The Bretton Woods system of monetary management established the rules for commercial relations among 44 countries, including the United Kingdom, United States, Canada, European countries, and Australia, after the 1944 Bretton Woods Agreement until the Jamaica Accords in 1976. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent states. The Bretton Woods system required countries to guarantee convertibility of their currencies into U.S. dollars with the dollar convertible to gold bullion for foreign governments and central banks. It envisioned greater cooperation among countries to prevent future competitive devaluations, and thus established the International Monetary Fund (IMF) to monitor exchange rates and lend reserve currencies to countries with balance of payments deficits. According to Barry Eichengreen, the Bretton Woods system operated successfully due to three factors: "low international capital mobility, tight financial regulation, and the dominant economic and financial position of the United States and the dollar".
Preparing to rebuild the international economic system while World War II was still being fought, delegates from 44 Allied countries gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference, also known as the Bretton Woods Conference. The delegates deliberated from 1 to 22 July 1944, and signed the Bretton Woods agreement on its final day. Setting up a system of rules, institutions, and procedures to regulate the international monetary system, these accords established the IMF and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. The United States, which controlled two-thirds of the world's gold, insisted that the Bretton Woods system rest on both gold and the US dollar. Soviet representatives attended the conference but later declined to ratify the final agreements, charging that the institutions they had created were "branches of Wall Street". These organizations became operational in 1945 after a sufficient number of countries had ratified the agreement.
Eurodollar growth increased capital flows, challenging regulation of capital movements. On 15 August 1971, the United States ended the convertibility of the US dollar to gold, effectively bringing the Bretton Woods system to an end and rendering the dollar a fiat currency. Shortly thereafter, many fixed currencies (such as the pound sterling) also became free-floating, and the subsequent era has been characterized by floating exchange rates. The end of Bretton Woods was formally ratified by the Jamaica Accords in 1976. Critics argue that the system's reliance on the U.S. dollar allowed the United States to operate with fewer constraints than other nations, while fixed exchange rates limited countries such as the major European economies and Japan in their ability to adjust monetary policy in response to rising inflation and shifting trade conditions. They also note that the IMF and World Bank often imposed policy conditions that placed significant strain on developing countries and restricted the flexibility of local economies.
Origins
The planners at Bretton Woods hoped to avoid a repetition of the Treaty of Versailles after World War I, which had created enough economic and political tension to lead to WWII. After World War I, Britain owed the U.S. substantial sums, which Britain could not repay because it had used the funds to support allies such as France during the War; the Allies could not pay back Britain, so Britain could not pay back the U.S. The solution at Versailles for the French, British, and Americans seemed to entail ultimately charging Germany for the debts. If the demands on Germany were unrealistic, then it was unrealistic for France to pay back Britain, and for Britain to pay back the US. Thus, many "assets" on bank balance sheets internationally were actually unrecoverable loans, which culminated in the 1931 banking crisis. Intransigence by creditor countries for the repayment of Allied war debts and reparations, combined with an inclination to isolationism, led to a breakdown of the international financial system and a worldwide economic depression.
The beggar thy neighbour policies that emerged as the crisis continued saw some trading countries using currency devaluations in an attempt to increase their competitiveness (i.e. raise exports and lower imports), though recent research suggests this de facto inflationary policy probably offset some of the contractionary forces in world price levels.
In the 1920s, international flows of speculative financial capital increased, leading to extremes in balance of payments situations in various European countries and the US. In the 1930s, world markets never broke through the barriers and restrictions on international trade and investment volume – barriers haphazardly constructed, nationally motivated and imposed. The various anarchic and often autarkic protectionist and neo-mercantilist national policies – often mutually inconsistent – that emerged over the first half of the decade worked inconsistently and self-defeatingly to promote national import substitution, increase national exports, divert foreign investment and trade flows, and even prevent certain categories of cross-border trade and investment outright. Global central bankers attempted to manage the situation by meeting with each other, but their understanding of the situation as well as difficulties in communicating internationally, hindered their abilities. The lesson was that simply having responsible, hard-working central bankers was not enough.
Britain in the 1930s had an exclusionary trade bloc with countries and territories of the British Empire known as the Sterling Area. If Britain imported more than it exported to such trading partners, recipients of pounds sterling within these countries tended to put them into London banks. This meant that though Britain was running a trade deficit, it had a financial account surplus, and payments balanced. Increasingly, Britain's positive balance of payments required keeping the wealth from across its Empire in British banks. One incentive for, say, South African holders of rand to park their wealth in London and to keep the money in Sterling, was a strongly valued pound sterling. In the 1920s, imports from the US threatened certain parts of the British domestic market for manufactured goods and the way out of the trade deficit was to devalue the currency. But Britain could not devalue, or the Empire surplus would leave its banking system.
Nazi Germany also worked with a bloc of controlled countries by 1940. Germany forced trading partners with a surplus to spend that surplus importing products from Germany. Thus, Britain survived by keeping Sterling-using countries' surpluses in its banking system, and Germany survived by forcing trading partners to purchase its own products. The U.S. was concerned that a sudden drop-off in war spending might return its population to the unemployment levels of the 1930s, and so wanted Sterling-using countries and everyone in Europe to be able to import from the US, hence the U.S. supported free trade and international convertibility of currencies into gold or dollars.
Post-war negotiations
When many of the same experts who observed the 1930s became the architects of a new, unified, post-war system at Bretton Woods, their guiding principles became "no more beggar thy neighbor" and "control flows of speculative financial capital". Preventing a repetition of this process of competitive devaluations was desired, but in a way that would not force debtor countries to contract their industrial bases by keeping interest rates at a level high enough to attract foreign bank deposits. John Maynard Keynes, wary of repeating the Great Depression, was behind Britain's proposal that surplus countries be forced by a "use-it-or-lose-it" mechanism, to either import from debtor states, build factories in debtor states or donate to debtor states. The U.S. opposed Keynes' plan, and a senior official at the U.S. Treasury, Harry Dexter White, rejected Keynes' proposals, in favor of an International Monetary Fund with enough resources to counteract destabilizing flows of speculative finance. However, unlike the modern IMF, White's proposed fund would have counteracted dangerous speculative flows automatically, with no political strings attached—i.e., no IMF conditionality. Economic historian Brad Delong writes that on almost every point where he was overruled by the Americans, Keynes was later proved correct by events.
Today these key 1930s events look different to scholars of the era (see the work of Barry Eichengreen Golden Fetters: The Gold Standard and the Great Depression, 1919–1939 and How to Prevent a Currency War); in particular, devaluations today are viewed with more nuance. Ben Bernanke's opinion on the subject follows:
... [T]he proximate cause of the world depression was a structurally flawed and poorly managed international gold standard. ... For a variety of reasons, including a desire of the Federal Reserve to curb the U.S. stock market boom, monetary policy in several major countries turned contractionary in the late 1920s—a contraction that was transmitted worldwide by the gold standard. What was initially a mild deflationary process began to snowball when the banking and currency crises of 1931 instigated an international "scramble for gold". Sterilization of gold inflows by surplus countries [the U.S. and France], substitution of gold for foreign exchange reserves, and runs on commercial banks all led to increases in the gold backing of money, and consequently to sharp unintended declines in national money supplies. Monetary contractions in turn were strongly associated with falling prices, output and employment. Effective international cooperation could in principle have permitted a worldwide monetary expansion despite gold standard constraints, but disputes over World War I reparations and war debts, and the insularity and inexperience of the Federal Reserve, among other factors, prevented this outcome. As a result, individual countries were able to escape the deflationary vortex only by unilaterally abandoning the gold standard and re-establishing domestic monetary stability, a process that dragged on in a halting and uncoordinated manner until France and the other Gold Bloc countries finally left gold in 1936. —Great Depression, B. Bernanke
In 1944 at Bretton Woods, as a result of the collective conventional wisdom of the time, representatives from all the leading allied states collectively favored a regulated system of fixed exchange rates, indirectly disciplined by a US dollar tied to gold—a system that relied on a regulated market economy with tight controls on the values of currencies. Flows of speculative international finance were curtailed by shunting them through and limiting them via central banks. This meant that international flows of investment went into foreign direct investment (FDI)—i.e., construction of factories overseas, rather than international currency manipulation or bond markets. Although the national experts disagreed to some degree on the specific implementation of this system, all agreed on the need for tight controls.
Economic security
Also based on experience of the inter-war years, U.S. planners developed a concept of economic security—that a liberal international economic system would enhance the possibilities of postwar peace. One of those who saw such a security link was Cordell Hull, the United States Secretary of State from 1933 to 1944. Hull believed that the fundamental causes of the two world wars lay in economic discrimination and trade warfare. Hull argued
[U]nhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war … if we could get a freer flow of trade…freer in the sense of fewer discriminations and obstructions…so that one country would not be deadly jealous of another and the living standards of all countries might rise, thereby eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.
Rise of governmental intervention
The developed countries also agreed that the liberal international economic system required governmental intervention. In the aftermath of the Great Depression, public management of the economy had emerged as a primary activity of governments in the developed states. Employment, stability, and growth were now important subjects of public policy.
In turn, the role of government in the national economy had become associated with the assumption by the state of the responsibility for assuring its citizens of a degree of economic well-being. The system of economic protection for at-risk citizens sometimes called the welfare state grew out of the Great Depression, which created a popular demand for governmental intervention in the economy, and out of the theoretical contributions of the Keynesian school of economics, which asserted the need for governmental intervention to counter market imperfections.
However, increased government intervention in domestic economy brought with it isolationist sentiment that had a profoundly negative effect on international economics. The priority of national goals, independent national action in the interwar period, and the failure to perceive that those national goals could not be realized without some form of international collaboration—all resulted in "beggar-thy-neighbor" policies such as high tariffs, competitive devaluations that contributed to the breakdown of the gold-based international monetary system, domestic political instability, and international war. The lesson learned was, as the principal architect of the Bretton Woods system New Dealer Harry Dexter White put it:
the absence of a high degree of economic collaboration among the leading nations will … inevitably result in economic warfare that will be but the prelude and instigator of military warfare on an even vaster scale.
— Economic Security and the Origins of the Cold War, 1945–1950
To ensure economic stability and political peace, states agreed to cooperate to closely regulate the production of their currencies to maintain fixed exchange rates between countries with the aim of more easily facilitating international trade. This was the foundation of the U.S. vision of postwar world free trade, which also involved lowering tariffs and, among other things, maintaining a balance of trade via fixed exchange rates that would be favorable to the capitalist system.
Thus, the more developed market economies agreed with the U.S. vision of post-war international economic management, which intended to create and maintain an effective international monetary system and foster the reduction of barriers to trade and capital flows. In a sense, the new international monetary system was a return to a system similar to the pre-war gold standard, only using U.S. dollars as the world's new reserve currency until international trade reallocated the world's gold supply.