The Lessons of Bretton Woods

One of my neighbors in the country, an old peasant, recently explained that he had found a very good horse – there are still a few horses in Normandy – that worked extremely well. There was only one trouble with it: it had died.

That is exactly what happened to the Bretton Woods regime. It provided the world with the benefit of stable parities and a very decent rate of growth – about 3.7 per cent per year in constant dollars in the U.S. But after 27 years of good service, it collapsed: de facto, on August 15, 1971; de jure, on December 18, 1971.

The essence of the Bretton Woods system is expressed in article IV of the Articles of Agreement, which obliges all members of the International Monetary Fund to purchase and sell gold or foreign exchange at a par value fixed once and for all, plus or minus a small margin.

In 1944, however, the U.S. was the only country selling gold for dollars. The Articles of Agreement thus resulted in a system in which every currency was actually convertible into dollars, with the dollars, in turn, convertible into gold at a fixed rate. This is how the Bretton Woods agreement produced, in effect, a gold exchange system based on dollars convertible into gold.

The collapse of the system was due to the enormous growth of foreign dollar balances, which were theoretically – and legally – payable in gold on demand. For almost twenty years, the United States continued to pay out gold, but in doing so America reduced its gold reserves steadily until they reached a level that – at least for military reasons, if nothing else – was as low as it could be allowed to go. At that point, the dollar, once the most prestigious currency in the world, became inconvertible.

All this was due to just one basic cause: the chronic American balance-of-payments deficit. Nor did it come as a surprise: I had been predicting it for twelve years.

In the late fifties, I was profoundly disturbed by the revival of a monetary system that, without any possible doubt, had been a major cause of the great depression: the gold exchange standard which, from 1922 onwards, had replaced the gold standard.

The essence of the gold standard is that the central bank issues national currency against gold or claims denominated in national currency, such as treasury bills or commercial bills, and possibly long-term assets; – but not against foreign exchange even if payable in gold.

Under this system, the central banks keep only enough foreign balances to cover, more or less, their daily needs. Under the gold standard, a deficit country can settle its balance-of-payments deficit by offering its own currency to the surplus nations. For instance, when there is a deficit in the American balance-of-payments with France, the U.S. simply pays France in dollars, but in due course, through normal banking channels, these dollars turn up in the Bank of France, and since the Bank of France, in accordance with the rules of the gold standard, is not allowed to accumulate dollar balances, it is bound to demand gold for the dollars received. The result is manifested in. a contraction of credit in the U.S., and in an expansion of credit in France, – and this contraction and expansion tends to bring about a restoration of the balance of payment.

Young people generally laugh at this description which they consider as outdated. I have written a book whose English title is “Balances of Payment” to show that this system was in fact very efficient It is precisely this mechanism, so effective in keeping under control the balance of foreign payments, that was destroyed when the gold exchange standard replaced the gold standard. Under the gold exchange standard, the central bank is authorized to issue money not only against gold or claims in national currency, but also against foreign exchange payable in gold, which from 1945 onwards meant dollars, and dollars only.

Thus, a creditor country receiving dollars as settlement for a balance-of-payments deficit was not obliged to convert the dollars into gold. It just kept them. But since they are useless as dollars – except in the Eurodollar market in Paris, Frankfurt or Milan – the creditor nation tends to convert its surplus dollar holdings into U.S. Treasury Bills and C/D’s. In other words, with the help of this mechanism, the dollars which had just been paid to foreign creditors returned to America almost instantly. The system was established unwittingly in 1945 and grew – not by American design, let me emphasize – but because of the full cooperation of the central banks of the surplus nations.

Remembering the tragic consequences in the thirties -— and the Great Depression which undoubtedly resulted from a similar arrangement -— I tried to sound the alarm in 1961. I wrote three articles -— which were published in many countries, and also appeared in the July 1961 issue of Fortune magazine – and I said, in effect, that what the world was practicing would entail three consequences:

a) The debtor country, relieved of any consequence to its credit structure as long as the system continued, would show a permanent deficit in its foreign payments. When you don’t feel the result of your payments abroad, nothing is going to stop you from continuing to buy, lend or generously give what you really don’t have to pay anyway. In other words, you have found the wonderful secret of piling up “deficits without tears.”
b) As long as the deficit remains in the debtor country, a commensurate amount of inflation will be generated in the creditor country. The only escape for the creditors would be to execute an adequate credit-control policy. But that is politically impossible, and would never be applied.
c) Convertibility of the reserve currency – namely, the dollar – into gold will be revoked because of the vast accumulation of foreign claims, represented by growing foreign dollar balances, on U.S. gold and foreign exchange reserves.

These forecasts were accurate.

In physics, verification by facts is considered proof that the premises were valid. If we apply the same rule here, we must conclude that the principles of my analysis are valid. If so, they lead to further conclusions – the main one being that the Articles of Agreement adopted at Bretton Woods in July 1944 did not fail. Given their aim, those articles have operated perfectly well.

What has failed instead is the grafting of an entirely foreign practice onto the otherwise rational system devised at Bretton Woods. I am referring to the absurd gold exchange standard which is responsible for making the dollar the sole reserve currency of the entire system.

It should be made clear that America is in no way responsible for this change; America never demanded it; America is not the creator but the victim of the system.

All the foregoing leads to the further conclusion that if we are to recreate stability in our world, there is no need whatever to modify the rules of Bretton Woods. It is absolutely indispensable, however, to abolish the legal changes adopted by virtually all European countries, and thus prevent their central banks from purchasing and keeping unlimited amounts of foreign exchange, even if payable in gold.

To reach the rational solution, all we need do is to return to the gold standard, as it existed before 1914 in most countries of the world. I do not have time here to go into the genesis of the gold exchange standard, but it is very important to remember that it was the result of a deliberate change in policy – made through Resolution No. 9 of the Genoa Conference of 1922, and systematically generalized in Europe by the Financial Committee of the old League of Nations.

If one basic change is made, that is, if the gold-exchange standard is eradicated, you can be sure that the Bretton Woods regime of convertibility and fixed parities will function quite well and will maintain order in international money markets.

The problem is thus not to modify, but to create the conditions that will make possible a return to the Bretton Woods Articles of Agreement by reestablishing the dollar’s convertibility.

Such a return, however, poses a difficult problem because of the legacy of thirty years of the gold exchange standard. During the past thirty years, through the accumulation of foreign claims on American gold, we have witnessed the gradual dwindling of U.S. gold reserves from $24.8 billion in 1949 to about $10 billion at present – and we have seen a simultaneous increase of dollar balances in foreign hands from about $7 billion in 1950 to more than $70 billion today.

In other words, a $70 billion claim on only $10 billion of gold.

Obviously, if the de jure convertibility resulting from a return to the Bretton Woods regime were to be applied, it would lead to a demand for repayment in gold which the United States would be completely unable to meet. The United States would, and rightly so, refuse to allow its gold reserves to drop below its present level, if only for military reasons.

Therefore, if we are to return to the Bretton Woods regime – and I see no other alternative – we must provide the United States with the resources it needs to repay those dollar and Eurodollar balances held by the creditor nations.

Like children playing with beans in place of money, we could offer, of course, Special Drawing Rights to these creditors. Defined in gold, but not convertible into gold. But SDR’s would be wonderful vehicles of inflation, and I doubt very much that SDR’s would bring an end to the demands for repayment.

If we do not consider the Special Drawing Rights as an effective way out, convertibility into gold remains the only way to give to the holders of dollars and Eurodollar balances the certainty that they will receive repayment in a universally accepted asset that has unconditional purchasing power everywhere.

I can just hear the very valid objection that will be raised: the United States is simply unable to accept a return to gold convertibility because it lacks sufficient gold at present. My answer is that sufficient gold resources do exist – but that they are concealed by the absurd undervaluation of central bank gold holdings far below their current market price.

If these official gold holdings were valued at $70 per ounce (which is only twice the official price fixed in 1934, but well under the current market price), then the U.S. gold reserves would be worth approximately $20 billion instead of $10 billion – and the gold reserves of other Western nations and international institutions would be worth $62 billion instead of $31 billion. The total increase in the nominal value of gold reserves in the West would thus amount to $41 billion: $31 billion belonging to non-American nations, and $10 billion belonging to the U.S.

I now propose, as I did on September 13, 1972, before the Committee of Foreign Payments of the Joint Economic Committee of the U.S. Congress, a plan whereby the United States would be offered $31 billion as a long-term loan, running for, say, 20 or 25 years, at a very low interest rate, as a stand-by credit for the repayment of foreign balances whose holders want cash. Of course, the greater the certainty of prompt repayment, the less will be the demand for repayment.

I am quite certain that the United States, having at its disposal $41 billion in gold (consisting of $31 billion from the loans I have proposed, plus the $10 billion the Americans will already have from revaluing their own gold holdings), will be able to reduce to a very small amount the foreign claims that will have to be repaid. At the same time, a large enough amount of gold will be left to strengthen the U.S. gold reserves materially and thus make possible full convertibility of the dollar.

This “Marshall Plan for the U.S.” will be a concrete expression of the deep gratitude of Western European nations for the generous help they received from the United States under the original Marshall Plan at the end of World War II. It will, I hope, moderate the bad feelings of some Americans towards the rest of the world, and inhibit the dangerous feeling of isolationism which is now spreading in this great country.

It would make possible again freedom of international payment throughout the West, possibly after some minor parity adjustments. It would put an end to controls of foreign payments, already in force, and obviate the menace which such controls represent to the prosperity of the free world.

The main result will be an immediate and powerful wave of economic expansion. The bulk of hoarded resources will be returned to the market, which will generate a great increase of capital available for investments, a definite decline in all rates of interest, a powerful incentive for full employment, a sharp increase in prices in the securities market – in short, a wave of prosperity almost without precedent.

Finally, it would put an end to those flights of “hot money” and foreign balances that constantly shake the stability of the West, endanger the European Community, and thwart all attempts at regional monetary policy, such as the one which was expressed in the plan for a European Monetary Union.

Let me conclude with a word about Bretton Woods. The lesson of Bretton Woods is that the monetary system created in July 1944 (which was really a new and special version of the gold standard) was perfectly efficient and could not be improved. But it has to be freed of a small cancer which developed on it flank: the gold exchange standard. Which seemed a small change at the time: the acceptance by central banks throughout the world of dollars as the base for the creation of their own national currencies.

Cancers very often are not big, but they kill. The Bretton Woods system, although not responsible itself for this perversion, has been nearly killed by it. If the system can be cured and the consequences of 30 years eradicated, then the Bretton Woods system will be restored to its full effectiveness and become again the international monetary system of the West.

Let’s hope we shall not have to wait too long for this indispensable restoration.

A reform of this magnitude, given the present intellectual confusion, may easily be delayed. If so, the chief creditor nations of the West will eventually decide to stop buying dollars, which will lead to a further flow of dollars into European currencies, and may – and probably will – produce a further decline in the value of the dollar in foreign exchange markets. Some Americans may be pleased with such a development, on the false assumption that a depreciating dollar will promote American exports. Actually, should the dollar depreciate too rapidly, and too much, foreign governments will consider protective measures such as duties (which, rightly or wrongly, will be called “anti-dumping”) to reduce the inflow of American exports.

This, in turn, will lead to countermeasures on this side of the Atlantic, with the West sinking more and more into a trade war, dangerous both for its economic well-being and its political solidarity. And it would certainly nurture the American desire for isolationism, which would endanger the security of the West.

I sincerely hope that such a situation will not develop. That is why I am proposing again and pressing for acceptance a “Marshall Plan for the U.S.” It is the only way left to maintain the indispensable solidarity of the West, to promote economic development, and to maintain the free trade and all the fundamental principles for which we have all fought in the past.

Western Civilization is in great danger. Let us hope that we shall not delay too long before adopting the measures that are indispensable if we are to save it.


Kathleen M. Packard, Publisher
Ralph J. Benko, Editor

In Memoriam
Professor Jacques Rueff

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