The Bretton Woods System

The Bretton Woods System JM Keynes & HD White Class 14 – Tuesday, 26 October 2010J A Morrison

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Lec 14: The Bretton Woods System • Keynes’ Revolutionary Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

You’ll remember that JM Keynes had been a virulent critic of the gold standard since the early 1920s. By the mid-1930s, the gold standard had once again become “dead as mutton.”

But Keynes knew that the revolution might prove only temporary.Throughout the 1930s, Keynes worked to refine his perspective and sharpen his criticisms.

Let’s turn, then, to consider precisely why Keynes despised the gold standard so vigorously…

“The problem of maintaining equilibrium in the balance of payments between countries has never been solved…So far from currency laissez-faire having promoted the international division of labour, which is the avowed goal of laissez-faire, it has been a fruitful source of all those clumsy hindrances to trade which suffering communities have devised in their perplexity as being better than nothing in protecting them from the intolerable burdens flowing from currency disorders.”-- Keynes (1941)

So, for Keynes, the central issue was the balance of payments.

What are states’ options for dealing with imbalances of payments?(Hint: Friedman in Class 6!)

Remember this slide? Lecture 6: Balance of Payments (Slide #38)

(1) Adjustment of Reserves • By directly intervening in the foreign exchange market, states can directly affect market price (exchange rate) • Asymmetry: lower to reserves but no upper limit  States might pursue positive BoP

(2) Adjustment of Internal Prices & Incomes • Uses price-specie-flow • Imbalanced demand  capital flows • Capital influx/efflux  inflation/deflation • Change in price levels counters imbalanced demand • Problem: domestic price levels are subjected to global economic forces • Politicians don’t like saying they can’t/won’t redress unemployment problems!

(3) Exchange Rate Adjustment • Here, price-specie-flow does not work • Imbalanced demand  pressure on ER • Change in market ER  change in cost of imports/exports • Change in relative price levels counters imbalanced demand • Potential Problems: • Minimum: creates ER instability and ER “risk” • Maximum: “undisciplined” governments  hyperinflation

Balance of Payments Current Account Trade in G&S Income Receipts Unilateral Transfers Capital Account Direct Investment Securities Purchases Checking Accounts (4) Exchange Controls Commercial Policy Capital Controls

Reconciling the Balance of Payments Under the Gold Standard But world gold supply is limited. • Adjustment of Reserves • Adjustment of Internal Prices & Incomes • Exchange Rate (ER) Adjustment • Exchange Controls • Capital Controls: Limit convertibility • Commercial Policy

Alleviating Imbalances of Payments

Given the finite supply of gold, policymakers on the GS are essentially forced to choose between sacrificing control over domestic macroeconomic policy and enacting commercial policy…

“[I]n an economy subject to money contracts and customs more or less fixed over an appreciable period of time, where the quantity of the domestic circulation and the domestic rate of interest are primarily determined by the balance of payments, as they were in Great Britain before the war, there is no orthodox means open to the authorities for countering unemployment at home except by struggling for an export surplus and an import of the monetary metal at the expense of their neighbours…”-- Keynes, General Theory (Ch 23)

“Never in history was there a method devised of such efficacy for setting each country's advantage at variance with its neighbours' as the international gold (or, formerly, silver) standard. For it made domestic prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious metals. ”-- Keynes, General Theory (Ch 23)

In other words, the gold standard creates enormous incentives for states to enact commercial policy. Is the gold standard worth sacrificing free trade?

Over the course of his life, Keynes favored different proposals but one thing never changed…

“It is the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment programme directed to an optimum level of domestic employment which is twice blessed in the sense that it helps ourselves and our neighbours at the same time. And it is the simultaneous pursuit of these policies by all countries together which is capable of restoring economic health and strength internationally, whether we measure it by the level of domestic employment or by the volume of international trade.”-- Keynes, General Theory (Ch 23)

Keynes always prioritized internal stability over external stability…Find some way—any way!—to alleviate imbalances of payments other than through domestic macroeconomic adjustments.

During the interwar period, foreign economic policy was made unilaterally and on an ad hoc basis.The result was not just a lack of cooperation, but many of the policies were cross-cutting. The difficulties of the 1930s were exacerbated.

The very rocky experiences of states during the interwar period increased their willingness to consider alternatives.But what were the robust alternatives to the gold standard?

Lec 14: The Bretton Woods System • Keynes’ Radical Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

II. Creation of the BWS Keynes and White Keynes versus White The Bretton Woods Conference Another Gold Standard System?

In the summer of 1941, with the United States far from entering the war and the Axis rolling through the Soviet Union, JM Keynes and HD White (independently) drafted their plans for the postwar monetary order.

John Maynard Keynes (GB) • 5 June 1883 – 21 April 1946 • Represented British Treasury at Versailles (1919) • Battled 1925 Return to Gold • Called for Abandonment of Gold in 1930s

Harry Dexter White (US) • 1892 – 1948 • Represented US Treasury • Possibly Authored Morgenthau Plan • Possibly leaked plan to Soviets • 1948: HUAC tried him as Soviet Spy

Both HDW & JMK proposed creating an international institution to manage the international monetary system.(JMK: International Clearing Union)(HDW: International Stabilization Fund)

Functions of the Proposed International Institution • Multilateral Clearing Mechanism: Centralize Currency Exchange • Orderly Exchange Rate Regulation • International “Banking” – Distribute Liquidity • “Creditor” countries acquire extra reserves • “Debtor” countries lose reserves • Int’l Institution will loan to debtors from creditors’ accounts

Essentials of Proposed Institution • ER Stability • ERs fixed to gold or currency backed by gold (e.g. US $) • ERs flexible within very narrow bands • Limited Adjustment: members vote to determine if there is “fundamental disequilibrium” • “Scarce currency” exception • Capital Controls • States encouraged to limit “speculative flows” • Facilitator: Make loans for temporary imbalances

Keynes and White broadly agreed on the purpose and scope of the proposed institution.But they didn’t agree on all of the specifics of implementation…

Points of Disagreement • Rigor of Capital Controls • JMK: more capital controls • HDW: fewer capital controls • Size of Quotas for Borrowing • JMK: large quota • HDW: small quota • Ultimate Adjustability of ERs • JMK: States should more freely adjust their ERs • HDW: ERs should remain fixed

Simply put, Keynes wanted a more radical departure from the gold standard than did White.Why? Partly because the US had all of the gold!

The US agreed to redistribute the gold through the International Bank for Reconstruction and Development (IBRD)—which later became the World Bank.

White & Keynes Timeline • 1935: HDW & JMK first meet • Summer 1941: HDW & JMK draft plans • Jul-Aug 1942: Plans Exchanged • JMK: “[The White Plan] obviously won’t work.” • Oct 1942: HDW visits GB Treasury • Fall 1942-Spring 1943: Jockeying for Position • Competing plans published • Int’l conferences • Summer/Fall 1943: JMK & HDW draft “Joint-Statement”

Ultimately, things looked more like White’s Plan than that of Keynes. This isn’t surprising given the asymmetry of bargaining power.

And Keynes was content…

“the Harry White Plan is not a firm offer.The real risk is that there will be no plan at all and that Congress will run away from their own proposal. No harm…if the Americans work up a certain amount of patriotic fervour for their own version. Much can be done in detail hereafter to improve it. The great thing at this stage is that they should get thoroughly committed to there being some plan…”--Keynes to Phillips, April 1943

By the autumn of 1943, Britain and the United States had sorted out essentially all of the details for the International Monetary Fund.

After GB and the US had reached agreement, the rest of the world was invited to Bretton Woods, NH, in July 1944 for the United Nations Monetary and Financial Conference.

Mount Washington Hotel, Bretton Woods, NH

Keynes and White dominated the conference. Essentially nothing was changed from their earlier agreement. And all but 1—the USSR—of the 45 invited nations eventually signed on.

The Bretton Woods System