On 1 July 1944, a monetary and financial conference began at a hotel in Bretton Woods, New Hampshire (USA), attended by representatives of 44 allied countries. The result of the conference included the creation of the International Monetary Fund (IMF), whose main task was to stabilise the exchange rates of national currencies. The main architect of the IMF was American economist from Harvard University and US Treasury Department Harry Dexter White.
Karolina Cygonek (The Magazine of Warsaw School of Economics) talked about the Bretton Woods system and its legacy at the first part of the scientific conference on the same subject with Professor Zbigniew Polański, the head of the Department of Money Theory and Economic Policy at the Warsaw School of Economics.
Why was the Bretton Woods system established?
The establishment of the Bretton Woods system – the new monetary and financial order of the free market Western world –began at the end of World War II and was completed immediately after the war was over. Its creation resulted from very negative economic experiences of the interwar period, when attempts were made to return to the gold standard from before World War I. They gave rise to the great crisis of the 1930s as well as depression and economic stagnation, including a long lasting high unemployment.
What were the consequences of the introduction of this system for economic policy, i.e. monetary, fiscal and exchange rate policy?
Before answering this question, I must briefly tell you what this new monetary and financial order, introduced under the agreements of the Bretton Woods Conference of July 1944, consisted in. In this context, it is worth adding that also the Polish delegation – as one of 44 – participated in this conference, becoming one of the founding countries of the system. Unfortunately, in 1950 it withdrew from the key institution of the system, i.e. the International Monetary Fund, and only in the autumn of 1981, it applied to rejoin it, which, however, materialised only a few years after the martial law period in Poland, i.e.in 1986.
What was the order agreed at Bretton Woods?
First, a system of fixed exchange rates was introduced. It could be significantly changed though in the case of more persistent imbalances in foreign trade. The new system was to combine the advantages of the fixed exchange rate system, which was the gold standard system, and the floating (variable) exchange rate system. The institution that was to supervise and coordinate this system was the aforementioned IMF.
Second, the new exchange rate system was not based directly on gold, but on the US dollar, which for the central banks participating in the system was convertible into gold in the possession of the American government (after the war, it had about two-thirds of the world’s monetary gold). In other words, it was a gold-dollar system for the monetary authorities in their mutual settlements. It should be remembered, however, that in the internal circulation of the economies of these countries, gold no longer circulated as money – this situation, i.e. the classic gold standard system was basically over at the beginning of World War I (in the USA a little later, i.e. during the Great Depression).
Third, the system agreed at Bretton Woods also included the International Bank for Reconstruction and Development, now known as an institution within the World Bank Group. It is an international development bank, which was created as a result of the problems of economic stagnation of the 1930s as well as the need for economic reconstruction after World War II. Obviously, the World Bank has been operating till now supporting the fight against poverty and facilitating the economic development of many countries of the world, including Poland.
The introduction of the new exchange rate system fundamentally changed the way economic policy was conducted.
Coming back to your question about the consequences of the introduction of the Bretton Woods system, for monetary, fiscal and exchange rate policy, we can confirm the statement. It should be added that the new exchange rate policy was accompanied by limited convertibility of the currencies participating in the system: it was not until the end of the 1950s that convertibility was introduced in foreign trade (and more precisely – in the current account of the balance of payments), which over time was gradually, but not fully coordinated, extended to the so-called capital flows, i.e. money movements related to investment and lending activities. In such a situation, both fiscal and monetary policy could fully focus on the domestic needs of the countries. Full employment was given priority. Problems with unemployment, stagnation and deflation were a key issue of the 1930s, the experience that really over due to the economic policy of World War II.
Not to simplify much, it can be said that the economic policies pursued under the Bretton Woods system resulted from the fear that the problems of the Great Depression could return. This new economic policy, or better to say: the economic situation in the 1950s and 60s, is remembered as unique in the history of the Western world. Suffice it to say that the economic growth averaged 5%–6% per year at that time, unemployment was low and inflation was stable. However, at the end of the sixties, the situation began to deteriorate.
August 2021 marked the 50th anniversary of the suspension of the dollar’s convertibility into gold. Why was it one of the most important events in economic policy, finance and the history of money? Why was this decision made in 1971?
As I have already said, one of the assumptions of the Bretton Woods system was the convertibility of the US dollar into gold, although limited only to central banks. The price of gold was $35 per ounce (about 31.1 g), constituting, metaphorically speaking, an “anchor” for the system. It is now recognised that this price of gold was too low from the beginning. I don’t want to make it sound far-fetched, but let’s note that in recent years the price of an ounce of gold reached as much as $2,000.
In 1971, it was decided that the convertibility of gold was unsustainable for the American authorities. As a result, on 15 August 1971, US President Richard Nixon, in a televised address, unilaterally announced that the Federal Reserve was suspending the convertibility of the dollar into gold. This decision was part of a more comprehensive economic package, the other elements of which I will come to mention later. Nixon’s speech can be viewed on the Richard Nixon Foundation website.
Actually, there are two important issues raised in your question. The first concerns the history of money and finance, and consequently the economic policy. In 1971, with the final suspension of the convertibility of the dollar into gold, the process of departure of money from bullion was completed, which began in the most developed countries in the mid-nineteenth century, and which became quite obvious at the outbreak of World War I. In mid-August 1971, money became fully fiat, which means that its creation became completely independent in the technical or material sense. Money creation lost the aforementioned “anchor”, largely independent of politics. It was a civilisational and epochal change. Currently, only economic and political factors, including the operation of the banking system, determine how much money is in circulation. Since 1971, we have been dealing with entirely fiat and banking (credit) money.
Why did this final “unanchoring” of money from gold take place exactly in mid-August 1971?
To simplify slightly, it should be said that two circumstances coincided here, namely the features of the Bretton Woods exchange rate mechanism and the economic policy objectives that were sought at that time, especially in the main country of the system, i.e. the United States. As we remember, the construction of the exchange rate system assumed the convertibility of the dollar into gold. In practice, this meant that foreign central banks exchanged dollars for gold in the US Federal Reserve System, especially as the US trade surplus gradually decreased and the US capital flowed out, while in other countries of the system (especially Germany, the Netherlands and Japan) there were growing foreign trade surpluses. As a consequence, already in the mid-sixties, the value of American gold holdings equaled the official American dollar liabilities.In the following years, the dynamics of changes in these figures began to diverge more and more, and confidence in the dollar remained only on the prestige of the American economy as the largest in the world, leading to a credible policy until the mid-sixties. In the second half of the decade, with the intensification of the Vietnam War and the development of American social programmes (the so-called “Great Society” project), there were more and more dollars and other US financial liabilities on the world markets, while its gold reserves continued to decline and inflation began to rise. By the end of the decade, the economic growth slowed down and unemployment was on the rise.
As a result, in the late sixties and early seventies, President Nixon, running for re-election in 1972, faced the dilemma of how to further boost the economy in order to reduce unemployment without the negative side effects of gold outflows and rising inflation. Since winning the upcoming elections was crucial for him, in August 1971, he announced the economic package that included the aforementioned final break with money creation based bullion resources.
Let us say at the end of this thread that President Nixon won the election in 1972, but two years later – as a result of the Watergate eavesdropping scandal – he was removed from office. It should also be noted that the USA was both the main constructor and creator of the Bretton Woods system and the driving force behind its decomposition. In other words, the Americans de facto created and destroyed the Bretton Woods system by giving the absolute priority to internal economic policy goals.
What did the suspension of convertibility of the dollar into gold contribute to in the short and long term? What about the consequences of the collapse of the Bretton Woods System.
In the short term perspective, the world, not only the USA, felt a large increase in inflation, accompanied by a significant economic slowdown – it is said that in the seventies there was stagflation, which means the coexistence of economic stagnation and inflation, i.e. the phenomena that (according to the main economic trends) should not occur together. It happened in this way because, as a result of the US policy (leading to the collapse of the Bretton Woods system), the economy became discordant not only in the US, but also elsewhere in the world. This process intensified due to the continuation of the economic package of August 1971 (in addition to the suspension of convertibility of the dollar, attempts were made to control inflation by means of administrative freeze on wages and prices, and a decision was made to introduce new anti-import tariffs), which overlapped with shocks caused by the increase in oil prices by the OPEC cartel in 1973 and subsequent years. In fact, the U.S. and the rest of the world began to recover from all these misguided policies and shocks only in the early eighties, when the nature of economic policy was fundamentally changed.
And here we switch to the long term perspective…
The collapse of the Bretton Woods system and the subsequent events that followed it caused a turn in the economic policy practically all over the world, towards what is referred to as “neoliberal”. It gave priority to self-regulating market mechanisms, emphasising the goal of limited inflation and stabilisation, with a more passive role assigned to fiscal policy, and a key role given to monetary policy in maintaining economic equilibrium. At present, or to be more precise since the outbreak of the 2008 crisis, we have been witnessing a departure from this simplified vision of economic policy.
However, stepping down to a slightly lower level of generalisation, I would point to the following long-term effects of the collapse of the Bretton Woods system. First, the widespread use – since 1973 – of floating exchange rates, i.e. those in which market forces determine the level of relations between currencies, and the role of monetary policy is limited (occasional currency interventions) or indirect (through interest rate policies). Second, more and more common international freedom of capital flows reinforced the need for floating exchange rates. Third, almost two decades after the collapse of the Bretton Woods system, the so-called inflation targeting strategy crystallised. It has been a dominant monetary policy strategy to date, in which the target becomes a new “anchor” for the activity of central banks. This change in monetary policy was accompanied, in fact, by the spread of central banks independence so that they could focus on inflation targeting. And eventually, fourth, the collapse of the fixed exchange rate system is reflected in the re-emergence of the tendency towards monetary integration. Of course, in the current world of re-intensifying disintegration phenomena, this statement may seem far out of place, but let us remember that since the collapse of the Bretton Woods system, the countries of the future European Union have put emphasis on stabilising their exchange rates, which at some point resulted in the creation of the euro area. Let methen risk a statement that the eurozone is a ‘child’ of collapse of the Bretton Woods system.
And one reflection more here. A definitive departure of money creation from the hard external “anchor” in the form of bullion resources meant that not only monetary policy, but in fact the entire economic policy, especially macro, began to depend to a decisive extent on the perception of political authorities, their credibility and trust in them. In the case of central bank, it is about the importance of inflation expectations, but in fact in the economic policy as a whole, the sentiment, expectations and beliefs of economic participants came to play a key role in the effectiveness of its implementation. Previously, it was definitely different – economic policy, and naturally those conducting it, was tied up as if in a kind of shackles determined by the resources of bullion; the society were – to a greater or lesser extent – aware of it and mostly accepted it.
Was the suspension of convertibility, summa summarum, a good decision? What advantages and disadvantages of this decision can you point to?
There are polar views on this subject. For example, the economists of the so-called Austrian school take an extreme position, claiming that in the summer of 1971, there was the “ultimate murder of real money”; it was, according to them, the proverbial “final nail in the coffin” of bullion money.Some continue this thread, saying that with the emergence of private cryptocurrencies (such as bitcoin) we may also return to the gold standard, but in a new form, where the issue of digital money will be limited as it is in the case of bitcoin.
I am trying to look at the development of forms of money and the principles of its functioning from a different perspective. After all, bullion money systems were not as great as they are sometimes portrayed, and they created a lot of problems for people (scientists speak about “the need for the real sphere to adapt to monetary phenomena”) and in fact the historical acceleration of economic growth in the world occurred after the loosening of the “yoke” of the gold standard system, in the !9th and 20th century, at different time in each country.From the point of view of today’s inflationary problems and a certain “discordance” of economies, longing for some external stabilisers is emotionally understandable, but probably undesirable.
I consider the abandonment of money convertibility an element of a broader process of democratisation of societies and countries. Societies and their authorities have more and more instruments that facilitate the conduct of policies, not only economic. Again, to put it in a scientific way, everything is becoming more and more endogenous, i.e. dependent on the will and behaviour of all of us – subjects of social life.I do not think that societies will deviate from this path of development, also in the area of money. It is all really about learning how to better manage what we possess, for example, money.
Is there any discussion about the return to the Bretton Woods system in one form or another among experts today? If so, in which aspects and for what reasons?
Answering this question, it is worth noting that after the collapse of the gold-dollar system, which was the Bretton Woods system, we now live in a dollar international monetary system, which is manifested by the fact that the US dollar is still the main reserve currency of the world (almost 60% of all foreign exchange reserves). Due to the emergence of the euro and the growing role of China and its currency – the yuan, the situation is changing to the disadvantage of the dollar, but everything indicates that it will still remain the main world currency for a certain period of time.
It may be said that we still live in a kind of “shadow” of the Bretton Woods system.
Since the dollar is still the main reserve currency of the world, at some time it was even said that the “Bretton Woods 2 system” was being spontaneously created. This was due to the fact that after the Asian currency and financial crises of 1997–1998, many countries, including primarily China, began to accumulate much larger dollar reserves than before. They did it, first of all, for their own safety, to have the weapon (i.e. these foreign exchange reserves) in the event of a speculative attack on their currencies. However, after 2014, global dollar reserves stopped growing and their nominal size stabilised, undermining the concept of renewal of the Bretton Woods system.
There is no doubt that certain components of the Bretton Woods system will or can be used within the economic policy, but they will be elements or components of the system itself, not the system as a whole. I mean such elements, or better to say, economic policy instruments, as selective restrictions on the free flows of capital, especially those of a speculative nature, or – what actually is being done to some extent – stabilising exchange rate fluctuations that are considered excessive and undesirable.
However, there are absolutely no political conditions to reactivate the Bretton Woods system in any form. Let us remember that the origin of this system in the political sense was a close cooperation of the two powers of the Western world at that time: gradually retreating Great Britain and the great winner of World War II, the new hegemon, i.e. the United States. Certainly, it can be said that it is similar now: we have two superpowers, one of which is rapidly expanding its influence (China), and the other seems to have already had the most dynamic development(the USA). However, after World War II, the two powers cooperated with each other, although the US played the key role. At the moment, there is a strong competition between the major powers, based on different economic and political interests, which is not conducive to the establishment of new economic structures based on cooperation. However, it is also true that the main institutions of the Bretton Woods system (the IMF and the World Bank Group) are still functioning, and it is with their participation that the most important coordination processes in the world economy will most likely continue to occur.
- has been working at the Warsaw School of Economics since 1982,
- in 1998 – appointed head of the Department of Monetary Policy,
- the head of the Department of Money Theory and Economic Policy since mid-2020,
- in 2000 – awarded the title of Professor of Economics,
- his main research interests focus on the theory of money and monetary policy, central banking and financial systems,
- since 1987 – employed at the NBP, working in its analytical and research departments,
- from 1990 to 1991 – on a Fulbright scholarship (University of Maryland),
- and in the years 1992–1993 – a scholarship holder of the Government of Canada (Carleton University),
- in 2006 – participated in the IMF mission in Ukraine,
- and in 2007 – worked for the ECB on Russian economy issues.