Bretton Woods System

Abstract

The Bretton Woods System generally refers to the international monetary regime designed in 1944 and implemented (in stages) from the end of the Second World War to the 1950s. The Bretton Woods agreement was meant to protect fragile currencies, provide increased stability and predictability to the world's economies, and, at the same time, encourage free markets. To these ends, the nations supporting the Bretton Woods agreements created the International Monetary Fund and the International Bank for Reconstruction (today known as the World Bank). Moreover, the U.S. Dollar was (in effect) pegged to gold at a set price of $35 an ounce and, further, was established as the world's reserve currency. Other currencies were then pegged to the dollar. Various other mechanisms were established to make currencies freely convertible, yet with pricing kept within predictable limits. The Bretton Woods System ultimately gave way to changes in the international financial system and was formally abandoned in the early 1970s. Yet, Bretton Woods is of far more than merely historical interest. The System created lasting institutions (the IMF, the World Bank) and provided the model for future international financial regimes.

Overview

The Bretton Woods System generally refers to the international economic and monetary regime which operated in the free market economies from the end of the Second World War to the early 1970s. The regime grew out of a series of meetings between the Allied Powers during World War II, climaxing in a conference at the Mount Washington Hotel in Bretton Woods, New Hampshire-hence the name (Grabbe, 1996). There, the American and British delegations agreed on a general schema for a post-war monetary structure. In particular, the delegates called for a system where-in the U.S. dollar was made the world's reserve currency. Further, the U.S. Dollar was pegged to gold at a set price of $35 an ounce and then other nations' currencies were pegged to the dollar. The general intention was to create a situation in which world currencies were fully convertible with one another, but would not be subject to wide fluctuations in value-in effect, currencies would be fixed but fluid (Cohen, 2001).

In addition, The Bretton Woods agreement created the International Monetary Fund (IMF) and the International Bank for Reconstruction (today known as the World Bank). The IMF was meant to be a standing reservoir of gold and currency—provided by member states—that the members could borrow from when they found their reserves of foreign currency running short. The Bank, meanwhile, was intended to help the devastated economies of Europe and Asia rebuild after World War II.

The Bretton Woods System functioned with mixed results during the 1950s and 1960s. In many ways, it ceased to be a multinational effort and instead became the system by which the United States acted to provide currency stability to the world. However, in that role, it was reasonably successful, at least until the 1960s and early 1970s, when it became clear that the global economy was now too large to be effectively managed by any individual state, no matter how affluent, and particularly so in an age of increasing oil prices (Hammes, 2005). Bretton Woods was therefore gradually abandoned. Yet, Bretton Woods is of far more than merely historical interest. The System created lasting institutions (the IMF, the World Bank) and provided the model for future international financial regimes.

Knowledge of the Bretton Woods agreement is thus important to any individual who intends to participate in or study modern international finance and commerce. It is, quite simply, the foundation on which much else was built.

Discussion. The Bretton Woods agreement grew directly out of the disasters of World War II and the Great Depression before it. Economists and other theorists argued that the horrors of the war could be traced at least in part to the collapse of the international economic system after 1919. These theorists held that in the aftermath of the Great War, the world more or less drifted into a period of protectionism, competitive devaluations (i.e., nations would devalue their currencies to make their own exporters cheaper than those of rival nations), "begger-your-neighbor" government policies, and more or less overt economic warfare (Ramsaran, 1998). Such policies led more or less inevitably to new wars-or so went the argument-in that nations were therefore forced to seek control over their own and other markets via armed conflict.

Determined not to repeat history, Britain and the United States elected to design post-war political and economic frameworks. The political framework came first, in the summer of 1941 (thus actually predating the entry of the United States to the war), and took form as the Atlantic Charter. This was a joint declaration by the USA and the United Kingdom, represented respectively by President Franklin D. Roosevelt and Prime Minister Winston Churchill, pledging the two nations to support world peace, the inviolability of national frontiers, global economic co-operation, and free markets (usinfo.state.gov, 2007). Following Pearl Harbor, the Atlantic Charter (the formal entry of the United States in the Second World War) became a potent psychological weapon; akin to Woodrow Wilson's "Fourteen Points," in that it seemed to presage a more just, prosperous era to come after what the Charter referred to as "the final destruction of the Nazi tyranny."

But, part of the appeal of the Charter was that it would be soon paired with a hard-headed vision of a new economic system. In 1944, the two countries convened a conference of all the Allied nations (plus Argentina) at the Mount Washington Hotel in Bretton Woods, New Hampshire (Cohen, 2001). There, the British delegation, headed by John Maynard Keynes, and the American delegation, headed by Harry Dexter White, worked out the details of the agreement with remarkable speed.

This is not to say that the Bretton Woods discussions were entirely without tension. While Keynes and White shared many goals and ideals, they did have significant differences. Keynes came to Bretton Woods with a plan for a world economic order that would include an international central bank, complete with the power to issue an international currency to be called the bancor. In addition, Keynes envisioned a system uniquely favorable to rapid economic development (partly in an attempt to rebuild Europe after the war) and, so, in the process, softened the requirements to be leveled on creditor nations. White also came to the Woods with plans for something like a central bank, and something like an international currency, to be called the unitas. However, he differed from Keynes in that his planned economic order favored economic stability over rapid development.

The International Monetary Fund & The International Bank for Reconstruction. Neither man got entirely what he wanted, and the bancor / unitas was a classic non-starter but in other ways both could claim some satisfaction from the discussion. The Bretton Woods agreement envisioned a new, stabilizing system that was also committed to free markets and free trade. The system (eventually) supported the creation of two new institutions, the IMF and the International Bank for Reconstruction (today known as the World Bank). The World Bank would act to provide technical and financial assistance to troubled economies worldwide—initially, this meant the war-ravaged nations of Europe and Asia. The IMF, meanwhile, was designed to provide assistance to any member nation that found it could not meet its requirements for foreign currency. Such assistance was, however, subject to whether the country in question was willing to follow guidelines and suggestions from the IMF. The IMF was, in turn, funded by "subscriptions" of currency and gold provided by member states. Both the IMF and the World Bank have, of course, developed many other missions.

General Agreement on Tariffs & Trade. The Bretton Woods agreement also called for a General Agreement on Tariffs and Trade (GATT). This was intended to be an official multinational organization, like the World the Bank and the IMF, whose mission was to work with member states to lower barriers to free international trade. However, for a variety of domestic political reasons, GATT was not (at first) popular in the United States Congress and so was not ratified. Still, GATT functioned quite effectively as a quasi-official organization (technically, it was an "agreement" rather than a full fledged treaty). In time, the usefulness of an international trade regime seemed so obvious that opposition faded even among GATT's harshest critics. In 1983, GATT was replaced by the World Trade Organization (WTO), effectively realizing the hopes of the Bretton Woods delegates.

Convertible Currencies. In addition to these institutions, Bretton Woods envisioned a mechanism for the controlled liberation of national currencies. Its founders wished to see currencies freely convertible, but they also wished to avoid the kind of competitive devaluations that had marred the 1930s. The American dollar was, therefore, designated the world's reserve currency (with the British pound playing a similar role when need be) and other nations would maintain their foreign reserves chiefly in the form of dollars (Grabbe, 1996). Further, each member of the IMF would maintain the value of its currency at one percent plus or minus a pre-established standard—something it would do by buying or selling dollars for its reserves, and thus increasing or decreasing the value of its holdings and hence of its own currency. The dollar, in turn, would be pegged to gold which the U.S. government pledged to buy at $35 an ounce. Finally, within these parameters, currencies were to be fully convertible (Grabbe, 1996).

It soon became clear that the Bretton Woods system would not function as originally planned. The world's free market economies were still simply too fragile to support an international monetary regime as complex as that envisioned by Keynes and White. Therefore, the role of the world's reserve banker fell increasingly to the United States itself. The system's critics argued that Bretton Woods had become little more than the official mechanism by which America disguised its real role as lender of last resort (Cohen, 2001).

However, if that was its real role, then Bretton Woods performed it relatively well for nearly two decades. Admittedly, there were some difficulties. Early in its life, many nations found themselves short of the dollars necessary for maintaining reserves in that currency. However, the host of American aid programs designed to rebuild Europe (and forestall Soviet influence there) soon addressed that problem. Then, as Europe and Asia began to rebuild, the U.S. government found itself somewhat embarrassingly short of gold. The United States had pledged to buy gold at $35 an ounce. European and other governments proceeded to use their newly won dollar reserves to buy it at that price.

Still, the Bretton Woods system did not show serious signs of strain until the late 1960s. Then, however, the system's faults became all too clear. First, governments and organizations outside the United States, who had long felt that the Bretton Woods gave far too much power to America, now began to (loudly) express that opinion. Second, Americans in turn were beginning to discover that no economy was strong enough to act as a final guarantor for every other economy on the planet—at least not in an age of increasing globalization. Third, international financial transactions were now simply too large to be handled by the Bretton Woods mechanisms. In 1944, the amount of capital moving around the world was relatively small. Twenty years later, it was considerably larger, and growing at tremendous speed.

After several unsuccessful efforts to reform Bretton Woods, the U.S. government (and the world) acknowledged the inevitable. In May 1971, then President Nixon announced that the dollar would no longer be convertible to gold (Grabbe, 24). By 1973, all the major industrial nations had abandoned fixed exchange rates. Today, their currencies float freely on the highly efficient, if sometimes hazardous, world markets.

This is not, however, to suggest that Bretton Woods is, today, only of historical interest. The Bretton Woods system has left several important legacies. Institutionally, this includes the World Bank and the IMF, both of which survived the system that birthed them and now are vital parts of the global economy. Moreover, even if the Bretton Woods system was not adequate to deal with a globalized economy in which trillions of dollars, yen, and Euros may flash about the world with a single mouse click, still, it did very well in the world from which it was designed. It shielded delicate economies recovering from war and gave fragile currencies stability that they could not otherwise have had. However, what may be Bretton Woods' most important bequest may be simply that of its own example. In effect, it provided evidence that an international monetary regime was possible.

Indeed, Bretton Woods' attempt to produce convertible but fixed currencies may be tried again, albeit on smaller scales. After the 1997 currency crisis, Prime Minister Mahathir bin Mohamad of Malaysia aggressively promoted currency controls to protect his country's economy from the worst effects of the emergency. He also suggested a precious metals-backed Gold Dinar to function as a trade currency for the Islamic world (Evans, 2003). In other words, the Prime Minister's plan looked a bit like a Bretton Woods for Pan-Islam.

Conclusion

Any student or practitioner of international finance needs at least a base understanding of the Bretton Woods agreement. The system based on it, though originally designed to deal with the relatively small volumes of international currency transfer of the early post-war period, provided the foundation upon which much of today's international financial market is based.

In brief, the Bretton Woods system was devised to restore financial and monetary stability to a world that had been devastated by the Second World War. To provide structure and stability to a situation which seemed otherwise chaotic, the United States and Great Britain devised a regime where-by the U.S. dollar was made the world's reserve currency. Further, the U.S. Dollar was pegged to gold at a set price of $35 an ounce and then other nations' currencies were pegged to the dollar. In the process, the Bretton Woods systems thus made certain that national currencies were fully convertible with one another, but would not be subject to wide fluctuations in value.

In addition, The Bretton Woods agreement created two financial institutions, both important to this day. These were the International Monetary Fund (IMF) and the International Bank for Reconstruction, a.k.a., the World Bank. The IMF was meant to provide a reservoir of currency and gold that the members could call upon for assistance if they found their own supplies of foreign currency inadequate. The Bank, meanwhile, was meant to assist in the reconstruction of the economies of Europe and Asia.

In the long run, the Bretton Woods system was incapable of dealing with the realities of modern global financial markets and it had been abandoned by 1973. Yet, this is in no way to fault the authors of the Bretton Woods agreements. If they did foresee the end of the journey they began in 1944, then it was because they were pioneers, quite literally entering uncharted territory. The system they created, despite its failures, functioned for nearly two decades, and the institutions that accompanied it—the World Bank and the IMF—have endured well into the twenty-first century.

Terms & Concepts

Bretton Woods: A town in the American state of New Hampshire. In this community in 1944, British, American, and delegates from other Allied powers gathered to discuss post-war economic arrangements.

Bretton Woods System: A term generally assigned to the international economic and monetary regime designed in 1944 and implemented (in stages) from the end of the Second World War to the late 1950s. The Bretton Woods system envisioned fixed but convertible currencies. Bretton Woods's authors also founded two important transnational economic institutions, viz., the World Bank and the IMF.

Interntional Monetary Fund (IMF): A fund and organization established by the Bretton Wood agreements. The IMF was designed to provide assistance to any member nation that found it could not meet its requirements for foreign currency. Today, the IMF's functions have been vastly expanded to include economic development assistance world-wide.

The International Bank for Reconstruction: An organization established by the Bretton Wood agreement to help the devastated economies of Europe and Asia rebuild after World War II. Today, the Bank is known as the World Bank and, like the IMF, has expanded its mission to include economic development assistance and other services world-wide.

John Maynard Keynes: Famed British economist. Head of the British Delegation at Bretton Woods.

Harry Dexter White: American economist and Treasury Department official. White was also the head of the American delegation at Bretton Woods.

World Bank: See The International Bank for Reconstruction.

Bibliography

Cohen, B. (2001). Bretton Woods system. In R. J. B. Jones (Ed.), Routledge encyclopedia of international political economy. London: Routledge.

Evans, A. (2003, July 8). Evolving a Gold Dinar trade bloc. Malaysian Business..

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Grabbe, J. O. (1996). International financial markets. Englewood Cliffs, NJ: Prentice Hall.

Hall, S.G., & Tavlas, G.S. (2013). The debate about the revived Bretton-Woods Regime: A survey and extension of the literature. Journal of Economic Surveys, 27, 340–363. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85896923&site=ehost-live

Hammes, D. and Wills, D. (2005). Black gold. Independent Review, 9, 501–511. Retrieved May 7, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16628736&site=bsi-live

Lew, Jacob J. (2016). America and the global economy. Foreign Affairs, 95(3), 56–68. Retrieved January 22, 2017, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=114537281&site=ehost-live&scope=site

Ramsaran, R. F. (1998). An introduction to international money and finance. New York: St. Martins Press.

Razmi, A. (2013). Bretton Woods II and the East Asian emerging economies: Lazarus, Phoenix, or Humpty Dumpty?. International Economic Journal, 27, 321–345. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89949425&site=ehost-live

United States Department of State (2007). The Atlantic Charter (1941). Retrieved May 26, 2006, from Basic Readings In U.S. Democracy.http://usinfo.state.gov/usa/infousa/facts/democrac/53.htm

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Suggested Reading

Cevik, S., Harris, R. F., & Yilmaz, F. (2017). Soft power and exchange rate volatility. International Finance, 20(3), 271–288. Retrieved January 22, 2017, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=126899559&site=ehost-live&scope=site

Gray, W. G. (2007). Floating the system: Germany, the United States, and the breakdown of Bretton Woods, 1969-1973. Diplomatic History, 31, 295–323. Retrieved May 7, 2007, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=24367616&site=ehost-live

Langley, P. (2002). World financial orders: An historical international political economy. New York: Routledge.

N.H.'s largest conference facilities. (2007). New Hampshire Business Review, 28, 104–115. Retrieved May 29, 2007, from EBSCO Online Database Regional Business News. http://search.ebscohost.com/login.aspx?direct=true&db=bwh&AN=23630163&site=ehost-live

Rahn, R. W. (2007, April 18). Sayonara to world finance sisters? The Washington Times, pp. A19.