5. Phase V: Bretton Woods and the New Gold Exchange Standard (the U.S.) 1945-1968

The new international monetary order was conceived and then driven through by the United States at an international monetary conference at Bretton Woods, New Hampshire, in mid-1944, and ratified by the Congress in July, 1945. While the Bretton Woods system worked far better than the disaster of the 1930’s, it worked only as another inflationary recrudescence of the gold-exchange standard of the 1920s and—like the 1920s—the system lived only on borrowed time.

The new system was essentially the gold-exchange standard of the 1920s but with the dollar rudely displacing the British pound as one of the “key currencies.” Now the dollar, valued at 1/35 of a gold ounce, was to be the only key currency. The other difference from the 1920s was that the dollar was no longer redeemable in gold to American citizens; instead, the 1930’s system was continued, with the dollar redeemable in gold only to foreign governments and their central banks. No private individuals, only governments, were to be allowed the privilege of redeeming dollars in the world gold currency. In the Bretton Woods system, the United States pyramided dollars (in paper money and in bank deposits) on top of gold, in which dollars could be redeemed by foreign governments; while all other governments held dollars as their basic reserve and pyramided their currency on top of dollars. And since the United States began the post-war world with a huge stock of gold (approximately $25 billion) there was plenty of play for pyramiding dollar claims on top of it. Furthermore, the system could “work” for a while because all the world’s currencies returned to the new system at their pre-World War II pars, most of which were highly overvalued in terms of their inflated and depreciated currencies. The inflated pound sterling, for example, returned at $4.86, even though it was worth far less than that in terms of purchasing power on the market. Since the dollar was artificially undervalued and most other currencies overvalued in 1945, the dollar was made scarce, and the world suffered from a so-called dollar shortage, which the American taxpayer was supposed to be obligated to make up by foreign aid. In short, the export surplus enjoyed by the undervalued American dollar was to be partly financed by the hapless American taxpayer in the form of foreign aid.

There being plenty of room for inflation before retribution could set in, the United States government embarked on its post-war policy of continual monetary inflation, a policy it has pursued merrily ever since. By the early 1950s, the continuing American inflation began to turn the tide the international trade. For while the U.S. was inflating and expanding money and credit, the major European governments, many of them influenced by “Austrian” monetary advisers, pursued a relatively “hard money” policy (e.g., West Germany, Switzerland, France, Italy). Steeply inflationist Britain was compelled by its outflow of dollars to devalue the pound to more realistic levels (for a while it was approximately $2.40). All this, combined with the increasing productivity of Europe, and later Japan, led to continuing balance of payments deficits with the United States. As the 1950s and 1960s wore on, the U.S. became more and more inflationist, both absolutely and relatively to Japan and Western Europe. But the classical gold standard check on inflation—especially American inflation—was gone. For the rules of the Bretton Woods game provided that the West European countries had to keep piling upon their reserve, and even use these dollars as a base to inflate their own currency and credit.

But as the 1950s and 1960s continued, the harder-money countries of West Europe (and Japan) became restless at being forced to pile up dollars that were now increasingly overvalued instead of undervalued. As the purchasing power and hence the true value of dollars fell, they became increasingly unwanted by foreign governments. But they were locked into a system that was more and more of a nightmare. The American reaction to the European complaints, headed by France and DeGaulle’s major monetary adviser, the classical gold-standard economist Jacques Rueff, was merely scorn and brusque dismissal. American politicians and economists simply declared that Europe was forced to use the dollar as its currency, that it could do nothing about its growing problems, and that therefore the U.S. could keep blithely inflating while pursuing a policy of “benign neglect” toward the international monetary consequences of its own actions.

But Europe did have the legal option of redeeming dollars in gold at $35 an ounce. And as the dollar became increasingly overvalued in terms of hard money currencies and gold, European governments began more and more to exercise that option. The gold standard check was coming into use; hence gold flowed steadily out of the U.S. for two decades after the early 1950s, until the U.S. gold stock dwindled over this period from over $20 billion to $9 billion. As dollars kept inflating upon a dwindling gold base, how could the U.S. keep redeeming foreign dollars in gold—the cornerstone of the Bretton Woods system? These problems did not slow down continued U.S. inflation of dollars and prices, or the U.S. policy of “benign neglect,” which resulted by the late 1960s in an accelerated pileup of no less than $80 billion in unwanted dollars in Europe (known as Eurodollars). To try to stop European redemption of dollars into gold, the U.S. exerted intense political pressure on the European governments, similar but on a far larger scale to the British cajoling of France not to redeem its heavy sterling balances until 1931. But economic law has a way, at long last, of catching up with governments, and this is what happened to the inflation-happy U.S. government by the end of the 1960s. The gold exchange system of Bretton Woods—hailed by the U.S. political and economic Establishment as permanent and impregnable—began to unravel rapidly in 1968.