The Bretton Woods Conference and the Contradiction of American Economic Might

On July 22, 1944, while still in the midst of World War II, the 44 Allied Nations convened in Bretton Woods, N.H. to discuss international monetary policy. Convinced that economic competition had encouraged the rise of totalitarianism and sparked the war, the delegates at what would come to be known as the Bretton Woods Conference were especially motivated on this occasion, in light of the extraordinary circumstances in which they found themselves, to sign an agreement unlike any other that had come before it.

The so-called Articles of Agreement they signed that day ushered in a thirty year period of unprecedented and virtually uninhibited economic growth for the Western world, a time that would be remembered as “the postwar boom.” Not only did the United States establish itself as an economic superpower in this era, it was also a period in which war-torn Europe rebuilt itself, and the defeated Axis Powers of Germany and Japan emerged as new economic forces in their own right. Thus, the postwar boom accomplished what had so brazenly eluded the West after the First World War: the successful reconstruction of defeated nations. (See: Treaty of Versailles.)

There is little doubt that absent the Bretton Woods system such unambiguous success could still have been achieved.

If the war had motivated the Allies to act quickly and in unison, it was the specter of past tribulations that really bore down on the participants at the 1944 conference. The fear that, without a formal system for economic coordination, the world would relapse into the Great Depression influenced their decision-making more immediately than even the motivation to avoid future military conflicts.

Economists then had already adopted what is still today the dominant understanding of what had made the Depression so severe. According to this view, “beggar-thy-neighbor” policies — which sought to boost a nation’s economic standing at the expense of another (like by putting up tariffs) — had prolonged the Depression by suffocating international trade. Once these protectionist policies set in, they took their toll on international cooperation, halting foreign investments and thereby producing what Charles Kindleberger referred to as a “liquidity squeeze” — a lack of available capital to stimulate trade and economic renewal.[1]

As a result, many policymakers came to the conclusion that what was needed to avoid future economic crises was a rigorously adhered to international system of free trade.[2] To this end, the Bretton Woods agreement established three primary policies promoting the liberalization of international trade relations.

First, each signatory would declare and maintain a fixed exchange rate for its currency “pegged” to the value of another member’s currency and adjustable within one percentage point. By ensuring the exact worth of a nation’s currency, this provided consistency for foreign investors such that they knew the conversion rate of dollars to pounds, for example, without fear of the British government suddenly changing that rate for the sake of its own economic well-being. Similarly, countries were to remove discriminatory exchange controls preventing the free flow of goods and services and to agree to make their currencies freely convertible — that is, purchasable with any other currency. Once again, these regulations promoted world trade and free competition. Finally, the agreement created the International Monetary Fund (IMF), a lending institution which would serve as a central reserve, providing temporary funds to nations in need of liquidity while also overseeing members’ implementation of these requirements.

In short, signatories to the Bretton Woods agreement pledged to open their economies to world trade, even though that meant they would be overmatched by the superior economic might of the United States, which was then producing half of the world’s consumer goods.

What is truly remarkable about this feat is that the maintenance of this system depended on these nations’ willingness, in recognition of their economic interdependence, to forego self-interested protectionist policies for the sake of the long-term health of an international economy based on free trade.[3] No longer could a country close its borders to foreign investors and producers, not even in a time of need. Instead, it would be expected to concede for the sake of avoiding future depressions internationally.

It was under the weight of this basic assumption that the system continually buckled in its thirty year reign over the capitalist world before finally collapsing in on itself in 1973.

Historians have analyzed numerous structural issues with the Bretton Woods system which prevented its effective implementation and encouraged member nations to bend the rules of the game. For example, they have pointed out that the IMF lacked the powers of enforceability necessary to prevent attacks against its regulations, as its reserves could not match the real demand for capital to sustain members’ chronic deficit problems (and thus IMF threats of sanction for misconduct would have rung hollow). Likewise, the IMF proved powerless to police member nations’ adherence to the agreement regardless of those sanctions.

While each of these factors surely contributed to the Bretton Woods system’s downfall, it was the contradiction of American hegemony that constituted the system’s fatal flaw.

In contrast to the interwar period, in which Americans closed the flow of capital abroad, in the postwar period, the U.S. government became the world’s premier creditor, doling out loans and grants to finance Europe’s reconstruction, most famously through the Marshall Plan. This was rational from the American perspective both as an attempt to create a foreign market for American goods and because, as the world became immersed in the Cold War, it served as a means of propping-up its capitalist allies.

Yet, this hegemony contained within it a fundamental contradiction that ensured the eventual collapse of the system. This flaw is known as the Triffin Dilemma. Basically, this dilemma asserted that the system depended on the availability of capital, which depended on American ability to furnish that capital, and yet, this very act of flooding the market with American dollars simultaneously devalued the currency that the world depended on for international trade.

As the primary benefactor of the Bretton Woods system, the United States had committed itself to fix its exchange rate to gold at $35.00 per ounce no matter the pressure it faced to slow free trade. Consequently, the U.S. dollar became the premier paper currency throughout the Western world. However, this spike in demand for American dollars put pressure on U.S. gold reserves; in its attempts to provide liquidity in order to maintain a healthy international marketplace, the amount of U.S. paper currency in circulation exceeded the amount of U.S. gold reserves backing that currency.

This situation produced the ultimate test of European commitment to the Bretton Woods system because once American foreign liabilities exceeded U.S. gold reserves in 1960, gold became more valuable than U.S. paper currency. This created the possibility of a “run” on U.S. gold reserves by holders of the paper currency — an impromptu series of foreign demands to turn in U.S. paper currency for gold, as the Bretton Woods agreement required — which is exactly what happened in 1971, forcing President Richard Nixon to “shut the gold window” by refusing to exchange the currency, thereby destroying the system that had presided over the postwar boom. Thus, when foreign nations holding U.S. dollars in reserve were faced with the fundamental decision of either losing value in their own reserves or destabilizing the hegemonic regime on which the entire system depended, they chose self-interest over ideological commitments.[4]

The Bretton Woods system failed to produce a consensus that long-term economic health of the international economy ought to override national self-interest in the name of free trade. History bears the opposite conclusion. While a deep appreciation for the lessons of the past inspired the system’s framers to utilize this knowledge and construct a stable international monetary policy that would both promote growth and eliminate the fear of violent downturns, historical circumstances repeatedly thwarted member nations’ dedication to that cause.

Thus, the history of the Bretton Woods system is the story of the temporary alignment of self-interested nations to cooperate in the formation of an international system destined to survive only as long as American policymakers were willing to allow its financial health to deteriorate for the sake of international free trade.

[1] James, International Monetary Cooperation, 52; Kindleberger, World in Depression, xv.

[2] James International Monetary Cooperation, 36

[3] Each of the following historians makes this point: Barry Eichengreen, Elusive Stability: Essays in the history of International Finance, 1919-1939 (Cambridge: Cambridge University Press, 1990), 271; James International Monetary Cooperation, 3; Fred L. Block, The Origins of International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977), 17.

[4] Two attempts were made to save the figurehead of this monetary order before it collapsed. The first was the creation of a Gold Pool, in which several European nations including France, Germany, and the United Kingdom, agreed to provide half of the international market’s demand for gold reserves. This arrangement ended in 1968 after members of the pool undercut the agreement by cashing in U.S. treasuries for U.S. gold reserves.  The second attempt to resolve the Triffin Dilemma was the proposed creation of IMF Special Drawing Funds (SDRs), synthetic currency which the IMF would issue as additional reserves, thereby taking pressure off the dollar. Before this measure could be implemented, however, the run on U.S. gold reserves finally occurred in 1971, leading Nixon to “shut the gold window,” which ended the U.S. government’s unwavering commitment to the Bretton Woods system.