‘A critical evaluation of the Bretton Woods System, its theoretical

underpinnings and its implications for the future.’

Joseph Duggan

51551094

JEL: N10, F51

This dissertation is submitted in part requirement for the Degree of

M.A. with Honours in Economics at the University of Aberdeen,

Scotland, and is solely the work of the above-named candidate.

Word Count: 9869

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Contents

1. Introduction………………………………………………………………… 3

2. The Turbulence of the Interwar Years (1919-39)………………………….. 4

2.1.Overview…………………………………………………………… 4

2.2.Economic Consequences of the War………………………………. 5

2.3.Floating Exchange Rates and the Post-War Boom (1919-25)…….. 7

2.4.Gold Exchange Standard (1925-31)………………………………..10

2.5.The Rise of Managed Floating (1931-39)…………………………..14

3. The Bretton Woods Conference and a New Monetary Order (1944)………18

3.1.Global Post-War Economy………………………………………… 18

3.2.Rodrik’s Trilemma of the World Economy………………………... 19

3.3.Keynes’ Bancor Plan………………………………………………. 20

3.4.The Final Agreement………………………………………………. 22

4. The Bretton Woods System in action: Pre-convertibility (1946-1958)…… 25

4.1.The Economic Miracle ……………………………………………. 26

4.2.Inflation……………………………………………………………. 28

4.3.Emergence of the Triffin Dilemma………………………………… 31

5. The Convertible phase and the demise of Bretton Woods (1959-71)……… 33

6. A New Bretton Woods……………………………………………………... 36

7. Conclusion………………………………………………………………….. 37

8. Bibliography………………………………………………………………… 39

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Abstract

This paper provides an examination of both the theoretical background of the Bretton Woods

System and its performance from 1946-71. For the theoretical background, the experience of

the Interwar Years (1919-39) will be discussed, as it provides an example of three distinct

monetary regimes. Furthermore, analysing the shortcomings and problems of this period

gives an insight into the reasons for the Bretton Woods Agreement, as it was in large part a

response to the Interwar period. The operation of the Bretton Woods System will be analysed,

identifying its successes and its deficiencies which would result in its eventual demise. A

comparison with alternatives to the Bretton Woods Agreement, namely Keynes’ Bancor Plan,

will be used to identify the reasons for its short-lived existence. This paper will conclude with

a discussion of the contemporary international economy and how, with the benefit of

hindsight, a system such as Bretton Woods could be constructed today.

Acknowledgements

I would like to thank Professor Ioannis Theodossiou for his advice and guidance.

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 1. Introduction

The Bretton Woods System was the first example of a fully negotiated international monetary

order. During its operation, the world economy experienced rapid economic growth

combined with relative stability and low unemployment, but its longevity was limited by

defects in its design. The example of the Bretton Woods System is particularly relevant to the

world at present, as large imbalances have emerged between countries with the potential for

greater instability. Therefore, an evaluation of the last time the economies of the world set

about to construct a coherent international framework could provide a lesson for future

attempts to do so. However, despite calls for a remodelled Bretton Woods by some European

leaders in the wake of the Great Recession of 2008, there has been no significant movement

towards its resurrection. In order to gain a theoretical understanding behind the Bretton

Woods System, the experiences of the International economy in the Interwar Years (1919-39)

will be reviewed. In relation to this period, the three monetary regimes of this period will be

analysed, with a discussion of the impact each regime had both domestically and

internationally. The next chapter will focus on the design of Bretton Woods, and using the

insights gained from the previous chapter, identify the problems it tried to avoid, namely

those related to adjustment, confidence and liquidity. In the second half, the functioning and

the eventual demise of the Bretton Woods System will be evaluated, analysing its impact on

the economies of Western Europe and Japan. Near the end, an overview of the economic

situation today will be given, and whether a reconstructed Bretton Woods System, with the

benefit of hindsight, could mitigate the ills of the global economy.

4
 2. The Turbulence of the Interwar Years (1919-1939)

2.1 Overview

After four years of war, the international monetary system was left in ruins, the consequences

of which brought about severe upheaval to world trade and investment in the years to come.

The Gold Standard which had existed from the late 19th century up until the outbreak of war,

was held to be central to the promotion of ‘trade, financial integration, and prosperity’

throughout this period (Wandschneider, 2008). Its disintegration under the immense strains

entailed in financing the war, gave way to a series of three distinct monetary regimes between

1919-39. Beginning with the 1918-25 period of floating exchange rates, which differed from

the latter period (1931-39) in that governments, unfamiliar with floating currencies, did not

intervene in the exchange market to manipulate currency values (Scammel, 1987). The Gold

Exchange Standard, established around 1925, differed from the Classical Gold Standard, in

that it was based around a few gold centres (Countries with a direct link with gold), while

other nations tied their currencies to one of the gold-backed currencies. This system was

abandoned by the 1930s, with the UK suspending convertibility in 1931, as maintaining it

became increasingly costly for the economies in the grips of the Great Depression. This led to

managed floating, in which governments actively took measures to manipulate exchange

rates, resulting in competitive devaluations, protectionism and economic nationalism, as a

means of counteracting the depression. The complete collapse of multilateralism, which had

been essential for the functioning of the pre-war Gold Standard, culminated in the currency

and trade wars of the 1930s, in which policies that benefitted one nation exported deflation

and unemployment to another. The economic difficulties of the 1930s were perhaps the

central factor in the rise of political extremism, for as Keynes said, ‘It is not liberal politics

5
that is the guarantor of prosperity. It is prosperity that is the only secure guarantor of liberal

politics.’ (Skidelsky, 2000).

2.2 The Economic Consequences of War

The consequences of war fundamentally transformed the global economic landscape. The

pre-war pattern of international trade had been radically altered, with the United States,

Canada and Japan emerging as major trading powers at the expense of European economies,

namely Britain, France, and Germany. The shift in global trading power can be evidenced by

Europe’s decline from 1913-20, with its share of global trade falling from 58.4% to 49.2%,

with the share of the Americas rising from 22.4% to 32.1%. Over the same period, American

exports of wheat and flour more than tripled in value during 1913-18 and its meat exports

expanded 10-fold (Eichengreen, 1991). The War bears responsibility for Europe’s decline in

global trade shares, as the explosion in demand for supplies had to be satisfied by a higher

volume of imports, while at the same time European economies had to divert a larger

proportion of their production away from export industries. While world industrial output had

recovered to its 1913 level by 1922, the volume of world exports in 1920 was approximately

half of what was recorded in 1913 (Aldcroft, 1977). As for Europe, the 1913 levels of output

were only marginally surpassed in 1925, yet its volume of trade remained approximately 10%

less than what it was in 1913 (Aldcroft, 1977).

The malaise of Europe can be attributed to the infrastructural damage inflicted by the war, its

heavy debt burden and the instability of the international monetary system. In terms of

physical damage, the destruction of productive capital, such as factories and machinery,

throughout Europe limited its ability to expand output and trade. Additionally, territorial

changes resulted in some countries loosing important industrial centres. Germany, for

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example, lost approximately 15% of its pre-war economic capacity due to loss of territory

(Aldcroft, 1977).

The accumulation of debt during the war exacerbated this, by reducing the funds available to

governments for reconstruction. The cost of war has been estimated at six and a half times all

national debt amassed between the end of the 18th century until 1914. Because deficit

financing was widespread, public debt levels grew explosively. When taken in sum,

approximately 80% of all wartime expenditures were funded by borrowing, and much of it

derived from bank credit (Aldcroft, 1977). The 1920 data concerning internal debt to GDP

ratio is illustrative of this rapid increase with France having a ratio of 1.64 and Britain’s

standing at 1.26- the US in contrast had a ratio of 0.27 (Eichengreen, 1991). The existence of

large overhanging short-term public debt, reaching 65% of France’s GNP in 1920,

undermined currency stabilisation, as if the public refused to renew short-term public debt,

the central bank would be forced to print money and transfer it to the treasury. This process

would increase the supply of money, resulting in inflation and a depreciation of the currency.

Therefore, debt was to greatly inhibit efforts to stabilise the international monetary system.

The absence of monetary stability subsequently diminished international trade and

investment, by increasing the cost of cross-border transactions.

As a result of all these factors, the nations of Europe experienced serious balance of payments

difficulties throughout the period. The war had brought America to the forefront as a net

creditor. Subsequently, the stability of Europe’s balance of payments became highly

dependent upon America recycling its surpluses in the form of capital exports (Aldcroft,

1977).

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2.3 Floating Exchange rates and the Post-War Boom (1919-1925)

The abandonment of the Gold Standard ushered in an unfamiliar era of floating exchange

rates which existed approximately from 1919-1925. The US was an exception to this, as it

returned to gold in 1919. Unlike future experiences of floating regimes, the one existing in

the immediate post-war era was subject to minimal direct intervention in the exchange

market. Instead, market forces were permitted to reassert themselves and thus the exchange

rate was to be determined by the market. Since such a system had not existed previously,

there was a limited understanding of how it functioned and how to best manage it. Because of

this, the notion of leaving the balance of payments to be adjusted by exchange rate changes

was disregarded (Scammell, 1987). The transition to a generalised float began in Mach 1919,

when the US ceased its intervention on behalf of the UK and France. Due to the divergence in

price levels during the war, Britain’s dollar exchange rate fell dramatically below its pre-war

levels, from $4.86=£1 to $3.40=£1 (Scammell, 1987). Thus, for Britain to fulfil the advice of

the Cuncliffe Committee (1918), which recommended a rapid return to gold at pre-war parity,

a significant deflation of British prices relative to American prices was required. However,

problems of demobilisation, reconstruction and high levels of debt made this goal unfeasible

at the time, and floating exchange rates had to be adopted as a necessity. The reason being

that the suspension of the Gold Standard gave greater autonomy to national monetary

authorities, and thus allowed for expansionary monetary policy to relieve domestic ills.

The adoption of a free-floating system of exchange rates while offering greater

manoeuvrability to policy makers in the face of crises, also permitted for unprecedented

instability. The example of the Post-War Boom (1919-21), is illustrative of the paradigm shift

of the international economy. A period of such extreme volatility had not occurred in living

memory, with prices rising and falling by 50% within the space of a 24 months (Eichengreen,

1991). However, this extreme volatility in economic activity and prices was primarily

8
confined to those countries whose productive capacities had been relatively unscathed by

war, namely the US, Western Europe and Japan (Aldcroft, 1977).

The final two years of the war saw wages rising quicker than prices, yet wartime restrictions

had prevented this higher purchasing power to be spent on consumers’ goods. Thus, once

controls were abolished following the war’s end, this accumulated purchasing power was

suddenly released, resulting in a severe upswing in prices (Skidelsky, 2000). With wages no

longer keeping pace with prices, a ‘Profit Inflation’ arose (Keynes, 1930). Adding to this, a

‘Restocking boom’ occurred, in which the retained earnings amassed by businesses during

the war, were used to replenish their stocks of capital and raw materials in preparation for

peace time production. This sudden release in demand, in combination with the disintegration

of internal transport systems and shortages in shipping space, created bottlenecks and

exacerbated inflationary pressures (Aldcroft, 1977).

The framework of free-floating exchange rates helped to maintain the Post-War Boom since

it enabled governments to pursue ‘cheap money’ policies, by keeping interest rates low.

Keynes characterised this period as one where ‘money was the one commodity to the rapid

manufacture of which there was no serious impediment’ (Skidelsky, 2000). However, the

maintenance of low interest rates even when the boom started to get out of control, enabled a

severe inflationary episode to take hold. Unlike the preceding Gold Standard, where central

banks would be required to deflate the economy in order to restore external equilibrium, there

was no longer an external mechanism to enforce monetary and fiscal discipline.

The maintenance of expansionary policies, low interest rates and deficit spending, during the

period from 1919-20 while inflationary, proved difficult to reverse in practical terms.

Because governments feared a sharp depression due to difficulties related to demobilisation

and transitioning to peace-time production, they saw inflation as a way of easing the

9
transition. Thus, they restrained central banks from implementing deflationary measures, to

prevent the conditions for labour unrest. Additional commitments made to war veterans such

as pensions, health care and housing provision, necessitated expansionary policies.

This period of low interest rates was also seen as a prerequisite for funding floating debt in

order to replace short-term treasury bills with long-term bonds, so that governments could

secure funding on more stable terms (Eichengreen, 1991). If the central bank were to increase

the market interest rates at this time, treasury bills would not be renewed and a switch to

commercial bills would be likely. This would necessitate the Treasury to seek funding from

the central bank, which would increase the money supply, worsen inflation and undermine

currency stabilisation. In the absence of this debt replacement, it would become almost

impossible for the central aim of economic policy of the post-war era to be achieved, that

being the eventual return to the Gold Standard.

As government policy was also responsible for magnifying the upswing, it also intensified the

downturn. The US government along with Britain and others began to pursue contractionary

monetary policy and fiscal retrenchment. In 1920, the British bank rate was increased to 7%

and held there for a year, with the addition of new taxes, in order to break the inflationary

trend. By October 1920, prices began to fall, while unemployment started to increase shortly

afterwards. At the height of the contraction, output had fallen by 15% and unemployment

stood at 22% in Britain.

The ensuing recession was severe but short lived, owing a great deal to the flexibility

afforded by free-floating. This lesson was not heeded, and the leaders of day proceeded

towards the return of the Gold Standard.

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2.4 The Gold-Exchange Standard (1925-31)

The creation of the new international gold standard was finally completed by 1928, after

almost a decade of effort to restore it. Britain’s return to gold in 1925, along with three dozen

other countries, and France’s DeFacto stabilisation in 1926 signalled that the process was

almost finished. After all the chaos of the past decade, it was believed that the final task of

restoring prosperity and tranquillity to the international economy had been achieved.

However, the Gold-Exchange Standard, despite its long and painful recreation, disintegrated

within a few years of its return. The ineffectiveness of the interwar Gold Standard was a

consequence partly of design but largely of how it was managed.

The framework of the Gold-Exchange Standard had been formulated at the Genoa

Conference (1922), where the use of foreign exchange as a substitute for gold reserves was

institutionalised. Therefore, the system would function with ‘Gold Centres’, being the US and

UK, which made their currency fully convertible into gold, while other countries could hold

foreign exchange, in the form of pounds or dollars, as part of their reserves. This system was

seen as a way of ‘Economising on Gold’, as it enabled countries with a shortage of metallic

reserves to hold foreign exchange of an international reserve currency instead. Concerns over

a global gold shortage had made this adaptation necessary, as global gold production had

been growing slowly since 1915 and it was feared that the supply of gold would be unable to

keep pace with economic growth. Therefore, central banks with insufficient gold reserves,

would be required to raise interest rates and restrict credit in order to attract scarce reserves

from other countries. If this practice became widespread among central banks, then global

deflationary pressures would be exacerbated as a result. The removal of Gold coin from

circulation was an additional measure to limit the strain on gold supplies.

11
Despite the wide spread belief that returning to the International Gold Standard would be the

beginning of an era of prosperity and price stability, in reality this was not the case. While

there was an initial boom after the return to gold, its foundations remained ‘fragile and

precarious’ (Aldcroft, 1977). Even though the expansion of output and trade increased, levels

of unemployment remained high, with rates of over 10% not uncommon, and growth of real

wages in many European countries was moderate or non-existent. The promise of price

stability also failed to materialise, as the remainder of the 1920s was marked by deflationary

tendencies. From 1925-29, Britain experienced a 15% decline in wholesale prices

(Eichengreen, 1991).

The reasons for the failure of the Gold-Exchange Standard to fulfil the hopes of many, can be

attributed to insufficient international cooperation, an ineffective adjustment mechanism,

inappropriate parity values and the growth of mass democracy.

The absence of effective international cooperation stemmed from bitter disputes over

reparations and war debts, which repeatedly proved to be an obstacle to establishing a

common framework of rules and regulations for the operation of the new gold standard.

Attempts to do this at the Genoa Conference (1922) failed, and as a result, in the face of

future crises, international cooperation would have to be convened on an ad-hoc basis, rather

than being systematic and guided by protocol. This proved to be detrimental to the function

of the Gold-Exchange Standards, as when crisis arose, countries suffering from gold

shortages and balance of payments difficulties were left to fend for themselves. Instead,

collective action on behalf of other central banks would have been able to ameliorate crises

by providing additional liquidity to those countries experiencing shortages.

The new system failed to maintain equilibrium in the international balance of payments, as

the adjustment mechanism proved unable to correct the imbalances. Consequently, the US

12
and France were able to maintain large surpluses, while Britain was in deficit for much of the

period. In theory the adjustment mechanism should have worked in such a way that the

international flows of gold would influence the domestic money supply, thus bringing about

adjustments in price levels that would eventually eliminate imbalances. However, the pursuit

of ‘Sterilisation’ policies by governments prevented international gold flows from having a

significant effect on domestic money supplies. It was estimated by Ragnar Nurkse, that

central banks failed to sterilise gold flows approximately a third of the time, and the US

Federal Reserve had been engaging in sterilisation for much of the 1920s. With failing to

reduce imbalances, gold would continue to flow from the deficit to surplus nations. The US

and France strongly pursued this policy and as a result they absorbed gold at an ‘alarming

rate’ throughout the latter 1920s, with their combined share of the global monetary gold stock

reaching 60% by 1931 (Eichengreen, 1987). Eichengreen estimates that the US and French

gold reserves were 110% and 280% in excess of levels required based upon their economic

characteristics. The failure of adjustment meant that the large imbalances persisted and thus

the international flow of reserves continued with ever larger inflows from deficit to surplus

countries. As a result, the balance-of-payments positions of deficit countries became

increasingly unsustainable, and the longer this was the case, the greater the risk of a

convertibility crisis. In the absence of fundamental adjustment, the fragile equilibrium in the

late 1920s rested upon huge quantities of imported capital, primarily from the US. Though in

contrast to the Marshall Plan after 1945, the loans flowing to Europe from the US were

overwhelmingly from private institutions, and herein lies a great source of instability. Since

the international equilibrium strongly depended upon the US recycling its surpluses, the fact

that they were recycled by private institutions, as opposed to US government loans, made

them highly volatile. Therefore, without an official mechanism for recycling surpluses, so

called ‘Fairweather Recycling’ takes hold. Private financial capital flows in such a way that it

13
will be in abundance during the expansion phase, and almost non-existent when the economy

begins to faulter.

This precarious equilibrium broke down in 1928 when the US Federal Reserve, due to

growing concerns of an inflationary boom, tightened credit and raised domestic interest rates,

resulting in a sharp contraction in US capital exports. Because the International Gold-

Exchange Standard tied the economic policies of its adherents together, foreign central banks

were obligated to match the increase in US interest rates. An asymmetric shock was

transmitted. In an era where democratic pressures on governments had risen significantly, the

willingness to carry out such ‘draconian compression of domestic spending’ had diminished,

especially when the domestic economy was already in a state of underemployment.

However, failure to execute these measures would intensify reserve loses, as capital would

flow towards the US, and eventually drive them off the gold standard. By 1931, Britain was

driven off the gold standard in the face of a convertibility crisis.

In summation, the Gold-Exchange Standard was ineffective and bears responsibility for the

global transmission and exacerbation of the Great Depression. The fundamental flaw was that

the new system lacked regularised cooperation, so much so that when crisis struck, countries

in the direst of circumstances had the burden of adjustment shifted almost entirely upon them.

The absence of a multilateral approach meant that countries often acted in their own

perceived interest, disregarding the fact that troubles in the rest of the world would ultimately

have severe implications for them, essentially the principle that ‘no man is an island’.

Furthermore, the external constraints placed upon governments limited their ability to

autonomously stimulate the domestic economy, as doing so would worsen their balance-of-

payments position leading to further outflows of gold reserves. Thus, the only way to

promote recovery within the gold standard framework required multilateral expansionary

policies.

14
2.5 The rise of managed floating (1931-39)

The end of the Gold-Exchange Standard as an international monetary system came in 1931,

when Britain along with nine other countries suspended convertibility, thus breaking the link

with gold. In the following months, many more were to follow. For Britain, facing a

convertibility crisis, had the choice between tightening its monetary policy, in keeping with

the Gold Standard framework, or abandoning the Gold Standard. Britain had found itself in

the so called ‘Mlynarski Dilemma’, in which, due to it being a reserve currency, it

accumulated foreign reserves. As the amount of foreign reserves grew in relation to Britain’s

gold reserves, confidence in the Bank of England’s ability to back these claims up fell,

resulting in an outflow of reserves. In the face of mass unemployment, reaching 21% in 1931,

the pursuit of financial stringency and tight money proved unpalatable for a government

subject to greater democratic pressures than in the past (Eichengreen, 1991). With the

disintegration of the Gold-Exchange Standard, the international economy fragmented into

different monetary blocs, with Britain being at the centre of the ‘Sterling Zone’ which

included much of its Empire. The countries that remained on gold, the US, France, the

Netherlands and Belgium to name a few, formed the ‘Gold Bloc’. Finally, there was a

collection of central European countries which imposed Exchange Controls while remaining

on gold, such as Germany, Austria and Romania.

Once freed of the external constraints arising from fixed parities, countries that devalued

could unilaterally reflate their economies, by lowering interest rates. Britain, with this greater

autonomy, pursued an easy money policy, choosing to keep interest rates consistently at 2%

from 1932-39 (Skidelsky, 2000). However, despite the increase in autonomy afforded by

leaving the Gold Standards, it was typical that six months to a year would elapse before

governments began to experiment with reflationary policies, due to the prevalence of the

Gold Standard Ethos which stressed financial rectitude (Eichengreen, 1991).

15
Unlike the experience with floating exchange rates in the early 1920s, the 1930s exchange

rates were subject to a considerable degree of manipulation by governments. Through direct

intervention in the foreign exchange market, governments could adjust the value of its

currency. The British Exchange Equalisation Account was setup for this purpose, and

actively managed the exchange rate to keep it at a competitively advantageous level. Other

countries, namely Germany and Austria, implemented exchange controls by restricting

capital exports in order to regulate their exchange rates. The impact of competitive

devaluation and monetary policy autonomy was beneficial for the economies that utilised

them. The countries that decided to go down this path, experienced higher rates of growth

and exceeded pre-1929 levels of output quicker than those who remained on gold.

(Eichengreen and Sachs, 1984)

Figure 1 demonstrates the relationship between devaluation and the recovery of industrial

production by 1935, with 1929 being the base year (Eichengreen and Sachs, 1984). As can be

16
seen, a significant relationship exists between the extent of devaluation and the pace of

recovery in industrial output. After an approximately 40% devaluation of the pound since

1929, British Industrial output had surpassed its 1929 levels by around 12%. In contrast,

France, as a member of the ‘Gold Bloc’, maintained its original parity and as a result by 1935

its level of industrial output remained approximately 30% below 1929 levels. Belgium is an

outlier in this sample, perhaps explained by the fact that it only devalued its currency in 1935,

thus insufficient time had passed for any changes to take hold.

The decision taken by countries to devaluate stimulated both output and employment. By

increasing the prices of imports relative to domestic goods, a shift in domestic expenditure

towards domestically produced goods occurs. While such a measure is beneficial for an

individual country, the decline in domestic expenditure on foreign goods is likely to exert

deflationary pressures abroad. The foreign country would likely experience a worsening

balance-of-payments and higher unemployment as a consequence. Eichengreen and Sachs

(1984), argue that the policy of devaluation need not necessarily be beggar-thy-neighbour,

depending upon the policies pursued alongside it. If a competitive devaluation is followed by

a sufficiently large monetary expansion in the devaluing country so a gold outflow is caused,

then the subsequent fall in world interest rates could stimulate economic activity abroad.

However, they conclude that in reality this was not the case as countries gaining from

devaluation failed to expand the money supply, thus they attracted gold away from abroad.

This worsened the economic situation abroad.

In the context of the 1930s, currency depreciation had negative repercussions for those

countries remaining part of the ‘Gold Bloc’. As Keynes (1931) said, ‘competitive

disadvantage will be concentrated on those few countries which remain on the gold standard’.

In an attempt to counteract the loss of competitiveness, ‘Gold Bloc’ countries imposed trade

barriers in retaliation, such as import tariffs and quotas. As a result of this struggle to gain

17
competitive advantage, the dollar value of global trade fell by 16% between 1931-32. Also,

output fell dramatically in gold standard countries due to a decline in competitiveness of their

exports, and the deflationary pressures put upon them through an outflow of their metallic

reserves. The measures used to improve the trade balance often worked, but more so by

decreasing imports rather than boosting exports.

The mounting pressure placed upon countries in the ‘Gold Bloc’ arising from continued

competitive devaluations, eventually forced the US to abandon it in 1934, and for France to

follow later in 1936. With the number of countries abandoning the Gold Standard increasing,

and the number of Exchange Funds being established with it, the potential for anarchy to

arise in the international monetary system become a tangible possibility. The existence of six

major exchange funds all pursuing their independent objectives would be a source of intense

instability, as each one of them acted to secure prosperity at the expense of the other. To

address these fears, the Tripartite Pact (1936) between France, UK and the US sought to

establish some degree of policy co-ordination by agreeing upon procedures regarding

exchange rate management (Scammel, 1987). When it was seen that unilateralism and

beggar-thy-neighbour policies had become too costly, then the only recourse was for the

return of multilateralism.

3. The Bretton Woods Conference and a New Monetary Order (1944)

As the 2nd World War was reaching its end, representatives of 44 Allied nations convened in

New Hampshire for the Bretton Woods Conference, where the post-war framework of global

capitalism was to be shaped. With the memories of the turbulence and mistakes of the

interwar years etched upon the minds of the delegates, they sought to construct an

international monetary order devoid of the failings of the past. The United States, being the

18
only major power that would emerge from the war with its industry and monetary system

unscathed, held the foremost role in shaping the new system. Additionally, given its large

current account surplus, amounting to more than 4% of its GDP (A value which in 2019

would amount to over $800 billion) and its possession of 60% of global gold reserves

(Soloman, 1982), the US had an unchallenged position, allowing it to remake ‘global

capitalism in its own image’ (Varoufakis, 2016). The fundamental principle of the new

system was to design a framework which allowed for the sovereignty of national

governments in the pursuit of domestic objectives, such as full employment, without

exporting their problems to other countries, as was the case with the ‘competitive

devaluations’ of the 1930s (Aliber, 1976).

3.1 Rodrik’s Trilemma of the World Economy

The design of every international economic order is faced by Rodrik’s ‘Political Trilemma of

the World Economy’. The ‘Trilemma’ states that when constructing an international

economic system, policy makers are faced with three choices that are simultaneously

incompatible with one another. Therefore, it is possible to combine two out of the three, but

never all three at once (Rodrik, 2010).

(Rodrik, 2010)

19
This trilemma is illustrated in the above diagram. For a system to combine the nation state

with hyper-globalisation, as was the case with the era of the International Gold Standard,

democratic politics would have to be sacrificed. This combination is referred to as the

‘Golden Straitjacket’ because it sacrifices autonomous economic management for pursuing

domestic objectives, in favour of external objectives. Essentially, the economic policies of

governments are focused on maintaining international credibility, even if these policies

worsen domestic conditions. The choices embodied within the Bretton Woods System were

to combine the nation state with democratic politics, this was to reflect the changing times

and the growth of democracy. The overriding ambition of the designers of the post-war order

was to construct a system that would ‘combine the advantage of the Classical Gold Standard-

exchange rate stability- with the advantages of floating exchange rates- the independence to

pursue national full-employment policies’ (Bordo, 1992).

The final framework that was decided upon was a result of a tug of war between the British

Representative, John Maynard Keynes, and Harry Dexter White, leading the US delegation.

Ultimately, the post-war designs of the US triumphed, due to its much stronger negotiating

position. The planning for the post-war economic order had begun in 1942. First, Keynes’

original plan must be reviewed.

3.2 Keynes ‘Bancor Plan’

Starting in 1941, Keynes began working on his framework for the post-war international

economy. An initial source of inspiration was the so called ‘Funk Plan’, which he had

received a copy of in 1940 (Skidelsky, 2000). The ‘Funk Plan’, formulated by the German

finance minister, Walther Funk, and building upon the ideas of ‘Bilateral clearing’ by Dr

Hjalmar Schacht, the previous finance minister, set out the post-war economic order as

envisaged by Nazi Germany. This new order sought to create a multilateral clearing union for

20
Europe, managed from Berlin, to prevent large imbalances arising. The plan also stated the

desire to create a system of fixed exchange rates within Europe, with the German Riechsmark

becoming the central currency. The Bancor Plan, in contrasts, was to be more liberal and

global in character, holding the potential to ‘stabilise global capitalism for a fabulously long

time’ (Varoufakis, 2016). Keynes advocated for the creation of an International Currency

Union, with an International Central Bank (ICB) responsible for issuing international bank

money, named ‘Bancor’. The Bancor currency would have a fixed but adjustable value in

terms of national currencies and would be accepted as the equivalent of gold by all member

states. Its’ essential purpose was to settle international balances among countries, as gold had

done previously. In contrast to gold, the supply of Bancor money could be easily adjusted to

meet the requirements of the global economy, increasing international liquidity when

circumstances demanded it, in order to avoid the deflationary pressures exerted by the Gold

Standard. Keynes strongly favoured a supranational currency that was separate from any

national government. Thus, the eventual decision to elevate the US dollar to global reserve

currency status undermined the long-term effectiveness of the system, as it encountered the

‘Triffin Dilemma’, in which domestic objectives and international obligations would come in

to conflict.

The fundamental aim of the Currency Union was to ‘generalise the essential principle of

banking, as it is exhibited within any closed system’ (Horsefield, 1969). The ‘Banking

Principle’ states the necessary equality of credits and debits, of assets and liabilities, meaning

that the credits generated cannot be removed from the system, only transferred within it.

Thus, the application of this principle in a global system would encourage countries to spend

their surpluses rather than hoard them. This would be particularly pertinent at the end of the

war, as the US would be the only major surplus nation. Additionally, Keynes wanted to alter

the creditor-debtor dynamic, by distributing the burden of adjustment more evenly between

21
the two. This principle was to address the problems of the Gold Standard, by which the

uneven burden of adjustment placed intolerable pressures upon debtor countries, resulting in

the collapse of the system.

The mechanism for limiting global imbalances would be operated via ‘clearing accounts’

held by national central banks at the International Central Bank. Each member country was

entitled to an amount of Bancor money equivalent to half the average value of its trade for the

previous five years. This entitlement to Bancor was referred to as a country’s ‘Index Quota’,

which meant that members could hold credits or debits equal to this amount over the course

of a year. In order to discourage imbalances, a set of measures were to be applied as countries

accumulated excessive debits or credits. For instance, a country with an ‘overdraft’ in excess

of half its annual index quota, would be required to depreciate its currency by 5% within a

year, to sell its free gold to the ICB and impose restrictions on capital exports. Similarly, a

country in excessive credit would be either encouraged or required to appreciate their

currency in steps of 5% and to unblock foreign owned balances and investments.

Additionally, interest would be charged on excesses, whether they be credits or debits, of 5%

for exceeding one quater of the index quota, and 10% for balances greater than half the

quota- the interest would be paid to the reserve fund. If members held credits beyond the

index quota, they would be confiscated and transferred to the reserve fund at the end of the

year (Skidelsky, 2000). The essential purpose of this mechanism was to avoid high levels of

unemployment by diminishing the attractiveness of holding money in the surplus countries.

3.3 The Final Agreement

The system that was agreed was a combination of Keynes’ ideas and those of the Americans,

represented by Harry Dexter White. However, the final agreement did not implement many

22
of Keynes’ key proposals, the International Clearing Union, and those that were failed to go

as far as Keynes had intended.

The Bretton Woods Agreement created the World Bank and International Monetary Fund

(IMF). The IMF was designed to promote collaboration and consultation between

governments regarding issues relating to the international economy. The adjustable peg

system that had been established was to be administered through the IMF. Each member state

would agree a par value with the IMF for their currency in relation to the dollar and must

commit to maintaining the market exchange rate of its currency within 1% of its declared par

value (Solomon, 1982). After a one-off adjustment of up to 10% of the original par-values,

countries would only be permitted to alter their exchange rates with approval from the IMF.

Approval by the IMF for exchange rate adjustment would be given under circumstances of

‘Fundamental Disequilibrium’, in which a country is unable to correct imbalances via means

other than currency adjustment. Though what constituted a ‘Fundamental Disequilibrium’

was never clearly defined. Furthermore, the IMF sought to reduce the necessity of

devaluation by providing funds to members experiencing temporary and cyclical imbalances

in their balance-of-payments. If possible, the use of reserves to finance these temporary

imbalances was also encouraged. The overall motivation for this was to ensure that

imbalances between countries would be corrected by policies other than exchange rate

adjustment. The gold and reserves gained from the subscriptions of IMF members gave the

fund the ability to act as an international lender of last resort for those in deficit.

The adoption of capital controls was also encouraged among member states. This was seen as

a means of increasing the independence of governments to pursue domestic objectives and

not to be beholden to international capital. Additionally, capital controls were a way of

suppressing short-term flows of capital, ‘Hot Money’, which had been a source of instability

in the 1930s.

23
Central to the Bretton Woods System was the status of the U.S. Dollar as an international

reserve currency, contrary to what Keynes had envisaged. Therefore, the dollar would serve

as an international means of payment, in which the other member countries would peg their

currency to dollar. The dollar, in contrast, was tied directly to gold at a fixed price of $35 per

ounce. At the war’s end, the economies of Europe and Japan had been devastated, and their

currencies were left unfit for international transactions. There was a desperate need for

imports of not only food, but for materials to replace damaged capital equipment and

infrastructure. With insufficient export capacity to facilitate higher levels of imports and low

foreign exchange reserves to finance current account deficits, the recovery of industrial

activity in Europe and Japan would be greatly hindered. The US, as the largest surplus nation,

realised that if war-torn economies were not adequately assisted, their capacity to purchase

US exports would continue to diminish leaving America without a destination for its exports

to be absorbed. Due America’s surplus, and the condition of the economies of Europe and

Japan, it was believed that US exports would remain superior in ‘price, quality and

availability’ for the foreseeable future. Because of this, America’s trade surplus would tend to

be larger than the rest of the world could find the dollars to finance it (Solomon, 1982).

Therefore, it was necessary for America to remonetise Europe by recycling the dollars

accumulated from its surplus, in order to alleviate the ‘dollar shortage’. For this reason, as

well as concerns about the spread of Communism, the US initiated the Marshall Plan in 1948,

in order to remonetise the rest of the world and the need to rapidly reconstruct the economies

of Europe and Japan. Over the course of 1948-1952, the United States provided grants worth

$11.6 billion and loans of $1.8 billion to the nations of Europe, a sum which would exceed

$100 billion in 2019 dollars.

Another feature of the agreement was that, after a period of transition, all currencies would be

made fully convertible, into either gold or the currency of the member requesting conversion.

24
Because most European countries had scarce reserves, they were encouraged to liberalise

trade within Europe, while maintaining restrictions on US imports so that they could rebuild

their dollar reserves. To facilitate the liberalisation of intra-European trade, the Organisation

for European Economic Cooperation (OEEC) (1948) and the European Payments Union

(EPU) (1950), were created, which eventually evolved into what is the European Union

today. It was only in 1958, that Western Europe made their currencies fully convertible, once

it was believed that the ‘dollar shortage’ was over. The substantial economic assistance

provided by the US resulted in the rapid accumulation of reserves abroad. Between 1952-59,

the gold and foreign exchange reserves of Western Europe and Japan more than doubled,

reaching more than $22 billion out of a total global value of $57 billion (Solomon, 1982).

4. The Bretton Woods System in action: Pre-convertibility (1946-1959)

This chapter will examine the performance of the Bretton Woods System in its pre-

convertibility phase, in terms of inflation, unemployment and growth, plus an overview of the

major developments of the period. A key feature of this stage was the lingering repercussions

of the war, which substantially delayed the full implementation of what had been agreed to at

the conference in 1944. Overall, the pre-convertibility is characterised by the rapid economy

recovery of Western Europe and Japan.

As mentioned in the previous chapter, the consequences of the war were as such that they left

all major industrial countries, besides the US, with large balance-of-payments deficits and

low exchange reserves. The scale of the problem meant that exchange controls were

widespread across Europe, in order to conserve scarce reserves so that they could be allocated

to the most vital areas for recovery, namely importing capital, raw materials and foodstuffs. It

25
was for this reason that full convertibility was not achieved until 1958. The UK’s decision to

make Sterling fully convertible in 1947 ended in failure, highlighting the weak position of

Europe. The United States, believing that it would remain economically dominant for many

years to come, tolerated such discriminatory practices. In fact, US policy makers, deeply

concerned about the dollar shortages, actively encouraged discrimination against US exports,

by allowing for exchange controls and devaluation, in addition to devising schemes to

encourage private capital to flow into Europe. Adding to this was the huge volume of US aid

granted to Europe and Japan in these years.

4.1 The Economic Miracle

The first stage of the Bretton Woods System was for member states to set their par values in

1946. The process was problematic due to the fact that the major European economies set

their parities at pre-war levels, based on the assumption that wartime inflation and disruption

had not seriously altered their competitive position relative to the United States. The

overvaluation of parities worsened the competitive position of Europe and in combination

with the harsh winter of 1946-47 resulted in the OEEC countries recording a deficit of $9

billion in 1947 (Bordo, 1992). Therefore, in 1949, a series of devaluations were carried out,

starting with the UK which saw Sterling fall by 30.5% in value, and 23 other countries

devalued shortly afterwards. The sharp devaluations, in combination with Marshall aid

(1948-52), helped Western Europe move towards a surplus position in the balance-of-

payments, which was an important step for restoring currency convertibility and for the

system to fully function. The impact of these actions is depicted in the graph below, which

shows the rapid improvement in OEEC countries’ current account balance, in addition to the

26
growth of their gold and dollar reserves between 1947-55. The next graph displays the

strengthening of the balance-of-payments position and the accumulation of reserves in three

of Europe’s most rapidly recovering economies, Germany, France and Italy between 1948-

58. The most notable feature of this period is the quick transition of Western European

economies towards balance-of-payments surpluses, particularly Germany which was

undergoing the ‘Wirtschaftwunder’.

(Bordo, 1992)

27
(Bordo, 1992)

The US programs for economic recovery, in which $33 billion was transferred from America

to the rest of the world (1946-53), plus the use of restrictive measures against US goods,

produced a rapid economic recovery for Western Europe and Japan. Angus Maddison stated

that for ‘continental Europe the decade of the 1950s was brilliant’ and goes on to say that it

surpassed ‘any recorded historical experience’ (Solomon, 1982). The period was also

characterised by the absence of a major recession for Europe. The OEEC experienced an

increase in real GNP of over 30% from 1953-59. The volume of exports for the OEEC

expanded by 59% from 1953-59 and by 89% for the core six members of the future European

Economic Community (Solomon, 1982). Industrial production also grew rapidly, progressing

by 60% between 1952-60. Furthermore, growth in output per capita was impressive, with

Germany experiencing a 6% increase per year throughout the 1950s, with France being at

3.9% and the Netherlands at 3.7% (Solomon, 1982). The United States, in comparison,

28
recorded annual growth of just 2.4%. For Japan, growth proceeded much more rapidly, with

income per capita increasing by 9% from 1951-59 (Solomon, 1982).

4.2 Inflation

In terms of inflation, the pre-convertibility period experienced lower rates of inflation than

the post-1971 floating regime, but higher than the Classical Gold Standard period. However,

the pre-convertibility phase of Bretton Woods had greater variability in inflation than that of

the Classical Gold Standard and the post-1971 floating period. A substantial portion of this

variability is due to Italian inflation in the 1940s and 1950s (Bordo, 1992). From 1953-59,

the GNP price deflator rose by 20% in OEEC countries, with Germany experiencing inflation

of 15%, the UK 21% and the US 14% (Solomon, 1982). The Bretton Woods system

considered as a whole (1946-71), exhibited the least variability in inflation of any system.

This can be seen in the graph below with the section from the late 1940s up until the early

1970s experiencing the least variability between 1890-1989, for the four G7 members

represented below.

29
(Bordo, 1992)

While the economies of Western Europe and Japan were undergoing unprecedented

economic growth, with their balance-of-payments starting to move into surplus by the early

1950s, problems started to emerge in the system. Since every surplus has a corresponding

deficit, the generation of surpluses in Western Europe and Japan, had the consequence of

pushing the United States into deficit. In 1950, when the US balance-of-payments initially

went into deficit, it was not considered to be a problem, for it was caused by outflows of

capital and government grants in excess of the surplus on goods and services (Solomon,

1982). Under the circumstances, the deficit was viewed as a necessity for re-dollarising

Western Europe and Japan. Though still in surplus, the US trade surplus had dramatically

declined from $10.1 billion to $2.6 billion between 1947-52 (Solomon, 1982). As a result of

the continuing restrictions placed on US exports by Western Europe and Japan, America’s

balance-of-payments position further deteriorated throughout the 1950s. A further factor

30
responsible for worsening the US’ payments position, was the emergence of the American

dollar as the dominant international money for both private and official transactions. The

growing demand for dollars was facilitated by long-term capital outflows, which led to

further imbalances. By 1958, the growing US deficit began to become a serious concern,

prompting American officials to start considering ways of restoring a ‘reasonable

equilibrium’ to its international transactions (Solomon, 1982). The growth and persistence of

the US’s deficit induced outflows of dollars and gold reserves, posing a threat to the Bretton

Woods System.

(Bordo, 1992)

31
4.3 Emergence of the ‘Triffin Dilemma’

The widening of the United States’ deficit by the end of the 1950s brought with it the

potential to undermine the international monetary system. The problem was known as the

‘Triffin Dilemma, named after Belgian economist Robert Triffin. The dilemma highlights the

conflict that arises between international and domestic objectives. In relation to Bretton

Woods, for the United States to be in deficit was merely an outcome of the system’s design.

Since the US dollar had been enshrined as the international reserve currency in 1944, the rest

of the world needed to acquire dollars in order to satisfy their growing demand for reserves.

Throughout the 1950s, with ever increasing demand for US dollars, the countries of Western

Europe and Japan came to depend upon American deficits to satisfy their reserve needs.

However, the continuation of large-scale outflows from the US could not be sustained in the

long-run. If the situation continued unchecked, the accumulation of US reserve liabilities

abroad, via its’ deficit, would eventually exceed the reserve assets held by the United States,

resulting in instability. The instability arises from the fact that as the cover-ratio of US assets

to external liabilities falls, official holders of US dollars will be concerned that the value of

their dollar reserves will change in relation to gold. When there is an acute lack of confidence

in the dollar, those official holders of US liabilities abroad will demand that their reserve

holdings be converted to gold at the Federal Reserve- as they were entitled to do at $35 an

ounce under the Bretton Woods Agreement. The fear of a run on US gold reserves would

force US authorities to tighten monetary policy resulting in worldwide deflation. The Triffin

Dilemma is illustrated in the figure below, where around 1959 external dollar liabilities start

to exceed U.S. monetary gold stock.

32
(Bordo, 1992)

Though the implications of a persistent U.S. deficit had consequences for the long-run

viability of a system built around the dollar, embarking upon measures to minimise or

eliminate it brought about new problems. As the dollar had become the central international

reserve currency, it was vital for ensuring liquidity in the international economy. Therefore,

any attempt on America’s part to limit its’ deficits would potentially starve the world of

liquidity and impart a depressing impulse throughout the global economy. Because of this,

Triffin, like Keynes, argued for the creation of a new source of international liquidity to

substitute for both gold and the US dollar (Triffin, 1978).

33
 5. The Convertible phase and the demise of Bretton Woods (1959-71)

The Convertible phase of the Bretton Woods System began in December 1958, when the

economies of Western Europe made their current accounts fully convertible for international

transactions. The Convertible subperiod proved to be one characterised by continued

prosperity and stability, with the final twelve years before is suspension exhibiting ‘higher

and more stable economic growth than in any other period in the past 150 years with the

exception of the Great Moderation from 1983 to 2006.’ (Bordo, 2017). As for inflation, the

Bretton Woods System post-1959 experienced the most stable rate of inflation of any regime

when judged by both standard deviation and forecast error (Bordo, 1992). These years also

saw the least variability of output of any monetary regime, though this could be attributed to

either the existence of fewer real shocks, or the widespread adoption of countercyclical

monetary and fiscal policies (Bordo, 1992). However, despite the seemingly successful

operation of the Bretton Woods System from the years 1959-71, the system came

increasingly under pressure, while measures taken to counteract the Triffin Dilemma proved

ineffective in the long-run.

In 1960, despite an improvement in the US current account, due to the removal of many trade

restrictions against American exports, its overall balance of payments deficit widened from

$2.2 billion to $3.4 billion between 1959-60 (Solomon, 1982). The deficit in the United

States’ balance of payments persisted during the years 1959-71, and as a consequence the US

stock of monetary gold and dollars continued to flow out of the country. Over the years 1950-

70, the US experienced a fall in its monetary gold stock from $23 billion to $11 billion, while

foreign holdings of US dollars rose from $8 billion to $47 billion (Aliber, 1977). The rapid

growth of US external liabilities relative to its monetary gold stock posed a serious problem

by undermining confidence in the dollar, as discussed in the previous chapter. Because a

number of surplus countries, namely Germany and France, had a proclivity to hold their

34
reserves in the form of gold, a sudden loss of confidence in the dollar would lead to these

countries seeking to convert their dollar holdings into gold. Since these countries held huge

dollar reserves, any attempt to convert their dollars into gold on a large scale would lead to a

convertibility crisis. The essential issue was that the world had no adequate alternative source

of reserve growth other than the continuation of American deficit. Thus, a major concern of

the 1960s was how to provide the rest of the world with enough liquidity without US deficits

(Bordo, 2017). The creation of Special Drawing Rights (SDRs) in 1969, as an alternative

source of liquidity, proved too little too late. Initially, the US took steps to mitigate the

problem by developing policies to discourage European countries from converting their

dollar holdings into gold. A notable example of this was threatening to withdraw American

troops from Germany if its government continued to convert its dollars into gold. These

measures by the US Treasury, though initially effective in protecting its monetary gold stock,

started to become ineffective by the mid-1960s.

The pursuit of expansionary fiscal and monetary policies by the US in 1965, as a response to

the Vietnam War and President Johnson’s Great Society Programs, hastened the collapse of

the Bretton Woods System (Bordo, 2017). The expansionary shift in the United States had

consequences for the rest of the world due to its status as the central reserve country. The

rising levels of inflation experienced in the US were transmitted to the rest of the world via

its balance of payments deficit. As a result, surpluses grew in countries such as Germany. The

higher interest rates in surpluses economies caused large-scale capital inflows, leading to

rising inflation as monetary authorities were unsuccessful in sterilising these capital inflows.

The emergence of an effective gold dollar standard in the 1960s, after Sterling had ceased to

be an alternative reserve currency, with the US as the centre country invoked growing

resentment among Western European countries, particularly France and Germany. With the

United States as the centre country, the so called ‘n-1th’ currency problem arose (Mundell,

35
1969). The n-1th currency problem highlights the asymmetric adjustment that the system

facilitates, as it allows the centre country, the US, to maintain balance of payments deficits

without having to adjust. By the late 1960s, the system had transformed into a de facto dollar

standard after the United States obtained tacit agreement from the other major industrial

countries that they would refrain from converting their dollar holdings into gold. The

constantly expanding deficits of the US caused dollars to flood in greater amounts towards

the surplus countries, causing German inflation to increase from 1.8% to 5.3% in the years

1969-71 (Bordo, 2017). The increasing pressures that Western Europe had to endure as a

result of the ‘Exorbitant Privilege’ afforded to the United States, made them increasingly

unwilling to absorb dollar outflows. The final decision to suspend convertibility between the

dollar and gold occurred in 1971, when Britain and France sough to convert their dollar

holdings into gold.

During this period, the adjustable peg system eventually transformed itself into a de facto

fixed exchange rate regime, as national monetary authorities became increasingly opposed to

adjusting their parities. The experiences of the devaluations in 1949, with the loss of national

prestige and the pressures from speculative capital movements if adjustments were expected,

made many countries reluctant to do so. Increasing capital mobility put greater pressure on

the parities of surplus and deficit countries to adjust, while the use of domestic policies to

prevent these pressures became ineffective. Furthermore, the surpluses countries were

reluctant to adjust their parities, because they believed the onus of adjustment rested with

United States. The refusal of countries to make the necessary adjustments to restore a

measure of equilibrium to the system undermined its longevity. Thus, the consequences of

this were to produce a system which was contrary to what its designers had intended and

replicated the problems of the Interwar gold exchange standard.

36
Ultimately, the demise of the Bretton Woods System was the due to deficiencies in its design.

The decision to establish the link between the dollar and gold at the centre of the system set

the stage for an eventual convertibility crisis. Additionally, the adjustable peg system became

increasing unfeasible, as a result of growing capital mobility, which meant a de facto fixed

exchange rate system came into existence with the absence of an effective means of

adjustment (Bordo, 2017).

6. A New Bretton Woods

The existence of huge imbalances in the world today, with countries such as China and

Germany running large surpluses with their counterpart deficits in the United States and the

UK, places the global economy in a state of precarious balance. In the Eurozone, for

example, the surpluses of Germany impart deflationary pressures upon the surrounding

countries, resulting in a worsening balance of payments, sluggish growth and high levels of

unemployment for the countries of Southern Europe, namely Greece, Italy and Spain.

Furthermore, the pursuit of deflationary policies in the Eurozone in response to the Great

Recession, have the potential to destabilise the global economy as the emphasis placed on

generating surpluses in the Eurozone undermines the economic prospects for China and the

US. Since 2008, both the US and China have managed to provide a degree of stabilisation to

the world, with the US absorbing the surpluses of other countries through its large deficit, in

addition to the creation of an economic bubble in China based upon construction (Varoufakis,

2016). The creation of a new Bretton Woods System could potentially correct this situation,

by bringing about a more balanced and rules-based international economy than at present. For

the new system to be effective, it would have to heed the lessons of the past. In particular, it

would have to provide a form of international liquidity more along the lines of what Keynes

and Triffin had proposed. In terms of imbalances, the reconstructed system would need to

incorporate a strong adjustment mechanism with an equitable balance between creditors and

37
debtors. The adverse impact of globalisation upon the welfare states, particularly in social

democratic regimes, could be limited by a reinvented Bretton Woods, as it would provide a

more effective shield for national governments against international capital flows (Kim and

Zurlo, 2008). Finally, for such a framework to be successful, it would require the close

cooperation of the United States, China and the European Union, as neither has the power to

unilaterally stabilise global capitalism today.

7. Conclusion

The Bretton Woods System was created in response to the shortcomings of the Interwar

Period. Its central aim was to provide the stability afforded by fixed exchange rates while

allowing for the pursuit of independent economic policy aimed at domestic objectives. This

development was to reflect the changing circumstances of the world, by making it more in

keeping with a desire for democracy and national self-determination. Throughout its

existence, capitalism experienced a so called ‘Golden Age’, with high rates of economic

growth, relatively stable inflation, low unemployment and expanding international trade.

However, despite its economic success, the design of the system was flawed and ultimately

undermined its existence in the long-term. The failure to adopt a system more like that

proposed by Keynes, with an international currency independent of national governments,

paved the way for a convertibility crisis, as the dollar could not supply enough liquidity to the

rest of the world unless the US was in constant deficit. The privileges afforded to the US as

the central reserve currency further undermined the system, as it bred resentment among

other nations and increased their unwillingness to adjust to American Policies. The decline in

international cooperation prevented the system from being fundamentally reformed and gave

way to the floating exchange rates that continue up until the present.

38
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Aldcroft, D (1977) ‘From Versailles to Wall Street: 1919-29’, University of California Press

Bordo, M. (1992) ‘The Bretton Woods International Monetary System: An historical

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Eichengreen, B. (1991) ‘Golden Fetters: The Gold Standard and the Great Depression 1919-

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Keynes, J.M. (1930) ‘A Treatise on Money’

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Keynes, J M (1943) (1969) “Proposals for an international clearing union”, April in K.

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