Wednesday, May 25, 2005

Bretton Woods: The Development of an International Monetary System

Econ 111
Economic History of the
United States

Bretton Woods: The Development of an International Monetary System

In July of 1944, a group of American and British officials met at the Mount Washington Hotel in Bretton Woods, New Hampshire (Eichengreen, 7). They were confronted with an immense challenge: How to create a stable international monetary policy at the end of the Second World War. What had emerged from Bretton Woods was a system that lasted for almost three decades while the institutions evolved to confront the challenges of today's global economy.

There were two objectives of Bretton Woods. The first objective was to promote faster growth through increased integration of the world economy. The second was to promote a stability of balance of payments system for international trade (Bayouni, 1995). Before Bretton Woods, the economics of global trade was based on the minting of gold and silver coins. Nations would engage in trade-importing and exporting products with other nations-conducting payments for goods in gold and silver coin (Eichengreen, 8-9). In the 19th century, Britain adopted a new monetary policy where the government would convert its currency into gold at a fixed rate of exchange on demand. This was the start of the gold standard (Eichengreen, 22). In the gold standard, balance of payments deficits were paid through the export of gold. This resulted in a decrease of the domestic money supply, causing a deflation of prices. This would cause an decrease in imports to the country. At the same time, the country's prices of exports would drop, stimulating international demand for the country's exports until the balance of payments deficit was corrected. A balance of payments surplus worked the opposed way. An increase in the money supply in a country would cause an increase in prices. This would have the opposite effect of increasing the demand for imports into the country and reducing exports, thus eliminating the surplus (Gavin, 1996). The gold standard lasted among the major powers until the 1930s and the world depression.

The participants of Bretton Woods recognized an important factor in trade liberalization and a system of open payments between nations (Bayouni, 1995). During the 1930s depression, nations had attempted to protect their industries and employment from an economic downturn by increasing exports, while at the same time limiting imports through high tariffs levied on products. While this policy may work on a single nation, however when all the great powers adopted these policies, international trade plummeted, further exasperating the economic malaise(A Fund By Design, 1991). The result of this downturn was the rise of fascist governments in Germany, Italy, and Japan in which each government embarked on a policy of military conquest for economic gains (Thurow, 1992).

To promote a stability of money supply and balance of payments, the International Monetary Fund (IMF) was created. This was the heart of Bretton Woods. The IMF was designed to monitor a system of fixed exchange rates between nations currencies and to provide short term loans to countries suffering balance of payments deficits (A Gift From The Cold War: Bretton Woods Revisited, 1994). The IMF was actually a compromise between British economist John Maynard Keynes and U.S. Treasury economist Harry Dexter White (Eichengreen, 97). Keynes wanted to allow countries to change their exchange rates and apply trade restrictions to reconcile full employment and balance of payments. White opposed this plan, insisting upon a world free of controls with pegged currencies supervised by an international organization (Eichengreen, 96). A compromised was worked out for the development of an "adjustable peg." This would allow for world currencies to be set at an exchange rate pegged to the gold or the U.S. dollar. The U.S. dollar would then be set at a fixed rate of gold. Currency adjustments were allowed under IMF supervision (A Gift From The Cold War: Bretton Woods Revisited, 1994). In effect, the U.S. dollar became the world's currency.

In one aspect, the IMF became a club where member nations would consult each other on international monetary problems. Upon joining the IMF, members would contribute a sum of money called a quota which would be used by the IMF to provide the short term loans to countries with balance of payments problems. Each member nation would have a percentage of voting power in IMF decisions based on the proportion of its quota (Fieleke, 1994). When the IMF began operations in 1946, the fund had 39 members. By 1994, the fund had grown to 178 members (Fieleke, 1994).

The IMF system of exchange rates worked up until the 1970s. By the early 1970s, the United States had incurred large balance of payments deficits (Fieleke, 1994). Much of the deficits were the result of increased U.S. military spending to finance the Vietnam War (Gavin, 1996). With more dollars chasing gold reserves, foreign governments confidence in the U.S government's ability to pay the original fixed dollar amount of $35.00 per ounce of gold had dropped. Governments began cashing dollars in for gold, causing a run on the U.S. gold reserves. On August 15, 1971, the Nixon Administration suspended the dollar's convertibility into gold, causing the dollar's value to rise and fall in relation to other world's currencies (Fieleke, 1994). The system of fixed exchange rates based on gold was scrapped. The dollar was no longer the world's currency.

But the International Monetary Fund still exists. The IMF continued its job as a lender of short term loans for countries experiencing balance of payment problems. In addition, the IMF developed lines of credit for nations to draw upon to pay cyclical deficits (A Fund By Design, 1991). Finally, the IMF has started to provide technical assistance to countries in areas of fiscal, monetary, and foreign exchange management. In 1993, the IMF dispatched 606 technical assistance missions to nations, (Fieleke, 1994).

The second unique institution created was the World Bank. The World Bank is a publicly owned institution which finances its loan operations by selling bonds (Crook, 1991. The bank's original purpose was to provide loans to nations for post-Second World War reconstruction and economic development (Mikesell, 2000). However, the World Bank was unable to complete the task after the United States embarked on the Marshall Plan for economic reconstruction of Europe and a similar reconstruction plan for Japan (Mikesell, 2000). In fact, one important aspect of the U.S. Marshall plan aid to Europe was the recipient's conditional agreement for a timetable to liberalize trade relations (Bayouni, 1995). This condition closely linked U.S and European trade policies closely together. No such condition of liberalizing trade policies existed with World Bank loans. What is interesting is that the World Bank adapted its role towards short term macro economic policy in developing programs of economic reform and backing the reform with loans. The bank attempted to place an economic theory into a viable program. Poor countries would have scarce capital for investment, but would have an abundance of labor and natural resources. The theory was that rich countries would provide an abundance of capital to poor countries on the premise that the investments into a poor country would provide a high rate of return on the investment (Singer, 1995). The World Bank would be the intermediary between the rich industrial countries providing capital for investment, and the poor countries requesting loans for economic development. However, attempts to design and implement this program became difficult and time consuming. The World Bank ended up operating on a limited basis (Singer 1995).
In 1970, former U.S. Secretary of Defense Robert McNamara became president of the World Bank. He adapted the World Bank's role away from funding large scale economical projects in developing countries to providing loans and resources to governments for spending on marginal projects which were not analyzed by the bank. The World Bank adapted to a new principle of fungibility (Singer, 1995). The World Bank has gradually evolved into an institution providing financial programs to countries for economic and social progress.

Finally, the members of the Bretton Woods conference recognized the importance of free trade. They were first hand witnesses of how governments, when faced with economic problems, would raise tariffs to discourage imports and push for exports, causing the collapse of free trade. The collapse of free trade and the introduction of projectionist measures resulted in the evolution of military blocks of powerful nations whose purpose was to expand and gain economic assets through military means. The delegates decided to create an organization called the International Trade Organization (ITO). The ITO was to coordinate the simultaneous reduction of tariffs and quotas in member nations (Eichengreen, 101). The ITO was finalized by 56 countries participating in the United Nations Conference on Trade and Employment, held in Havana, Cuba. However, the U.S. killed the ITO by failing to ratify the Havana Charter which would result in the creation of the ITO (Eichengreen, 101). The ITO was attached in the United States by trade protectionists who opposed its liberal policies on trade, and perfectionists who criticized the exceptions by countries seeking to establish full employment, accelerating economic development, and stabilizing prices of commodity exports (Eichengreen, 101). Out of the ashes of the ITO came the General Agreements of Tariffs and Trade (GATT). GATT provided a forum in which nations could reduce the levels of tariffs and promote open trade. In the first GATT round in Geneva, 1947, the U.S. agreed to cut its tariffs by a third (Eichengreen, 101). In 1995, the Uruguay Rounds of GATT created the World Trade Organization (WTO). The WTO takes up where the ITO left off-promoting free trade and the reduction of tariffs. However, the WTO has enormous powers, such as the authority to impose trade sanctions on member nations violating free trade rules (Evans, 1995). The authority to impose trade sanctions was never provided to GATT or the ITO. Yet GATT and the WTO will be facing a world at a crossroads. While the nations of the world espouse the ideas of free and liberal trade, however, a sense of regionalism has crept in as seen with the North American Free Trade Agreement--which creates a trading block between the United States, Canada and Mexico. A second regional trading block is the European Union which creates a free trade area among the nations of Western Europe. These are only two of the regional blocks of nations which are evolving and the WTO must find a means of promoting free trade among these blocks before protectionism can set in.

Bretton Woods may not have been the perfect system created to manage international finance on those summer days in New Hampshire. But the system has worked to a point where the world has remained at peace and international trade has continued without major problems.

Works Cited.

A Fund By Design. (1991). The Economist. Vol. 321. No. 7728. Pg. 57.
A Gift From The Cold War: Bretton Woods Revisited. (1994). The Economist. Vol. 332. No. 7871. Pg. 69.

Bayoumi, Tamim. (1995). The Postwar Economic Achievement. Finance & Development. Vol. 32. Pg. 48-51.

Crook, Clive. (1991). Two Pillars Of Wisdom: The IMF And The World Bank. The Economist. Vol. 321. No. 7728. Pg. 51.

Eichengreen, Barry. Globalizing Capital. Princeton. Princeton University Press. (1996).

Evans, Richard. (1995). Brave New World Order. The Geographic Magazine. Vol. 67. Pg. 39-42.

Fieleke, Norman S. (1994). The International Monetary Fund 50 Years After Bretton Woods. New England Economic Review. Pg. 17.

Gavin, Francis J. (1996). The Legends Of Bretton Woods. Orbis. Vol. 40. Pg. 183.
Mikesell, Raymond F. (2000). Bretton Woods-Original Intentions And Current Problems. Contemporary Economic Policy. Vol. 18. No. 4. Pg. 404-414.

Singer, Hans W. (1995). Bretton Woods And The UN System. The Ecumenical Review. Vol. 47. No. 3. Pg. 348.

Thurow, Lester C. (1992). New Rules For Playing The Game. National Forum. Vol. 72. No. 4. Pg. 10.

No comments: