The Bretton Woods System
JM Keynes & HD
White
Class 14 – Tuesday, 1 November 2011
J A Morrison
1
Admin
• Niall Ferguson's The Ascent of Money -available online
2
Lec 14: The Bretton Woods
System
I. Keynes’ Revolutionary Vision
II. Creation of the Bretton Woods
System
III. History of the Bretton Woods
System
3
Lec 14: The Bretton Woods
System
I. Keynes’ Revolutionary Vision
II. Creation of the Bretton Woods
System
III. History of the Bretton Woods
System
4
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.”
5
But Keynes knew that the
revolution might prove only
temporary.
Throughout the 1930s, Keynes
worked to refine his perspective
and sharpen his criticisms.
6
Let’s turn, then, to consider
precisely why Keynes despised
the gold standard so
vigorously…
7
“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)
8
So, for Keynes, the central
issue was the balance of
payments.
9
What are states’ options for
dealing with imbalances of
payments?
(Hint: Friedman in Class 6!)
10
Remember this slide?
Lecture 6: Balance of Payments (Slide #38)
11
Reconciling the Balance of
Payments Under the Gold
Standard
But world gold supply is
limited.
1. Adjustment of Reserves
2. Adjustment of Internal Prices &
Incomes
3. Exchange Rate (ER) Adjustment
4. Exchange Controls
1. Capital Controls: Limit convertibility
2. Commercial Policy
16
Alleviating Imbalances of
Payments
Method
Gold Standard
Adjust Reserves
Limited Stock of Gold
Adjust Domest Price
Level
Yup: Price-SpecieFlow
Adjust ERs
No: Violates Rules
Exch Control: Capital
Controls
Exch Control:
Commercial Policy
No: Violates Rules
Yup: Not against the
Rules
17
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…
18
“[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...there is no orthodox means...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)
19
“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)
20
In other words, the
gold standard creates
enormous incentives
for states to enact
commercial policy. Is
the gold standard
worth sacrificing free
trade?
21
Over the course of his life,
Keynes favored different
proposals but one thing never
changed…
22
“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)
23
Alleviating Imbalances of
Payments
Method
Gold Standard
Keynes’ Proposals
Adjust Reserves
Limited Stock of
Gold
Adjust Domest
Price Level
Yup: Price-SpecieNEVER!!!!!!
Flow
Adjust ERs
No: Violates Rules
Exch Control:
Capital Controls
No: Violates Rules 1944
Exch Control:
Yup: Not against
Commercial Policy the Rules
1944
1923-1926, 19311940
1929-1931
24
Keynes always prioritized
internal stability over external
stability…
Find some way—any way!—to
alleviate imbalances of
payments other than through
domestic macroeconomic
adjustments.
25
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.
26
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?
27
Lec 14: The Bretton Woods
System
I. Keynes’ Radical Vision
II. Creation of the Bretton Woods
System
III. History of the Bretton Woods
System
28
II. Creation of the BWS
1.
2.
3.
4.
Keynes and White
Keynes versus White
The Bretton Woods Conference
Another Gold Standard System?
29
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.
30
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
31
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
32
Both HDW & JMK proposed
creating an international
institution to manage the
international monetary system.
(JMK: International Clearing Union)
(HDW: International Stabilization Fund)
33
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
34
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
35
Alleviating Imbalances of
Payments
Method
Gold Standard
Bretton Woods
Adjust Reserves
Limited Stock of
Gold
Adjust Domest
Price Level
Yup: Price-SpecieUnnecessary! 
Flow
Adjust ERs
No: Violates Rules
Exch Control:
Capital Controls
No: Violates Rules Please do!
Exch Control:
Yup: Not against
Commercial Policy the Rules
IMF will
redistribute
10%, more with
authorization
No: Promote free
trade
36
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…
37
II. Creation of the BWS
1.
2.
•
•
Keynes and White
Keynes versus White
The Bretton Woods Conference
Another Gold Standard System?
38
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
39
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!
40
The US agreed to redistribute
the gold through the
International Bank for
Reconstruction and
Development (IBRD)—which
later became the World Bank.
41
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 “JointStatement”
42
Ultimately, things looked more
like White’s Plan than that of
Keynes.
This isn’t surprising given the
asymmetry of bargaining power.
43
And Keynes was content…
44
“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
45
II. Creation of the BWS
1.
2.
3.
•
Keynes and White
Keynes versus White
The Bretton Woods Conference
Another Gold Standard System?
46
By the autumn of 1943, Britain
and the United States had
sorted out essentially all of the
details for the International
Monetary Fund.
47
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.
48
Mount Washington Hotel, Bretton Woods, NH
49
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.
50
The International Monetary
Fund and the International Bank
for Reconstruction and
Development (precursor to the
World Bank) were created with
a ceremonial signing 27
December 1945.
51
II. Creation of the BWS
1.
2.
3.
4.
Keynes and White
Keynes versus White
The Bretton Woods Conference
Another Gold Standard System?
52
Keynes had originally proposed that
gold be replaced with a new
international currency (“unitas”).
Unitas could be linked to gold but its
supply would be regulated by the IMF.
Combined with IMF reserve
management and periodic ER
adjustments, Keynes believed this
would prevent states from fighting over
a limited supply of gold.
53
The US, however, liked the idea of
continuing to use gold or “any currency
backed by gold” as the Nth Currency.
After all, the US had all of the gold!
The US did not want to cede control
over its extensive reserves to an
international regime.
As with trade, the US got its way.
54
The textbooks suggest that
“under the Bretton Woods
system, the world was on a gold
standard once removed.”
(Colander 2006, 482)
So, was the BWS really just a
modified GS?
55
 It depends on your preferred
emphasis.
56
The BWS formally preserved a
special role for gold.
But it substantively
recognized—for perhaps the
first time—the priority of internal
over external stability.
57
Remember Keynes’s insight: the
informal “rule of the gold standard
game” was that states would use their
monetary policies to initiate internal
adjustment to maintain external
balance.
By contrast, the informal “rule of the
BWS game” was that the IMF would
facilitate external adjustment, freeing
monetary policy to focus on internal
macroeconomic objectives.
58
Lec 14: The Bretton Woods
System
I. Keynes’ Vision
II. Creation of the Bretton Woods
System
III. History of the Bretton Woods
System
59
Notice the familiar pattern with
the creation of the postwar
order:
Great Britain and the United
States forge an agreement
(biased towards the US) and
the countries outside the Soviet
orbit sign on…
60
The Anglo-American Postwar
Order
• Money: International Monetary Fund &
World Bank
– Agreements between White and Keynes
• Trade: General Agreement on Tariffs and
Trade
– Anglo-American Negotiations on Trade
Liberalization
• Security: United Nations
– Roosevelt & Churchill’s Atlantic Charter (Aug
1941)
61
The early history of the IMF was
also defined by Anglo-American
relations in 1947…
62
Britain’s Postwar Financial
Position
• 1938-1947
– British money supply tripled
– But GDP only doubled (to £10.5bn)
• Private and official gold & dollars down
50%
• Overseas sterling balances > £3.5bn
• UK Reserves: Just over £0.5bn
 In sum: maintaining convertibility at the
prewar parity was going to be very, very
63
Restoring Convertibility
• US feared Imperial Preference
• US demanded Britain restore convertibility
 ensure level field for US exporters
• Keynes resisted
– GB needed Imperial Preference to resolve
BoP
– Negotiated US loan to build up reserves
• JMK: getting the loan was “absolute hell”
• Easter Sunday, 1946: Keynes died
– (First heart attacks had been at Bretton
Woods)
64
Sterling Crisis of 1947
• Anglo-American Loan
– GB gets $3.75bn loan from US
– But GB must restore convertibility
immediately (5 years earlier than required by
BWS)
• 15 July 1947: Pound is convertible at
$4.03
– Devalued from pre-WWI parity of $4.86; but
still overvalued
• Results
– Loan exhausted within weeks (not decade as 65
The 1947 Sterling Crisis
unambiguously confirmed the
financial weakness of western
Europe.
The BWS required countries to
have either gold or dollars, but
Europe had neither.
The postwar order depended on
the US remedying this “dollar gap.”66
The Sterling Crisis inspired political
pressure in US to (1) allow greater
devaluations in Europe; and (2)
furnish more robust aid.
67
Bretton Woods in Europe
• 1948: Marshall Plan provides $13bn aid
• 1948: Franc devalued from 119 to 214
• 1949: Sterling devalued 30%
– 23 more countries followed Sterling within a
week
• European Payments Union created to
manage European imbalances
• 31 December 1958: Europe fully restores
current-account convertibility
• 1961: IMF says Europe is finally in
compliance with BWS
68
Throughout the 1950s, the US
pressed Europe to fully adhere to
the Bretton Woods Agreements.
The US attempted to remedy the
“dollar gap” by printing money.
It spread this money abroad with
the Marshall Plan, wartime
expenditure, and bilateral aid.
69
The Changing US Position
• Changing Reserves
– 1948: US has 2/3rds of global reserves
– 1958: US has ½ of global reserves
• 1949-1950: US current-account surplus
dropped by > 50%, to $3bn/year
• By early 1960s, US is consistently running
trade deficits
• 1960: US foreign monetary liabilities
exceed US gold reserves
• 1963: US liabilities to foreign monetary
authorities exceed US gold reserves
70
The Vietnam War and the Great
Society deepened these trends.
By the late 1960s, “dollar gap” had
given way to “dollar glut.”
The market price of gold rose well
above $35/oz and the holders of
dollars became concerned.
71
Nixon
• Initially promised not to leave gold
• Resisted by using price controls;
increased restrictions on convertibility
• August 1971: Nixon “closed the gold
window,” the dollar was no longer
redeemable in gold
 The Bretton Woods System was finished.
72
[Bonus Slides]
73
Reconciling Imbalances of
Payments...
73
(1) Adjustment of Reserves
• By directly intervening in the
foreign exchange market, states
can directly affect market price
(exchange rate)
• Asymmetry: lower limit to
reserves but no upper limit
 States might pursue positive
BoP
12
(2) Adjustment of Internal Prices &
Incomes
• Uses price-specie-flow
– imbalance  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!
13
(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
14
(4) Exchange Controls
Balance of Payments
Current Account
Trade in G&S
Income Receipts
Unilateral Transfers
Capital Account
Direct Investment
Securities Purchases
Checking Accounts
15
Was the BWS “knave proof”?
73
Remember that one of the
principal motivations for
pegging a currency to gold was
to tie policymakers’ hands—to
make the monetary system
“knave-proof”—to prevent
excessive monetary growth.
74
Judged by this standard, how
effectively did the BWS mimic
the GS?
(Consider the course of the dollar between
1945 and 1971.)
75