Global Policy Forum

Bretton Woods: Birth and Breakdown


By John Braithwaite and Peter Drahos *

Extract: pages 97-101 of "Global Business Regulation"
April 2001

Fathom Editor's note:
The second half of the twentieth century witnessed international economic coordination on a scale never previously achieved. But the nature of the system has changed since the 1944 Bretton Woods Agreement. Here, John Braithwaite and Peter Drahos trace the highs and lows of the international economic climate over 50 years.

Toward the end of the Second World War it was realized that more than just a gentlemen's agreement would be needed to achieve meaningful economic coordination between states. An international monetary system administered by an international organization was required if states were to renew their economies and live in peace. With this in mind, delegates from forty-four countries met in July 1944 at a place called Bretton Woods.

Bretton Woods is just a little beyond Mt Washington in New Hampshire. In this tiny place plans were laid for three big global institutions--the International Monetary Fund (IMF), the World Bank and the International Trade Organization (ITO). At the closing Plenary Session of the Conference, John Maynard Keynes, one of the principal architects of the Agreement, opened with these words (see D. Moggeridge (ed.), The Collected Writings of John Maynard Keynes, London, vol. 26, p. 101, 22 July 1944):

We, the Delegates of this Conference, Mr President, have been trying to accomplish something very difficult to accomplish. We have not been trying, each one to please himself, and to find the solution most acceptable in our own particular situation. That would have been easy. It has been our task to find a common measure, a common standard, a common rule applicable to each and not irksome to any.

He concluded on an optimistic note (Moggeridge, p. 103, 22 July 1944):

Finally, we have perhaps accomplished here in Bretton Woods something more significant than what is embodied in this Final Act. We have shown that a concourse of forty-four nations are actually able to work together at a constructive task in amity and unbroken concord. Few believed it possible. If we can continue in a larger task as we have begun in this limited task, there is hope for the world.

Thirty years after Keynes had delivered these words, analysts were producing tracts describing the breakdown of the Bretton Woods system. Keynes was right to think of the Final Act at Bretton Woods as a magnificent achievement. For the first time there was a codified form of rules and principles that imposed some obligations on states in the conduct of their monetary affairs. Given that money had always been a symbol of political power, the incursion of Bretton Woods into state sovereignty was considerable.

Moreover, the institutions of Bretton Woods were part of a planned global regulatory system for trade and finance. Financial regulatory cooperation among states in the past had been bilateral. It had been based on the need to deal with a crisis, as in the case of cooperation between the central banks of England and France during the nineteenth century, or it had been cooperation based on following the Bank of England's lead. Bretton Woods represented a different kind of cooperation. It was a shift away from the tacit, convention-based cooperation of central bankers to a sweeping, rule-based, multilateral cooperation of states.

The slide to breakdown

During the 1930s states had experienced a series of connected problems: shortage of gold, exchange rate instabilities, the movement of "hot" money in and out of their realms, and the lack of a mechanism to adjust balance of payments problems. The IMF was designed to deal with these difficulties by putting in place an international monetary system that contained a stable exchange rates regime with some scope for revaluation ("pegged but adjustable"), provided for the convertibility of currency, provided a mechanism for overcoming short-term liquidity crises and an organizational actor for managing the system (J. Williamson, The Failure of World Monetary Reform, New York, 1977, pp. 2-28). The World Bank was designed to help the economic and industrial reconstruction of Europe and to help developing countries achieve industrialization. The purpose of the ITO was to propel states down the path of free trade, to stop them from defecting to protectionism as a way of responding to balance of payments problems (e.g. by imposing import quotas as an alternative to devaluing their currency). The ITO never emerged, because of US concerns. Instead, a weaker agreement known as the General Agreement on Tariffs and Trade took its place. In this grand plan for international institutions in the postwar era tax, as an object of regulation, was absent. Keynes' letters and reports around the time of Bretton Woods do not discuss the coordination of tax policy between states. Tax policy, the implication seems to be, would be retained by the nation-state.

It is an exaggeration to say that the whole Bretton Woods system broke down. What did break down was the rules of cooperation for the convertibility of the dollar into gold and the exchange rates regime. After the war, the US dollar became the international reserve currency. The US also went from being in surplus to running trade deficits. States at first wanted US dollars to meet their trade obligations. They were also happy to let the US run deficits since this provided liquidity in the international monetary system. This situation led, however, to a crisis first anticipated by the economist Triffin in 1960 (R. Triffin, Gold and the Dollar Crisis, New Haven CT, 1960). The problem was that if the US attempted to correct its balance of payments deficit it would cause a liquidity crisis. If it allowed its deficit to continue, other states would lose confidence in the dollar as a reserve currency and seek to convert their dollars into gold. US deficits continued to increase, partly because the US had to pay for its war in Vietnam. Confidence in the dollar started to slide. States began to seek, as the gold standard allowed them to, the conversion of their dollars into gold. The US reacted by announcing in August 1971 that it was going to abandon the convertibility of the dollar.

This unilateral action ended the exchange rates regime that had been negotiated by states at Bretton Woods. Other states were more or less forced to float their own currencies. There was the minor matter that the US and other states were in breach of the IMF agreement. The real problem lay in deciding on a new form of cooperation for exchange rates. Between 1971 and 1974 there was a series of international meetings aimed at solving this problem. The US found that its action in suspending convertibility had led to its isolation at the G-10 (the IMF'S main creditor nations). It went forum-shopping, a strategy it has repeated with success in other regulatory domains. The forum which eventually emerged was an ad hoc forum within the IMF, officially called the Committee of the Board of Governors on Reform of the International Monetary System and generally referred to as C-20. The membership of C-20 was drawn from countries that had control over executive positions at the IMF (Williamson, The Failure of World Monetary Reform, p. 61). The C-20 negotiations allowed states very considerable sovereign discretion over the setting of exchange rates. Williamson (1977, p. 73) put it thus: "The outcome of the C-20 was, in effect, a decision to learn to live with the non-system that had evolved out of a mixture of custom and crisis over the preceding years."

US financial hegemony

The era of flexible and floating exchange rates that followed the breakdown of the Bretton Woods exchange regime was not really a victory for the principle of national sovereignty as much as a triumph of US financial hegemony. Keynes had always thought that in the postwar era the only hope for peace and economic growth lay in the creation of an international monetary system. He saw that sterling's lustre was fading and so the UK had to cooperate with the US in this enterprise. In his briefing notes to the UK Chancellor on 15 February 1945 he writes:

The idea that there is some bilateral system which would weld the empire more closely together is a pure delusion. Nothing would be more likely to break up the economic relations within the empire and destroy the primacy of London in the sterling area system than a wanton rupture with the currency and commercial systems of North America before there was any proof that the alternative system, so much better for all concerned if it would work, must necessarily break down (Moggeridge, p. 191).

Keynes wanted a genuinely independent international monetary system, one that disciplined deficit and surplus nations alike. The IMF Agreement that came out of Bretton Woods contained a scarce currency clause, which, as Keynes pointed out, "commits the US to finding a way out in the event of the balance of trade turning obstinately in its favour" (Moggeridge, p. 189, 15 February 1945). This clause was never invoked against the US. European states wanted US dollars. When the US also became a deficit country it was able to avoid disciplinary adjustment by suspending the convertibility of its currency into gold. In fact the suspension of convertibility in 1971 was accompanied by bellicose demands that other countries should revalue their currencies so as to eliminate "unfair exchange rates," backed up by the imposition of a 10 per cent import surcharge until such time as they complied (Williamson 1977, p. 43). The US was, in other words, seeking to pass on the cost of adjustment to other states.

International monetary regulation had led to a particular kind of structural problem. Basically the problem arises when the dominant currency in world monetary relations is also the currency of a hegemon. The convenience of a dominant currency in trade terms is undoubted. It is this convenience that drove the formation of monetary unions in Ancient Greece and it was through trade that sterling achieved much of its ascendancy at the end of the nineteenth century. If at the same time this dominant currency is the currency of a hegemon (hegemonic dominant currency), the temptation facing the hegemon is to use it to run its own agenda and solve its domestic, economic and political problems (e.g. the deficit financing of a war). Moreover, the hegemon may use its power to evade the discipline that an international monetary order must impose on surplus and deficit nations alike in order to achieve a stable equilibrium. Hegemonic dominant currencies are, in other words, a fragile basis on which to build an international monetary order. Other states are left without any real disciplinary recourse when the hegemon defects from the order.

Keynes had been a strong advocate of the idea of an international monetary authority administering a new international monetary unit. His plan was for a central bank for the world, an "International Clearing Union" that could issue a new unit to be called the "bancor, unitas, dolphin, bezant, daric and heavens knows what" (Keynes, 23 May 1944, 10). This plan for a more powerful international monetary authority was never discussed seriously at Bretton Woods. Support for it in the UK was lukewarm. Nor did the US support it. The IMF that was born at Bretton Woods was probably as much as Keynes could have hoped for. In a report to the Chancellor in 1946 about Bretton Woods, he writes:

The Fund can scarcely be, at any rate in the early years, the nucleus of a super-central bank, such as we hoped. It will be a different kind of body, much more closely linked in its activities to the Treasury and other Whitehall Departments, and much less to the Bank of England, than we had been anticipating. But it may prove none the less important (Moggeridge, p. 232, 27 March 1946).

In the years that followed the events of 1971, international monetary cooperation again changed its nature. Keynes' vision of an international monetary system capable of disciplining both deficit and surplus nations, thereby bringing equilibrium to the economies of the world, faded. Instead states looked to fora like the G-7 and the G-5 to coordinate international monetary policy. In a world of floating exchange rates the level of cooperation also floated. The meetings of G-7 finance ministers became a centre of monetary cooperation, but from that centre came a different kind of cooperation to the institutionalized, rule-based, multilaterally binding cooperation of Bretton Woods. G-7 meetings were more about information exchange and consultation, conditional policy understandings, than about rule-based guarantees. Industrialized countries kept lines of communication open with each other and used the IMF to bring monetary and fiscal discipline to developing debtor nations. At the Bonn G-7 summit of 1978 the US, Germany and Japan agreed to restart the world's economy, but this cooperation dissipated in the face of inflationary fears. Cooperation was rekindled with some success with the Plaza Accord of 1985 (an agreement to let the value of the dollar decline) and the Louvre Accord of 1987 (an agreement to stabilize the value of the dollar). Generally, the G-7 has a mixed record in delivering the kind of public goods from monetary cooperation that the IMF was initially designed for. Similarly, central banks have coordinated their operations in foreign exchange markets, but the success of this has become increasingly problematic in the face of ever more powerful currency speculators.

Towards the euro

Another consequence of the breakdown of Bretton Woods was that it speeded up EC planning for monetary union. By the 1970s the Bundesbank was the most powerful central bank in Europe. After the suspension of dollar convertibility and the ensuing currency storms of the early 1970s, it realized that defending fixed exchange rates was futile. More important was the establishment of the European Monetary System (EMS) in 1979. This system was intended to bring exchange rate stability to Europe by setting up an exchange rates regime in which the currencies of participating European states would adjust against one another within a fixed range rather than simply floating. This was an initiative taken by Chancellor Helmut Schmidt and President Valéry Giscard d'Estaing. Schmidt's role was crucial, as he made a passionate speech to the Council of the Bundesbank persuading it to support the EMS when the Council was worried about the implications of the EMS for German monetary independence and power (D. Marsh, The Bundesbank, London, 1993, p. 194). The logic of European monetary union had been talked about since the early 1960s. After the creation of the EMS that logic drew increasing support, particularly from the influential French policy-makers who saw monetary union as a way of breaking free of the hegemony of the Bundesbank. Under the leadership of Jacques Delors, President of the EC, the EC devised a three-stage plan for European monetary union. Bundesbank leadership underwrote Delors' leadership:

If there is no stability there can be no monetary union. We as the anchor state need to solve our inflation first. Then dialogue is important and learning. That means you have to defend your case within the union. But against the shared objective of non-inflationary growth. They want union and the price is price stability policies (Bundesbank interview 1994).

At a meeting in Maastricht in 1991, European states entrenched in treaty form a timetable and set of conditions for monetary union. Essentially, states wishing to be part of the union had to commit themselves to the prevailing principles of macroeconomic orthodoxy; a low inflation rate, reduced government deficits and the stabilization of their currency. Monetary union would involve the introduction of a single currency (the euro, introduced on 1 January 1999) and the creation of a single monetary authority for Europe (the European Central Bank). On 1 January 1999 Germany, France, Italy, Spain, Netherlands, Belgium, Austria, Portugal, Finland, Ireland and Luxembourg participated in stage 3 of economic and monetary union by adopting the euro as their currency. The UK, Sweden and Denmark opted to stay out of the single currency for the time being, while Greece did not achieve the required economic targets to be able to adopt the euro.

This is an extract from pages 97-101 of Global Business Regulation, by John Braithwaite and Peter Drahos, published by Cambridge University Press. Copyright John Braithwaite and Peter Drahos, 2000. This book won the Hart Socio-Legal Studies Book Prize in 2000.

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FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.