy. Higher interest rates would attract hot money. Central banks abroad, particularly the German Bundesbank and the Bank of Japan, accumulated dollars as international reserves when they held their exchange rates fixed to the dollar at the undervalued parity. Yet by buying up the excess of dollars with their own currency, these countries expanded their own monetary base and laid the foundation for inflation at home. The result was the global price inflation.
In December 1971, with the so-called Smithsonian Agreement, a final attempt was made to save the old system. The United States devalued its currency against gold and other currencies. However, it soon became evident that there was no chance of reviving the old regime. In 1973, with the new rule that each country could choose its own currency arrangement, the Bretton Woods System ended.
Originally published at https://www.aier.org on November 1, 2018.