Has the Bretton Woods system provided stable global economic governance?

By Maciej Blasiak

Originally published in July 2014.

In July 1944 a new chapter in global economic governance has begun. First fully negotiated multilateral agreement established a system of governing international monetary policies -The Bretton Woods system. 44 nations agreed to adopt set of rules and policies with a hope of delivering stable structure able to streamline international trade. States agreed to peg their currencies to dollar, which in turn has been exchangeable to gold at a fixed price. At first glance this system is not very distinctive from the 19th century gold standard, but in reality there were important differences (Bordo, 1993). High expectations were placed in the system, which was supposed to eliminate protectionist beggar-thy-neighbour policies of the past and create a new international environment described by Ruggie as ‘embedded liberalism’ (Ruggie, 1982). Yet the system has been very short lived and collapsed in the 1970s (Bordo, 1993). This work aims to provide an account for the instability of governance in the Bretton Woods regime by exploring the Triffin Dilemma. The author advocates that contradictions resulting from the dilemma effectively paralysed governance of the system. The US independent monetary policy was at odds with other policies that could stabilise the system. Unwillingness of the US to alter its inflationary policy caused substantial pressure on the whole system. At the same time, Europe was reluctant to accept the dollar hegemony and advocated for a different system which would be governed in a more inclusive way.

As the question refers to stable global economic governance, it is necessary to distinguish between performance and stability of the system itself and stability of its governance. Naturally these are interconnected, stable governance often fosters cooperation and facilitate good results nonetheless there might be other factors that affect the system. This work is going to focus on the stability of governance in the Breton Woods and its impact on the overall performance of the system, rather than on the performance itself. Firstly in order to find the origins of the governance system under the Bretton Woods this paper examines the process of creating the regime in line with the hegemonic stability theory. This perspective it is able to provide an account on the regime change itself and the dominant position of the US in the new system. The shift in power relations among states caused by the World War two is regarded here as the key factor. Subsequently by applying the theory of epistemic communities this essay explains the outline of the system and the governance within it. Epistemic shift in economic thinking triggered by the great depression is considered as a key event influencing the outline of the Bretton Woods system. In a latter part, the work focuses on the economic problems facing the system and its implications for shifting the ‘centre of gravity’ within it. As a consequence of the US dominating position by the Triffin dilemma emerged paralysing the system’s governance. It argues that measures taken to resolve the dilemma proved inadequate causing the problem to progress. With European countries reluctance to accept the dollar hegemony and their growing demand for more inclusive governance the system has collapsed.

The Bretton Woods conference took place in 1944 when the Second World War was already slowly coming to its end. Thus timing of the conference is not a surprise, it has been a high time to reconstruct the world economy, but the key point to note is that the Bretton Woods was more than a simple attempt to restore global economic order. It was about setting a new order that would bring peace, a system that would be able to tackle problems which led to the collapse of previous regimes. As James puts it, ‘The Bretton Woods order looks like a solution, not just to the question of post-war reconstruction, but to the problem of recasting capitalism in such a way that it would not permanently destabilize both itself and the international political and legal order.’ (James, 2012, p.412). At this point one should think what inspired this change? Was it a real regime change or just a mere evolution of the previous regime? Eichengreen provides a very interesting view. According to him the Bretton Woods is somewhere in the middle. It is a ‘transitional regime’ a middle ground between the old system- the gold standard and fiat money system that has emerged after 1971 (Eichengreen, 2006, p.38). Evidence suggests that indeed the architects of the Bretton Woods aimed to find a compromise between these two different regimes. But how did the system come into being?

Realists would find a shift in the power relations caused by the World War II as a key factor responsible for the emergence of the system. During the negotiations in Bretton Woods, New Hampshire, United States in 1944 it was already clear that the US is going to be a new superpower. Thus it aimed to use the conference to set up a new order that would suit its needs (Eichengreen, 1989). Hegemonic stability theory offers quite a convincing account regarding this event. In its simplest form the theory states that existence of a hegemon is a prerequisite for an establishment of a regime and maintaining free trade (Webb & Krasner, 1989). It has to be said that there are evidence that the US official were well aware of their position and did not hesitate to use it. During the negotiations Henry Morgenthau U.S. Secretary of the Treasury said to Harry Dexter White American chief negotiator ‘Now the advantage is ours here, and I personally think we should take it’ (van Dormael, 1978, p.211). Thus taking into account US dominant position, and the fact that US was very successful in negotiating the regime they the opted for, it is possible to say that hegemonic stability theory is successful in explaining why the new regime was heavily dependent on the US. Yet it is not comprehensive. It is unable to address the question why the regime created under Pax Americana is so distinctive from the Pax Britannica in the 19th or Dutch hegemony in the 17th century (Ruggie, 1982).

A theory which could explain the distinctive form of the Bretton Woods system has been offered by a theory of Epistemic Communities. It argues that as the policy making becomes increasingly complex task, leaders need a guidance which could help them formulate state interests. In other words, ‘Actors can learn new patterns of reasoning and may consequently begin to pursue new state interest’ (Haas, 1992, p.2).As governments seek the advice on how to achieve the desired outcome or even to define what the desired outcome is, often turn to ‘Epistemic Communities’ that is ‘networks of knowledge-based experts’ (Haas, 1992). Therefore a change in the way economists see market and the way they define desirable healthy policy can influence the behaviour of different actors. Hence, the gold standard has been reconstructed after the First World War, because there was no epistemic shift and states interests remained unchanged (Giovanni, 1993).

Such shift occurred after the experiences of the Great Depression and the Second World War. Keynes, who opposed the classical gold standard as early as in 1920s (Keynes, 1924), has become an important figure and one of the architects of the Bretton Woods system (Giovanni, 1993). With the new consensus economists were both pessimistic about the Gold Standard and freely floating exchange rates and fiat money of the 1930s (Dominguez, 1992). As Bordo argues the most important lesson of the inter-war experience was that paper currency exchanges should not be able to fluctuate under control of market supply and demand (Bordo, 1993, p.29).In line with Epistemic Communities policy makers changed their perceptions. In fact negotiating the new system has been largely left to the experts in the field-the epistemic community (Adler & Haas, 1992).

If one combines these two theories discussed here it is possible to successfully account for the creation and the outline of the Bretton Woods system. It is no surprise that the US as a hegemon has been placed in the centre of the system. Furthermore the experience of the Great Depression and the collapse of previous regime explain the epistemic shift which aimed to create a system distinct from its predecessor. As Ikenberry puts it ‘the policy ideas inspired by Keynesianism and embraced by a group of well-placed British and American economists and policy specialists were crucial in defining government conceptions of postwar interests,’ (Ikenberry, 1992, p.291). Therefore, the system that emerged from the new epistemic consensus under the US hegemony was very unique; a governed regime of fixed exchange rates with US dollar as the only currency backed by gold and international organisation responsible for supervision and provision of liquidity in the system (Bordo, 1993). Subsequent paragraphs will attempt to analyse the governance within this set up and its implications for the stability of the system.

The old system was based on gold- durable commodity with quite stable supply. Of course role of the British Empire was important in a sense that it could ‘supervise’ the system and enforce the rules of the game. But as strong epistemic community maintained that it is in individual states’ interest to play by the rules, the system was not solely dependent on the hegemon (Giovanni, 1993). Liquidity was preserved by gold supplies and no country could exclusively control them. Thanks to the specie-flow mechanism the system was self-regulating and proved to be very stable, it was only a dramatic rise in demand caused by World War One that shifted state interest towards different direction and distorted the regime (Bordo, 1993).

In some ways the Bretton Woods system was similar to the gold standard, in line with hegemonic stability theory a hegemon was present in both systems and played a supervising role, new epistemic community that emerged after the war was still in favour of fixed exchange rates despite reduced role of gold. The fundamental difference and in essence instability of the system lied in its governance. Scarce gold supplies of the interwar period have been partially replaced by the dollar which was the only currency directly exchangeable to gold. Therefore its liquidity was largely dependent not on a durable commodity, but on a paper money issued by the hegemon (Bordo, 1993, p.37). As following paragraphs demonstrate this has turned out to be unsustainable solution.

Architects of the Bretton Woods hoped that the liquidity will not be provided directly by the US, but rather by an international institution- the International Monetary Fund. It has been assigned a supervising role and its possessed assets deposited by all member states in a form of gold and national currencies. By using these assets the fund was supposed to maintain the liquidity within the system. IMF could grant a loan to a country facing a balance of payment deficit based on the principle of conditionality and hence, it could enforce necessary adjustments and restore equilibrium (Giovanni, 1993). Unfortunately the system has never worked as planned, major countries were not keen on following the IMF guidelines. In 1948 France created a system of multiple exchange rates, which was against the IMF articles, and thus was denied access to its resources. But the action based on the conditionality rule had little effect since France could use the resources from the Marshall Plan. Bordo lists several developments which had similar effect of deteriorating Fund’s position in the system, for example the devaluation of sterling in 1949 which has been done without a proper consultation with the IMF. What is more, the Fund’s resources were far too small to provide a considerable liquidity and govern the system (Bordo, 1993:45-47). In effect the IMF has been relatively unimportant institution throughout the Bretton Woods. Similarly the International Bank for reconstruction and development (The World Bank) which supposed to facilitate reconstruction after the war has been quickly marginalised. Majority of funds have been transferred to Europe through the Marshall Plan. In effect, the governance has shifted to the US, which decided to take up the role (Dominguez, 1992).

Therefore, the system quickly drifted away from what has been planned, as Bordo notes: ‘The system that began operations after the Bretton Woods conference and the establishment of the IMF was different in many major respects from what the architects intended’ (Bordo, 1993, p.37). Governance of the system relied largely on the US. Liquidity was based on two assets- gold and the US dollar, which in principal was supposed to be exchangeable to gold and ‘as good as gold’. Initially this dependence did not prove problematic. U.S. was in a hegemonic position and trustworthy partner, all the actors within the system accepted its hegemonic role and almost unilateral governance of the Bretton Woods (Bordo, 1993).

The possible instability in the core of the system has been first noted and described by Robert Triffin in 1960. The increasing volume of global trade required the US to provide liquidity to the system by running a balance of payments deficit, but in the long run it could be harmful to its economy (Triffin, 1961). Dilemma faced by the US possessed a fatal threat to the system. Monetary authorities in the US could not simultaneously pursue independent policy and provide liquidity to the system. That meant that the US would need to subject its fiscal and monetary policy to the requirements of the system. To curb the balance of payment deficit and improve its own economy was to cut the source of liquidity available in the system and collapse it. To pursue expansionary policy was to transfer inflation to other countries and to create a space for confidence crisis which could drain gold reserves and destabilise the system (Triffin, 1961). Furthermore, even policy subjected to the requirements of the system was not sustainable in the long run. With increasing volume of international trade and US liabilities the US gold reserves would become increasingly scarce in relation to the number of dollars. Without major adjustments confidence could be undermined in the long run. (Triffin, 1961).

First crisis began in 1960 and has been triggered by rather prosaic event. It is believed that during the presidential elections in the US in the 1960 and Kennedy’s declaration ‘to get America moving again’ was interpreted as possible expansionary and thus inflationary policy that may cause a devaluation of the dollar. That caused a ‘run on gold’ market prices of this commodity drifted away from official one, undermining confidence in the system and draining US gold reserves (Solomon, 1977, p.35). This situation exposed the vulnerability. Under the gold standard, every currency has been pegged to gold, thus a devaluation of one currency did not need to be very significant for other economies. Under the Bretton Woods a devaluation of dollar would alter prices in every other country. That opened up a space for speculation. Any crisis in confidence could cause a major speculative attack on the dollar and a drain of US gold reserves. Therefore as argued before the US would need to adopt very strict and responsive policy that could be adapted to the requirements of the system and effectively do not pursue independent goals in monetary and fiscal policy. However in the age of the Cold War there were other competing interests which prevented that from happening. One example is the war in Vietnam and the way fiscal and monetary policy was subjected to it (Solomon, 1977). In the 1960s the governance of the Bretton Woods has become increasingly paralysed, the US was unwilling to restrain its policies and further undermining confidence in the system. The longer such situation existed the more severe adjustments were needed. Instead, of restraining its policy the US introduced various measures to protect its gold reserves and postpone the confidence crisis.

Many technical actions were initiated, for example swap arrangements, roosa bonds etc. but also persuasive actions in an attempt to convince other central banks not to convert their dollars into gold, and to stabilise the market for gold (Bordo, 1993). But as this exchangeability was an inherent part of the system the US had to persuade its allies not only to play by the rules but to play accordingly with the US interests. It has to be said that it was the collective interests of European countries to restrain from converting dollars into gold, but simultaneously, it was not in line with individual interests of members who would prefer to play safe and exchange dollars before the supposed devaluation happens (Eichengreen, 2006, p.36). Therefore a stability of the governance within the system was increasingly questioned.

The burden slightly shifted to Europe with the creation of the London Gold Pool seven European countries and the US committed to collectively stabilise the gold market and thus protect the system. In return for the support the US granted participating countries the right to exchange dollars acquired by intervening in the pool (selling gold at the higher market price), into gold at lower price offered by the FED (Eichengreen, 2006). This incentive given to the European countries has been necessary as they were unhappy with developments within the system. US had to protect its gold reserves in order to stabilise the system and thus were encouraging other states to keep dollars instead of gold as reserve assets. But, due to that the initial gold-dollar standard eventually transferred into de facto dollar standard. European countries have been reluctant to accept it (Bordo, 1993, p.72). Because they have grown in relation to the US they were sceptical of the increasing costs of maintaining the system, without being able to govern it as they were dependant on the US dollars and the commitment of gold exchangeability was increasingly a fiction. The US was dependant on other countries committing not to convert dollars into gold. It is clear that the outline of the system, which was heavily dependent on the dollar, was not flexible enough to allow for necessary adjustment there was no space for other currencies which could play a major role. There was a growing need to redesign it. France even demanded a return to the gold standard (Bordo, 1993). Nonetheless despite these tensions The London Gold Pool worked well, but it was clear that European countries are not prepared to bear too much cost.

The pressure mounted in 1965 when the US decided to pursue expansionary fiscal policy in order to finance the Vietnam War (Solomon, 1977:100-02). Rising inflation transferred to other member states and caused another run on gold, speculative actions and free riding by governments increasingly worried about possibility of dollar devaluation have put substantial pressure on the Pool. Moreover, in 1966 despite growing concerns over the inflation and its impact on the international monetary system President Johnson refused to combat the problem by increasing income taxes, as Solomon argues he has been concerned that the Congress might in return ‘cut back his “Great Society” programs’, in effect once again the US government has been reluctant to sacrifice their independent policy for the sake of rescuing the system (Solomon, 1977:100-02). Mounting costs of the operations of the Pool forced France in 1967 to announce its withdrawal from the Pool. Few months later another reserve currency- British pound sterling has been devaluated causing another confidence crisis on the market and another run on gold. As a result in March 1968 London Gold Pool collapsed (Eichengreen, 2006).

In line with the arguments presented here, the collapse of the Pool is not a surprise. Europe was never prepared to defend the system it did not fully support. The failure of this fragile coalition which defended the system meant that the US became the only actor defending it. Since the system has been heavily reliant on US currency and it was the US inflation that caused the confidence and consequently governance crisis, European countries were able to defend the system to a certain point, but as it increasingly transferred to a dollar standard, European countries and especially France were unhappy or even hostile to the dollar hegemony (Eichengreen, 2006). Introduction of two tier gold market was a method of last resort. But it was incredibly fragile. In fact it meant that the US gave up. Its stance of benign neglect was in essence an attempt to ignore the dilemma and to refuse governance in a system which has been designed to be governed (Eichengreen, 2006). With the election of Richard Nixon the US continued its expansionary policy. There is evidence that the president put substantial pressure on Arthur Burns a chairman of the Federal Reserve to continue monetary expansion (Solomon, 1977, p.107) Continuous speculative attacks on the dollar forced the US to look for alternative solutions. Ignoring the problem was no longer possible. In his famous speech in august 1971 Richard Nixon argued: ‘In the past 7 years, there has been an average of one international monetary crisis every year.’ (Peters & Woolley, 1971). Persuaded by his advisors, in his he decided to unilaterally break the Bretton Woods and close the gold window (Peters & Woolley, 1971). Final attempt to preserve the fixed exchange rate were the Smithsonian agreements, they allowed for greater flexibility, but failed quickly due to speculative attacks ending the Bretton Woods era (Garber, 1993, p.463).

The system felt short of the expectations. This work examined governance within the system and its impact on the stability of the system. Firstly by applying hegemonic stability theory and theory of epistemic communities it analysed the events leading to the creation of the system. Changes in power relations caused by World War II and the experience of the Great Depression have been found as the major factors influencing the outline of the Bretton Woods. Consequently the essay argued that neglectful attitude of major economies towards the IMF on several occasions, such as the sterling devaluation of the 1949 effectively marginalised that institution and shifted the governance within the system causing the US to take up leadership role. These developments have been found here as the root cause of the instability within the system as they are responsible for the emergence of the Triffin Dilemma. In the latter part, this paper examined how the US dealt with the dilemma and how it affected the governance within the system. It has been argued here, that the US independent fiscal and monetary policies have been at odds with policies required to effectively manage the system. Thus, the instability has been growing and the system has been very prone to crisis. By setting up the London Gold Pool the US hoped to stabilise the system together with 7 other European countries. Nonetheless as the work proved these countries were prepared to defend the system only up to a point. With US continuing its expansionary policies, speculative attacks continued causing France to withdraw from the Pool. With the collapse of the Pool, governance within the Bretton Woods has been paralysed. The US created two-tier gold market and effectively adopted a stance of benign neglect ignoring the Triffin dilemma and not managing the system in any way. Thus as the work proved, the governance within the Bretton Woods has been increasingly unstable causing recurring speculative attacks. When the US could no longer handle defending of the system it adopted two tier gold market. This only increased speculative attacks and in 1971 the system effectively no longer governed finally collapsed


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