Bretton Woods and Our Current Economic Distemper

Among the many aspects of individual and family life over which the state gained control during the first half of the twentieth century was the realm of money. During and after World War I, incredible inflations, especially in Russia and Germany―but also to a degree in the United States―denuded or eliminated life savings, inheritances, and marriage dowries. During the 1930s and early 1940s, new central-banking institutions, now realizing the extent of their powers, confiscated bank accounts (witness especially the experience of the Jews in Nazi Germany). Governments began to proscribe the use of money not issued by the state (the United States did so in 1933 by outlawing the private possession of gold bullion or coins), leaving the individual with no clear means outside the state monetary system by which to maintain and transmit family assets.

A transition that the industrial revolution had promised was now complete. When in the nineteenth century factory work and other urban jobs replaced farming as workers’ primary occupation, the traditional notion (and practice) of passing down a family plot and hearth over generations through entail became moot. The monetary developments described above neutralized attempts to approximate this husbanding of family assets through the medium of money. Individuals and families lost a longstanding means of protecting―through their property―their independence from the polity.

The Bretton Woods Solution

In 1944, as the Allied powers saw that victory in World War II was nigh, they took steps to arrange a postwar international system that would address some of the monstrous monetary problems that had emerged since 1914. At a conference in Bretton Woods, New Hampshire in July 1944―seventy-five years ago this month―forty-four countries agreed to an American plan that, first, endorsed an international gold standard and, second, encouraged the establishment of national currencies that could be converted into dollars or perhaps gold.

The Bretton Woods agreement paid respect to the popular disillusionment that had arisen since 1914 over the state’s progressive takeover of money matters. It required that at least the United States define its currency in gold, even if it bought and sold gold only to foreign authorities (as opposed to all comers as before). Furthermore, it established a multiplicity of currencies, one for every nation, with the list of nations about to expand with the coming of decolonization.

Individuals—Americans in particular—still would not be able to hedge national money in gold. However, because the United States had to honor foreign authorities’ requests for gold, the dollar had no room to maneuver against the market price of gold in non-American locales. If the dollar wavered at all against gold in any market worldwide, foreign authorities could buy United States gold per their Bretton Woods privilege and arbitrage the difference. This effectively guaranteed the dollar in gold globally, at the then-current market price of $35 per ounce. It was not the same as before 1933, when people could buy gold to hedge the dollar as they pleased, but it was something.

Moreover, the increasing number of national currencies meant that individuals, in theory at least, could abandon their own national currency for currencies of other states. Government capital controls could prevent this, but the countries that attended Bretton Woods made clear they would officially frown on such measures. The agreement also created the International Monetary Fund, which was charged with maintaining the multiplicity of national currencies, fixed exchange rates against the dollar (and thereby among all currencies against each other), and a dollar that was defined in gold and redeemable at an established price.

The structure of the Bretton Woods agreement implicitly acknowledged that the state’s way of controlling money since World War I had to be reworked into some kind of traditional monetary status quo ante. There had to be some viable legal alternative to state currency―in the form of gold; the risk of the devaluation of currencies had to be minimized; and currencies had to be numerous enough to incentivize their controllers to compete for the interest and business of the global public. Absent these developments, monetary authoritarianism would persist in the international order that the Allied victors had created.

Bretton Woods eventually collapsed—or so we often hear. In 1971, the United States backed out of its promise to allow foreign authorities to redeem the dollar in gold. Per the Bretton Woods rules, this move permitted countries to dispense with keeping their currencies’ rates of exchange fixed to the dollar. As of 1974, most currencies of the world were floating relative to each other, and the United States no longer officially valued the dollar in gold. This is the world that remains with us today.

From Historic Prosperity to Stagnation

All the same, the period when the Bretton Woods agreement was in effect, from immediately following World War II until the early 1970s, remains the most cherished era of economic history. It was a time of new, comprehensive, global prosperity, so marvelous that many countries spontaneously developed their own local expressions for it: “postwar prosperity” in the United States, “the economic miracle” in West Germany and Japan, and “the thirty glorious years” in France. It was the time of the rise of the East Asian “dragons,” including South Korea, Taiwan, and Hong Kong. Economies grew like weeds everywhere, not only in the nations that had been obliterated in World War II and were starting afresh (France and Italy, for instance, grew at considerable rates). Speaking before Congress in 1965, the monetary economist Robert Mundell asked, “Who would complain if the world economy in the next fifteen years were as prosperous as [in] the last fifteen?” Later in 1981 he wrote, “The quarter-century of this regime [of Bretton Woods] was exemplary in its stability, growth, and world economic development, perhaps unmatched at any time outside an imperium, such as the Roman Empire.”

As the Bretton Woods era recedes into the past and oblivion, the 75th anniversary of its inception offers an opportunity to ponder the alternatives to our current circumstances that it suggests.

Without question, the American people are longing for something like the era of Bretton Woods. They pine for the time when it seemed that everyone had a good job or could get one; when manufacturing, not finance, was the dominant economic sector; when the next generation did better than the last—the time of postwar prosperity.

Moreover, since the early 1970s, Americans have experienced grave doubts about the dollar. The inflation of the 1970s and early 1980s, regularly in the double-digits per year, made the dollar a laughingstock for the first time in its history, dispatching―for good as it turned out―the phrase “sound as a dollar” from American parlance. The mania over saving for retirement, which began in the 1970s, is in large part the result of expectations about the depreciative nature of the dollar after the era of Bretton Woods. The purpose of saving for retirement in 401(k) accounts is not merely to corral stock-market gains, but to get a long-term return that beats inflation, costs, and taxes. Financial advisors and investment strategies (and the costs they imply), now the property of the masses, were a boutique industry prior to the 1970s. Finally, the Federal Reserve has attracted popular derision and skepticism, as exemplified by former Rep. Ron Paul’s “end the Fed” movement, the viral Ben Bernanke videos after the 2008 crisis, and the big increases in purchases of gold.

To sum up, there are two major elements to the current economic distemper. The first is the strong nostalgia for the perhaps not-so-imaginary golden years of the postwar American economy, and the second is the acute dissatisfaction with the current state of affairs: the dominance of the financial sector, the persistent difficulty of landing a good job, the retirement-savings rat race, and the immensity of governments’ fiscal bureaucracies.

The Lessons of the Bretton Woods System

How do we face the challenges of our present economic circumstances? We can begin to put together an answer from the lessons that recent economic history teaches. The economy works best when the value of the dollar is officially defined, presumably in gold. It works best when the dollar trades at fixed rates of exchange against other major currencies, and when people are free to choose among currencies so defined. And it works best when the United States and major and minor powers agree that these elements are essential to the monetary system and, indeed, to a prosperous democratic order generally, like the one that the Allied victory in World War II secured.

As the lessons of history go, those of Bretton Woods are some of the clearest. When the system got cashiered in the early 1970s, the world was treated to a decade of stagflation that only abated with a long-term, moderate inflation―one that completely rerouted a great portion of everybody’s economic activity toward financial planning and strategy. In the meantime, the absence of an official role for gold prompted an inordinate, never-before-seen demand for the world’s strongest currency, which remained the dollar. At the same time, foreigners had to pay for the dollar in non-currency instruments (i.e., goods and services). This precipitated the U.S. trade deficit, and the departure of economic production from America to the rest of the world, about which there is so much carping and angst today.

The United States could have foreseen all this and handled the situation correctly, but it did not. The proper response, given the enormous quantity of products coming into the country in exchange for nothing but U.S. currency, should have been to cut taxes beyond anything we saw even after 1981.

Or we could keep it simple. If the public wants currencies that are not vulnerable to authoritarian manipulation and officials’ caprice (which of course it does), and if responding to this desire was one of the reasons why the Allies fought World War II (as the Bretton Woods protocol indicates), then we should try to return to the world of Bretton Woods that we have lost. To propose that we muddle through the whole of the twenty-first century with the present monetary system, making excuses for it and saying it is the best of all possible scenarios, is at once dispiriting and laughable. If we want to revive the era of postwar prosperity, we should revive its monetary system.