Bretton Woods System

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Routledge Encyclopedia of International Political Economy

The Bretton Woods system is commonly understood to refer to theinternational monetary regime that prevailed from the end of WorldWar II until the early 1970s. Taking its name from the site of the 1944conference that created the *International Monetary Fund (IMF) and*World Bank, the Bretton Woods system was history's first example ofa fully negotiated monetary order intended to govern currencyrelations among sovereign states. In principle, the regime wasdesigned to combine binding legal obligations with multilateraldecision-making conducted through an international organization, theIMF, endowed with limited supranational authority. In practice theinitial scheme, as well as its subsequent development and ultimatedemise, were directly dependent on the preferences and policies ofits most powerful member, the United States.Design of the Bretton Woods systemThe conference that gave birth to the system, held in the Amricanresort village of Bretton Woods, New Hampshire, was the culminationof some two and a half years of planning for postwar monetaryreconstruction by the Treasuries of the United Kingdom and theUnited States. Although attended by all forty four allied nations, plusone neutral government (Argentina), conference discussion wasdominated by two rival plans developed, respectively, by Harry DexterWhite of the U.S. Treasury and by *John Maynard Keynes of Britain.The compromise that ultimately emerged was much closer to White'splan than to that of Keynes, reflecting the overwhelming *power of theUnited States as World War II was drawing to a close.Athough, at the time, gaps between the White and Keynes plansseemed enormous - especially with respect to the issue of futureaccess to international *liquidity - in retrospect it is their similaritiesrather than their differences that appear most striking. In fact, therewas much common ground among all the participating governmentsat Bretton Woods. All agreed that the monetary chaos of the interwarperiod had yielded several valuable lessons. All were determined toavoid repeating what they perceived to be the errors of the past. Theirconsensus of judgment was reflected directly in the Articles ofAgreement of the IMF.Four points in particular stand out. First, negotiators generally agreed

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that as far as they were concerned, the interwar period hadconclusively demonstrated the fundamental disadvantages ofunrestrained flexibility of *exchange rates. The floating rates of the1930s were seen as having discouraged trade and investment and tohave encouraged destabilizing speculation and competitivedepreciations. Yet in an era of more activist economic policy,governments were at the same time reluctant to return to permanentlyfixed rates on the model of the classical *gold standard of thenineteenth century. Policy-makers understandably wished to retainthe right to revise currency values on occasion as circumstanceswarranted. Hence a compromise was sought between the polaralternatives of either freely floating or irrevocably fixed rates - somearrangement that might gain the advantages of both without sufferingthe disadvantages of either.What emerged was the 'pegged rate' or 'adjustable peg' currencyregime, also known as the par value system. Members were obligatedto declare a par value (a 'peg') for their national money and tointervene in currency markets to limit exchange rate fluctuationswithin maximum margins (a 'band') one per cent above or belowparity; but they also retained the right, whenever necessary and inaccordance with agreed procedures, to alter their par value to correcta 'fundamental disequilibrium' in their *balance of payments.Regrettably the notion of fundamental disequilibrium, though key tothe operation of the par value system, was never spelled out in anydetail - a notorious omission that would eventually come back tohaunt the regime in later years.Second, all governments generally agreed that if exchange rateswere not to float freely, states would also require assurance of anadequate supply of monetary reserves. Negotiators did not think itnecessary to alter in any fundamental way the *gold exchangestandard that had been inherited from the interwar years.International liquidity would still consist primarily of national stocks ofgold or currencies convertible, directly or indirectly, into gold ('goldexchange'). The United States, in particular, was loth to alter eitherthe central role of the dollar or the value of its gold reserves, which atthe time amounted to three quarters of all central bank gold in theworld. Negotiators, did concur, however, on the desirability of somesupplementary source of liquidity for deficit countries. The bigquestion was whether that source should, as proposed by Keynes, beakin to a world central bank able to create new reserves at will (whichKeynes thought might be called *bancor); or a more limited borrowingmechanism, as preferred by White.What emerged largely reflected U.S. preferences: a system ofsubscriptions and quotas embedded in the IMF, which itself was to beno more than a fixed pool of national currencies and gold subscribedby each country. Members were assigned quotas, roughly reflectingeach state's relative economic importance, and were obligated to payinto the Fund a subscription of equal amount. The subscription was

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to be paid 25 per cent in gold or currency convertible into gold(effectively the dollar, which was the only currency then still directlygold convertible for central banks) and 75 per cent in the member'sown money. Each member was then entitled, when short of reserves,to borrow needed foreign currency in amounts determined by the sizeof its quota.A third point on which all governments agreed was that it wasnecessary to avoid recurrence of the kind of economic warfare thathad characterized the decade of the 1930s. Some binding frameworkof rules was needed to ensure that states would remove existing*exchange controls limiting *currency convertibility and return to asystem of free multilateral payments. Hence members were inprinciple forbidden to engage in discriminatory currency practices orexchange regulation, with only two practical exceptions. First,convertibility obligations were extended to current internationaltransactions only. Governments were to refrain from regulatingpurchases and sales of currency for trade in goods or services. Butthey were not obligated to refrain from regulation of capital-accounttransactions. Indeed, they were formally encouraged to make use of*capital controls to maintain external balance in the face of potentiallydestabilizing 'hot money' flows. Second, convertibility obligationscould be deferred if a member so chose during a postwar 'transitionalperiod.' Members deferring their convertibility obligations were knownas Article XIV countries; members accepting them had so-calledArticle VIII status. One of the responsibilities assigned to the IMF wasto oversee this legal code governing currency convertibility.Finally, negotiators agreed that there was a need for an institutionalforum for international cooperation on monetary matters. Currencytroubles in the interwar years, it was felt, had been greatlyexacerbated by the absence of any established procedure ormachinery for inter-governmental consultation. In the postwar era, theFund itself would provide such a forum - in fact, an achievement oftruly historic proportions. Never before had international monetarycooperation been attempted on a permanent institutional basis. Evenmore pathbreaking was the decision to allocate voting rights amonggovernments not on a one-state, one-vote basis but rather inproportion to quotas. With one-third of all IMF quotas at the outset,the United States assured itself an effective veto over future decision-making.Together these four points defined the Bretton Woods system - amonetary regime joining an essentially unchanged gold exchangestandard, supplemented only by a centralized pool of gold andnational currencies, with an entirely new exchange rate system ofadjustable pegs. At the center of the regime was to be the IMF, whichwas expected to perform three important functions: regulatory(administering the rules governing currency values and convertibility),financial (supplying supplementary liquidity), and consultative(providing a forum for cooperation among governments). Structurally,