16. Dollar Imperialism: The Bretton Woods System

One of the factors that contributes to the great confidence in the United States dollar which exists the world over … is undoubtedly our large gold holdings. …
[I]nternational agreement is not a substitute for gold.
– HARRY DEXTER WHITE

With the beginning of the First World War the era of the worldwide gold money ends. Unbacked paper money (or: fiat money) becomes standard money. But this type of money causes many problems: it causes inflation and exchange rate fluctuations that affect the global division of labor and trade. The international community of states therefore tries to continue the tradition of using gold money. But it will only be a half-hearted and therefore misguided attempt. From July 1 to July 22, 1944, the finance ministers and central bank governors of forty-four states of the later victorious powers met in Bretton Woods, New Hampshire. The aim of this international monetary and financial conference is to work out how to reorganize the world financial system for the period after the end of the Second World War.88 The British supported the Keynes Plan (named after John Maynard Keynes, 1883–1946), the Americans the White Plan (named after Harry D. White, 1892–1948).89

The result of the conference is the Bretton Woods system. It is marked by three characteristics. First, the new monetary system is designed as a gold exchange standard. Gold is the only internationally recognized means of payment in 1944 and is used to settle cross-border trade. The gold-backed US dollar is elevated to become the world’s reserve currency, as from 1934, thirty-five US dollars were worth one troy ounce of gold. The US Federal Reserve promises to redeem US dollar holdings held by other central banks into physical gold at any time and without restriction. This promise of the Americans is believed, because at the time the monetary agreement is signed, they have about three-quarters of the world’s currency gold at their disposal, and because hardly anyone can imagine that the United States would one day have chronic balance-of-payments deficits (i.e., permanently import more than export and thus suffer from a gold outflow).

Second, the Bretton Woods system provides for fixed exchange rates. All participating currencies have a fixed exchange ratio (parity) against the US dollar. In this way they are indirectly tied to gold. The currency of a participating country may only fluctuate around parity within a narrow range of a maximum of ± 1 percent. If, for example, the deutschmark is under revaluation pressure against the US dollar, the Deutsche Bundesbank is obliged to intervene in the foreign exchange market: it has to buy US dollars and put them into circulation until the exchange rate is back within the specified exchange rate range. There is no obligation for the US Federal Reserve to intervene.

Third, in the Bretton Woods system, currencies are freely interchangeable (convertible) between themselves. For example, on the foreign exchange markets, German marks, British pounds, and French francs can be exchanged for US dollars. The US dollars can be exchanged for physical gold at the US Federal Reserve on request. However, this exchange possibility only exists for payments between central banks. Moreover, currency convertibility is initially limited to payment transactions for commodities. It does not exist for the autonomous movement of capital. It was not until 1958 that convertibility was introduced for capital movements independent of trade in goods.

The Bretton Woods system basically does not deserve to be described as a form of gold standard—although that is often the case today. Rather, it was a “pseudo-gold standard.” But at least the Bretton Woods system initially contributes to reviving world trade in the immediate postwar period and promoting prosperity. It prevents the disruptive effects of fluctuating exchange rates on the international division of labor. However, from the very beginning, the system has flagrant design flaws that bring it down in the early 1970s: the acute problem areas are balancing the balance of payments and providing international liquidity.

Initially, America exports more than it imports. The foreign country therefore pays more dollars to America than Americans pay to the foreign countries. There is talk of a “dollar shortage.” In fact, the countries that have reported a trade deficit with the US should have lowered their prices in order to increase their competitiveness at fixed exchange rates. But that was politically not desired. From 1959, the US balance of payments turns into a deficit: America imports more than it exports. The foreign countries begin to accumulate dollar assets. The dollar shortage turns into a “dollar glut.” America had started to expand the US dollar money supply—mainly because of its belligerent foreign policy—without having a corresponding gold backing. This puts the US dollar under devaluation pressure and forces central banks in other countries to intervene in favor of the US dollar.

In the Bretton Woods system, they are forced to buy US dollars and pay for their purchases with newly created domestic currency. As a result, they import the Americans’ inflationary monetary policy. The now rising money supply in their own country is causing prices to rise. In this way, the Americans cause an inflation of the entire system. In order for foreign countries to escape the devaluation of their own currency, the exchange rates are subsequently adjusted (realignments). For example, the German mark is revalued several times against the US dollar.

However, the US dollar is also beginning to depreciate against gold. As a result, eight major central banks—seven from Europe in addition to the US central bank—begin to hold the gold price at US $35 per troy ounce as early as November 1961 (London Gold Pool). They sell gold from their own reserves in order to counteract the rise in the price of the precious metal against the US dollar. But in vain. The markets drive the price of gold higher and higher, because the US dollar is inflationary. In March 1968, the central banks officially end their interventions in the gold market.

On August 15, 1971, US president Richard Nixon (1913–94) declared in a television speech that from now on the US dollar could no longer be redeemed for gold. The Americans had not been allowed to own physical gold since 1933, as President Franklin D. Roosevelt had forbidden it. Now the central banks of other countries can no longer exchange their dollar balances for gold. This unilateral decision not only removes the gold backing from the US dollar, but also turns all the world’s major currencies into unbacked paper money, or fiat money.

The Bretton Woods system failed, because many countries were unwilling to unconditionally comply with the bidding of American inflationary policies. They escaped inflation by revaluing their own currencies. The voluntary solidarity that was supposed to hold the Bretton Woods system together proved too weak. Governments in many countries placed their domestic economic concerns above the obligations that arose from the international monetary system agreement, which Americans abused by inflating. The Bretton Woods system was finally terminated on March 2, 1973. Nevertheless, the US dollar strengthened its status as a world reserve currency.

The International Monetary Fund (IMF) amended its statutes in 1976. From then on, each IMF member country was free to choose its own exchange rate system, allowing flexible exchange rates. Exchange rate fluctuations were to be contained by “domestic stability” in the economies, no longer by central bank intervention in the foreign exchange markets. In principle, manipulation of exchange rates, intended to create advantages in foreign trade, was to be avoided.

As a result, a mixed exchange rate system emerges worldwide. Some countries (mainly developing countries) peg their currencies to other currencies or a basket of currencies at a fixed exchange rate. Still others agree fixed exchange rates with each other and flexible exchange rates with third parties (as is the case with the European Monetary Union, for example). Countries such as the United States, Japan, or the United Kingdom rely on flexible exchange rates.

The experience of the “dollar shortage” that emerged in the early years of the Bretton Woods system gave rise to a desire on the part of many countries to make their international liquidity independent of the US balance of payments situation. Until then, gold and US dollars had been the means of payment and currency reserves accepted worldwide. But by the end of the 1950s, the US had already begun to issue more and more US dollars that were not backed by gold. Under these conditions, it was foreseeable that the gold price in US dollars would come under appreciation pressure.

But raising the official gold price—a devaluation of the US dollar against gold, which was even explicitly provided for in the IMF agreement under certain conditions—was not politically opportune for several reasons:90 (1) It would have benefited gold producers South Africa and the Soviet Union, one country an apartheid regime, the other the main opponent in the Cold War. (2) It would have discriminated against countries that in good faith held US dollars instead of gold. (3) It was feared that an increase in the price of gold would fuel speculation about further increases in the price of gold.

Since the official gold price was not to be raised, a further reserve currency was devised in addition to gold (which was increasingly in demand but limited in quantity) and the US dollar (which was less and less in demand and whose quantity was increasingly expanded): this was known as the special drawing right (SDR). The decision that the International Monetary Fund may issue special drawing rights was made in 1967. SDRs were first created in 1969 and issued to IMF participants. SDRs were allocated on the basis of the share of capital (“quota”) held by each country in the IMF.

SDRs are not money but represent a claim against all IMF participating countries for foreign currencies. Specifically, this means that a country with a balance-of-payments deficit can convert its SDRs at the IMF into a desired participating country’s national currency. The IMF then designates a country with a balance-of-payments surplus to provide the desired currency. The SDRs can be exercised under certain conditions by any IMF member country and have the potential to increase the global money supply; the SDR has therefore been aptly referred to as “global helicopter money.”91

Originally, each SDR was worth exactly 0.888671 grams of gold. After the collapse of Bretton Woods in 1973, the definition was changed: from then on, the SDR was no longer an equivalent value of physical gold but corresponded to a “basket” of the main unbacked currencies. The composition of the SDR basket is reviewed every five years. Since October 1, 2016, the currency basket defining the SDR has consisted of US dollars, euros, Chinese renminbi, Japanese yen, and British pounds. The currencies are weighted as follows: US dollar, 41.73 percent; euro 30.93 percent, Chinese renminbi 10.92 percent, Japanese yen 8.33 percent, and British pound, 8.09 percent. SDRs can only be held by the central banks of IMF member states and are used for payments between participating countries and toward the IMF. For example, the IMF can grant loans in the form of SDRs instead of national currencies, or it can replenish a country’s scarce foreign reserves by granting SDRs. SDRs cannot be used directly on the foreign exchange markets. They must first be exchanged for a marketable currency.

The global financial and economic crisis of 2008–09 has given new impetus to political interest in the IMF. In April 2009, the G20 decided to strengthen the IMF by significantly expanding its ability to issue SDRs and create additional credit. Initially, it was decided to triple the IMF’s freely available financial resources to a total of more than $750 billion and to increase the SDRs to the tune of around $250 billion; before that, the stock was only $33 billion.92 Following a resolution on November 24, 2009, the IMF’s financial resources were further increased to a total of $934 billion.

The inspiration for these decisions was the idea to turn the IMF into a “global rescue fund.” However, according to the IMF agreement, it is the IMF’s task to provide financial assistance for a country’s balance of payments problems—an objective derived from the Bretton Woods system (which is actually no longer necessary in today’s flexible exchange rate system). The purpose of SDR allocations is to meet a long-term need for additional foreign reserve assets. Now, however, the IMF has been provided with bilateral credit lines to increase its financial firepower in the short term.

The IMF—also because the scope of action of its leadership has been extended—therefore increasingly resembles a world central bank that can issue SDRs and also grant loans in national currencies. The SDR is therefore often seen as a precursor, a kind of nucleus, of a single world currency. From a purely technical standpoint, this view is not unfounded: it would only take a few decisions or actions to make the SDR a single world currency—proclaiming and enforcing irrevocably fixed exchange rates or merging national currencies with the SDR.

This idea inspired the creation of the euro at the beginning of 1999 and has already been tried out in practice. What today is praised as the successful unification of monetary relations in Europe is to be interpreted quite differently from a logical point of view: the euro is the result of an effort to put an end to monetary diversity in Europe and to create a unified state currency. It was not left to the free-market forces to provide the desired unified money; instead it was promoted by state coercive measures and therefore also conceived as state fiat unified money. This will be explained in the following chapter.

• 88A good overview is provided by the Federal Reserve Bank of Boston, The International Monetary System: Forty Years after Bretton Woods, Proceedings of a Conference Held at Bretton Woods, New Hampshire (Boston: Federal Reserve Bank of Boston, 1984).
• 89For details see International Monetary Fund, The International Monetary Fund, 1945–1965: Twenty Years of International Monetary Cooperation, vol. 3, Documents, ed. J. Keith Horsefield (Washington, DC: International Monetary Fund, 1969), pp. 3–96.
• 90See Robert A. Mundell, “The International Monetary System and the Case for a World Currency” (lecture no. 12 of the Leon Koźmiński Academy of Entrepreneurship and Management and TIGER Distinguished Lecture Series, Warsaw, Poland, Oct. 23, 2003), p. 7; he cites five reasons here.
• 91Strictly speaking, the global money supply only increases if a country determined by the IMF to provide another country with an amount in its own currency expands its own money supply in order to do so.
• 92See Deutsche Bundesbank, Finanzierung und Repräsentanz im Internationalen Währungsfonds, March 2010, pp. 57–58.