Bretton Woods system
- Creation of the Bretton Woods Institutions
- Dollar Standard
- Changing Roles of the Bretton Woods Institutions
The Bretton Woods agreements negotiated at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, in 1944 laid the groundwork for the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, now known as the World Bank. These institutions provided the framework for the postwar international trade and financial system that came to be known as the BrettonWoods system.
In the early 1940s the Allied powers started to consider the shape of the post World War II international financial and trading system. Influencing their decision on measures to be taken was the assessment ofwhy the trading systemhad broken down in the 1920s and the causes of the economic depression that had plagued the United States and the United Kingdomin the 1930s. The period had been characterized by record levels of unemployment, excessively onerous war reparations payments imposed in the Treaty of Versailles, and volatile international capital flows, as well as the collapse in the prices of primary commodities.
The response to these problems had been the introduction of policies to protect domestic producers by restricting imports, placing controls on the access to foreign exchange used to purchase imports, introducing preferential tariffs on imports from selected countries, and bilateral clearing and payments arrangements to ensure that imports balanced exports. Other measures included international schemes restricting supplies of primary commodities, as well as national import restrictions, export subsidies, and agricultural price supports. The objective of these policies was to defend domestic income and employment and the stability of domestic financial institutions. Instead, the attempted return to the gold standardwas thwarted by sustained financial crises.
Postwar planners recognized the need to coordinate national policy objectives in an interdependent international system and concluded that multilateral institutional structures could eliminate the financial factors that had caused international trade to be viewed as a threat to national economic welfare. Itwas generally agreed that a stable international financial and exchange rate system was a prerequisite to successful restoration of free international trade.
The United States and the United Kingdom played the major role in the discussions of the shape of the new system, and both governments contributed proposals of what was to be the first step in this process. The UK proposal, authored by John Maynard Keynes, called for an international clearing union based on an internationally created and managed unit of account. The U.S. proposal, devised by U.S. Treasury official Harry Dexter White, proposed an international stabilization fund, similar to the U.S. Federal Reserve System on an international scale, that would hold reserves of the currencies of all members, from which countries could borrow to support their exchange rates.
The difference in the two proposals reflected the different motivations of the two countries. The United Kingdomwas concerned that large payments imbalances under the gold standard had required debtor countries to reverse their balance of payments deficits and protect their declining gold stocks by reductions in domestic income and employment. Surplus countries, on the other hand, were accumulating gold and could easily postpone any action to reduce their surpluses through policies to expand their imports from the deficit countries. The goal of the United Kingdom, as a postwar debtor country, was thus to eliminate this asymmetric adjustment to trade imbalances by ensuring full participation of creditors in the international adjustment process.
The United States, on the other hand, was more concerned by the breakdown in free trade and the manipulation of exchange rates that had occurred in the interwar period as countries attempted to protect themselves from the exchange rate instability caused by large payments imbalances and the instability of international financial flows. The U.S. concern, as the major creditor country, was to prevent deficit countries fromresolving their debt positions by using protection and exchange rate manipulation to create trade surpluses.
Article VII of the Atlantic Charter, negotiated by Winston Churchill and Franklin D. Roosevelt at the Atlantic Conference in August 1941 during a secret shipboard meeting, set out the conditions for U.S. support of the British war effort. It reflected U.S. concerns that the postwar trade and financial system be built on a rules-based system of relatively free multilateral trade as opposed to the British approach of trade preferences.The differenceswereworked out at the Bretton Woods Conference in 1944.The trade and commercial policy aspects of the new system were the subject of discussions at the UN Conference on Trade and Employment held in Havana in 1947.
Creation of the Bretton Woods Institutions
The Bretton Woods Conference created the International Monetary Fund, largely on the lines proposed in theWhite plan. On a proposal from the United States, concerned to separate the financing of the postwar reconstruction of Europe from the financing of exchange rate stability, an International Bank for Reconstruction and Development (IBRD) was also created to deal with the longer-term problem of development finance for postwar reconstruction in Europe.The unanimously adopted Havana Charter, proposing the creation of an International Trade Organization (ITO) that would deal with the regulations on commercial policy, create a Commodity Stabilization Fund, and meet the British concerns for symmetric balance of payments adjustments,was never ratified bymember states. Instead, a single chapter, the General Agreements on Tariffs and Trade (GATT), which dealt with commercial policy, was the only part of the charter that survived as a series of bilateral treaties to eliminate subsidies and reduce tariffs in support of world trade.
The role of these multilateral institutions with complementary mandates to ensure favorable international trade and financial conditions to support rapid income growth and employment is reflected in their stated objectives. The IMF was created ‘‘to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as the primary objectives of economic policy.’’ The ITO charter (Chapter 2,Article II)was evenmore explicit: ‘‘The Members recognize that the avoidance of unemployment or underemployment, through the achievement and maintenance in each country of useful employment opportunities for those able and willing to work and of a large and steadily growing volume of production and effective demand for goods and services, is not of domestic concern alone, but is also a necessary condition for the achievement of . . . the expansion of international trade, and thus for the well being of all other countries.’’ Finally, the role of the IBRD was ‘‘to promote the long range balanced growth of international trade and the maintenance of equilibriumin balances of payments by encouraging international investment for the development of the productive resources of members, thereby assisting in raising productivity, the standard of living and conditions of labor in their territories.’’
This ambitious project of negotiating a new, coherent, and coordinated set of international institutions for the postwar period was never completed, however.The IMF and the IBRD became specialized agencies within the UN system, which allowed them to maintain independent governance mechanisms with representation based on each country’s economic weight and financial contribution instead of on the UN General Assembly’s rule of one country, one vote. In 1996 the GATT was transformed into the World Trade Organization, an ad hoc international body outside the UN system and without the wider mandate to eliminate discriminatory bilateral agreements as the third pillar of Bretton Woods originally intended for the ITO.
As a result, nomultilateral institution was created to deal with the stabilization of primary commodity prices or to oversee trade in agriculture. Instead, official intervention in support of the prices of primary commodities continued in the form of ad hoc agreements dependent on controls over supply, and national and (in the case of European Union countries) regional schemes for the support of agricultural prices and incomes. The most important and most costly examples of the latter were found in industrial countries, and, as in the earlier period, they were generally supported by tariffs and other restrictions on imports, aswell as by subsidies and othermethods of export promotion. The responsibility for the consequences of fluctuations in developing country export earnings caused by volatility in commodity prices was left to the IMF.
The IBRD, although itwas commonly referred to as a ‘‘world bank,’’ was not a ‘‘bank’’ because it could not create money, and the majority of the financing for European reconstruction effort was provided by the Marshall Plan. As a result most European countries delayed full observance of their obligations in the international trading system,while the need for finance for reconstruction and trade was met by official aid or through regional multilateral monetary arrangements such as the European Payments Union. The financing problems facing the growing number of newly created democratic developing countries were addressed by the creation of special institutions in the World Bank such as the International Development Association and regional development banks. In addition, the UN Conference onTrade and Development,which had no financing capabilities, provided a forumfor the formulation of financing policies designed to benefit developing countries.
Membership in the International Monetary Fund required a country to maintain a fixed parity for its national currency relative to gold or the dollar. If necessary, countrieswere to maintain these rates by borrowing reserves temporarily fromthe IMF and by implementing policies to ensure external equilibrium. Only in the case of a ‘‘fundamental disequilibrium,’’ where such adjustment would have meant insupportable domestic hardship, could a country contemplate a change in exchange rates, and such a change was to be negotiated with the other members of the IMF.
Since most countries did not have the requisite gold stocks after World War II, they chose to fix their exchange rates to the dollar. The United States, with most of the global gold stocks, fixed its parity relative to gold. Nonetheless, theweak external positions ofmost European countriesmeant that convertibility at fixed parity for imbalances created by commercial account transactions was not implemented until the end of the 1950s. By 1960 the Bretton Woods fixed exchange rate system came under pressure when gold traded above its official dollar peg of $35 an ounce on the London gold market. Several years earlier, Yale economist Robert Triffin had suggested that this was the inevitable result of the decision made at Bretton Woods to require members to fix their exchange rates relative to gold or the U.S. dollar. Since all countries except the United States had fixed their currencies relative to the dollar, this created a system that resembled the prewar gold standard that the Bretton Wood system was supposed to replace, as the dollar had simply taken the place of gold.
When U.S. external deficits created a stock of international claims on the dollar that exceeded the U.S. gold stock, the United States could no longer ensure the exchange of dollars for gold at the rate of $35 per ounce. This is precisely what occurred in 1960when the value of U.S. gold stocks at the official parity of $17.8 billionfell short of the$18.7 billionof outstanding liquid foreign dollar claims. To avoid changing the dollar parity, a series of ad hoc measures to prevent dollar conversion into gold and to increase foreign demand for dollars were introduced during the decade of the 1960s. These included a two-tier gold market separating official and private conversions of currencies into gold; an interest equalization tax on borrowing in the U.S. capital market; Operation Twist, which attempted to produce an increase in short-term rates while keeping long-term rates low in order to support U.S. growth prospects; and new methods of calculating the U.S. balance of payments on the basis of liquidity balances.
In 1966, to provide a supplement to the dwindling U. S. gold stocks and an alternative to the dollar in countries’ reserves, theGroup of 10 (composed of theministers of finance of the 10major industrialized countries) proposed a ‘‘special reserve drawing right,’’ whichwas implemented by the IMF in 1967with the creation of a facility based on ‘‘specialdrawing rights’’ (SDRs) in the fund.The SDRs, also known as ‘‘paper gold,’’ were simple credit entries in the International Monetary Fund accounts, distributed to members in proportion to their existing membership quotas in the IMF. They could be used in place of dollars or gold to settle payments imbalances. The value of the SDR was initially defined as the gold equivalent of the dollar (0.888671 grams of fine gold), but after the collapse of the Bretton Woods system the SDR was initially redefined as a basket of 16 currencies. In 1981 it was reduced to 5 currencies,with a revision of the weights and currencies that comprise the basket conducted every five years. Rather than a transaction currency that can be used to finance purchase and sale, it is a unit of account to be used by deficit countries losing foreign exchange reserves in defense of their parity to acquire currencies of other members.
Despite all these attempts to shore up the system, U.S. gold stocks by 1971 had fallen to just over $10 billion against outstanding claims of more than $60 billion. In August of that year the United States suspended convertibility of the dollar to gold at the fixed $35-an-ounce parity and introduced an import surcharge. This represented the de facto confirmation of Triffin’s prediction and the end of the BrettonWoods system.
From 1971 to 1974 an ad hoc Committee of the Board of Governors on Reform of the International Monetary System and Related Issues (composed of the 20 executive directors of the IMF and known as the Group of 20) worked on proposals for the resurrection and reform of the Bretton Woods system. This attempt was abandoned, however, after the outbreak of the oil crisis in 1973, and negotiations focused instead on interim arrangements such as a quota increase, the creation of a new governance structure in the formof an ‘‘InterimCommittee’’ and a ‘‘DevelopmentCommittee,’’ abolitionof anofficial price of gold, and regulations for the valuation of gold held by the International Monetary Fund on behalf of its members. The changes were finally completed at a special meeting held in Jamaica in 1976 that eliminated the formal obligation under Article IV for members to fix a parity relative to gold or the dollar. Under the new arrangement each member was bound to ‘‘collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates.’’ In particular, each memberwas encouraged to ‘‘avoidmanipulating exchange rates or the internationalmonetary systemin order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members’’
Changing Roles of the Bretton Woods Institutions
After the reform there was no longer a need for countries to borrow from the IMF in order to support their exchange rates. In theory, under flexible exchange rates countries no longer needed to hold exchange reserves since adjustment to external imbalances would take place through the changes in the relative prices of tradable and nontradable goods produced by exchange rate adjustment. International Monetary Fund operations were thus concentrated on orderly adjustment by ensuring that flexible currency exchange rates reflected underlying economic forces.
The World Bank’s mandate has also changed. As the need for European reconstruction finance disappeared, attention shifted to the financing of large economic infrastructure projects to support developing countries. The bank is an active borrower in private capital markets to finance its projects in developing countries. Dissatisfaction with the development impact of these projects, however, and criticism of widespread corruption in their implementation during the 1980s, led the bank to focus on supporting the creation of markets and institutions in developing countries that would eliminate poverty and support their more active participation in the international trading system.
Thus the two Bretton Woods institutions have lived on beyond their original mandates negotiated in 1944 to become complementary and sometimes conflicting institutions that aim to finance development and eliminate poverty in developing countries. See also currency crisis; dollar standard; exchange rate regimes; Federal Reserve Board; financial crisis; foreign exchange intervention; gold standard, international; international financial architecture; international liquidity; International Monetary Fund (IMF); international policy coordination; international reserves; special drawing rights; Triffin dilemma; World Bank; World Trade Organization