The Loss of Credibility and Stability in the Bretton Woods System

  • Heinz-Peter Spahn


The Bretton Woods currency order exhibited a double nature:
  • On the one hand, a two-tier system, continuing the external constraints on monetary policy making, was established where fixed exchange rates of national currencies were set up vis-à-vis the dollar, which in turn was defined as containing some fixed amount of gold. This framework was chosen in order to evade difficulties stemming from the actual uneven distribution, and a possible overall scarcity of gold reserves, in the future.

  • On the other hand, the desire to end the subordination of internal policy goals to balance-of-payments restrictions runs all the way through the negotiations and agreements of the treaty. Keynes could not get his plan accepted which was to establish an artificial world currency — the “bancor” — and to some extent abolish the budget constraint of deficit countries. Full convertibility of national currencies was not restored until 1959; and governments felt encouraged to employ restrictions on capital movements3 and sought to sterilize the monetary effects of exchange rate interventions. Moreover, in the case of “fundamental disequilibria”, each member country was allowed unilaterally to alter its exchange rate. There was no rule or norm enforcing a return to the former parity. With the traditional Restoration Rule abolished, speculation no longer acted as a stabilizing force. Finally, the U.S. gold reserve was, in a way, protected by the proviso that private agents were not allowed to demand gold at the fixed dollar price from the Federal Reserve, but only foreign official institutions, which could be deterred from doing so by means of political pressure. “The reason why the major industrial countries failed to use their disciplinary device had more to do with politics than with economics.”5


Interest Rate Monetary Policy Central Bank Money Supply Monetary Expansion 
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    Quoted from Giovannini 1993: 118, cf. Keynes 1942: 176, Kregel 1994/95.Google Scholar
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    In 1943, Keynes expressed a widely shared opinion: “We think it entirely impracticable that individual nationals of a country should be free to move assets abroad or to invest abroad quite irrespective of whether their country had a favourable balance which made such transactions possible. […] Foreign investment of individuals that does not correspond to a favourable balance is clearly something which can only cause trouble and can do no good, in the same way as flights of capital for reasons of political fear or fluctuating ideas of where the ‘better ’olé is. All that we want to get rid of. […] We can not hope to control rates of interest at home if movements of capital moneys out of the country are unrestricted” (1943a: 212, 276, cf. Moggridge 1986, Giovannini 1993 ).Google Scholar
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    Actually these assets were mostly held with the American banking system, which in the above model is amalgamated with the private non-bank sector. The gain of interest payments of course is a poor compensation for the loss of market power of the national central bank; but, contrary to the two-country model above, any single member country of the Bretton Woods system could not expect to gain substantial influence on world monetary conditions by keeping its foreign reserves in cash.21 Data from OECD: Main Economic Indicators, Bundesbank: 50 Jahre Deutsche Mark (CD-ROM).Google Scholar
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    Volcker’s attempt to put the loss of American competitiveness down to an initial misalignment in the Bretton Woods treaty is hardly convincing, because the deterioration of the U.S. current account can be explained by altering inflation differentials in the 1960s: “With the benefit of hindsight, it would seem that an erosion of the United States competitive position was implicit in the postwar arrangements. First Europe and later - with even greater momentum - Japan brought its industrial capacity and efficiency close to United States standards. It took some twenty years, but eventually the United States payment position was irreparably undermined” (1978/79: 6).Google Scholar
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    This collapse of dollar-based par values was hardly inevitable. If the U.S. Federal Reserve System had continued to anchor the common price level, and if the Americans had not asserted their legal right to adjust the dollar exchange rate as promised by the Bretton Woods Articles, the fixed dollar exchange parities could have continued indefinitely once the residual commitment to gold convertibility was terminated “ (McKinnon 1993: 26 ).Google Scholar
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    It was not ‘high living’ that wrought the change in the dollar. Rather was the deliberate exploitation of its role in the international system to defray current government expenditure abroad, to obtain resources and to accumulate high-income-bearing assets against paper obligations of steadily depreciating value. It was the result of military and corporate megalomania“ (Balogh 1973: 33, cf. Kindleberger 1967 ).Google Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2001

Authors and Affiliations

  • Heinz-Peter Spahn
    • 1
  1. 1.Lehrstuhl für Wirtschaftspolitik, Institut für VolkswirtschaftslehreUniversity of Hohenheim (520 A)StuttgartGermany

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