The Bretton Woods Institutions – the Backstory

October 4, 2019 The Periscope Report Political Theory 0

WORLD BANK

The creation of the Bretton Woods Institutions in 1944 just a year before the end of a devastating World War II (WWII) represents one of the most important moments in the history of our world. The mechanics and interactions behind the creation of the International Monetary Fund (IMF) and the World Bank (WB), the two multilateral institutions to emerge out of the Bretton Woods Conference at New Hampshire, United States, are important to understanding the subsequent and current discourse in international economic relations. This is more so from a developing world perspective.

It can be said that historically, many scholars and writers have tended to downplay the detailed reasons leading to the creation of the Bretton Woods system. To give an example, Baylis and Smith simply state that the Bretton Woods Institutions were created to “ensure that the Great Depression of the 1930s would not happen again” 1.  While this may be true, it gravely shortchanges the reader of an understanding of deeper and more complex manoeuvres behind the creation of the system.

Ghizoni (2013) writing for the website Federal Reserve History had this to say about the proceedings at the New Hampshire conference;

These countries saw the opportunity for a new international system after World War II that would draw on the lessons of the previous gold standards and the experience of the Great Depression and provide for post-war reconstruction. It was an unprecedented cooperative effort for nations that had been setting up barriers between their economies for more than a decade 2.

While insightful, we think that this is a highly sweetened overview of what actually transpired at the conference. As shall be shown, what eventually brought the many delegates and countries represented to Bretton Woods was more complex and demanding than often said. While the accounts and reasons as given by different writers are valuable contributions, it is our submission that a sustained glossing over of other equally important facts behind the creation of these Institutions robes understanding of the Bretton Woods system in its proper context particularly in the eyes of those of us of the Southern Hemisphere.

Perhaps the general dissatisfaction over time by the Global South pertaining IMF and World Bank conduct should not come as a surprise among those fully aware of the genesis of these Institutions. It is because of this dissatisfaction that efforts continue among other so called Global South friendly great powers to find an alternative to the system. For example, Liao (2015) notes that;

When China proposed the Asian Infrastructure Investment Bank (AIIB) in late 2013, it hoped to offer a regional alternative to the multilateral institutions of the Bretton Woods system that left Asia underrepresented 3.

Digging Deeper

In this article we make the case that there is absolute value in digging deeper, as it were, to discuss the mechanics and complexities surrounding the creation of this far reaching new economic world order in the form of the Britton Woods system. It is from this stand point that we shall seek to critically examine in detail what can be regarded as the overt and covert reasons behind the creation of the Wold Bank and the IMF.  As shall be shown, before taking a new form of what it has become today, the original idea behind the Bretton Woods system collapsed in 1971 at the hands of the steward of the system, the American government.

Trade and Bretton Woods Conference

Apart from creating the two, IMF and WB, also on the table at the New Hempshire conference were matters to do with the resolution of trade related problems that triggered WWII. In as much as an International Trade Organisation (ITO) failed to materialise as originally envisaged, the Bretton Woods Conference had something of this sort in mind. There was desire to address important trade issues which had driven countries to initiate selfish ‘beggar-thy-neighbour’ trade wars which are thought to have exacerbated the Great Depression 4 Considering that an ITO could have possibly been the third member of the two-some institutions, we will also seek to examine albeit in brief the idea behind the ITO and how it eventually failed to take-off in its original form.

Overt reasons behind creation of the Bretton Woods Institutions

Officially known as the United Nations Monetary and Financial Conference, the Bretton Woods Conference as it has come to be commonly known was attended by delegates in excess of 700 from 44 countries 5 These countries represented the victors of WWII which, itself, by the time of the meeting was coming to end. They notably included the USSR, Germany, France, Britain, China and the convener and host of the meeting, the United States over and above other European countries.

The events prior to both world wars particularly the Great Depression that ended in WWII necessitated that some action be taken. The United States and Great Britain played a leading role in this regard. As mentioned in the introduction, save for a few, an overwhelming number of published scholarly text has not concerned itself in detail with the more telling underlying reasons behind the creation of the Britton Woods Institutions. The World Bank’s mandate at the Conference was disseminated as follows. It was to be a vehicle to fund massive reconstruction desperately needed in war-torn Europe and the rest of the world 6

It is therefore no coincidence that the Bank started out as the International Bank for Reconstruction and Development (IBRD). The Bank was to give development assistance to those European countries in World War ruins including any other countries around the world that required help. The IMF sort “to foster (1) orderly foreign exchange arrangements, (2) convertible currencies and (3) a shorter duration and lesser degree of balance-of-payments disequilibria”7

These three aspects were critical to addressing some of the identified causes of deep economic problems just prior to WWII. In particular, balance-of-payments (BOP) challenges were directly related to challenges associated with fair trade. Countries that had negative BOP, a clear sign of imports exceeding exports, would receive support through the IMF. The IMF would also manage foreign exchange matters, in particular a fixed exchange rate, a role which was dramatically altered on the 15th of August 1971.  At the time of the creation of the Britton Woods Institutions, it was agreed that world currencies would be pegged to a gold standard which gold was in the hands of the United States considering that America’s Federal Reserve in the earlier years controlled up to 80% of the world’s gold reserve 8

Therefore one of the main reasons why the IMF came to being was to halt currency wars targeted at the United States Dollar (USD) and arrive at a common interest of all nations in monetary terms that would be more important than opposing economic interests of different countries. The scope and objectives of the Britton Woods Institutions was unexpectedly interrupted by the arrival on the scene of the Marshall Plan in 1947. The Marshall Plan was apparently more pressing and urgent in view of advancing communism at the hands of the Soviet Union. US foreign policy was redirected for fear of war devastated, vulnerable and desperate western European countries seeking salvation in communism.

Once the Marshall Plan was executed and ended, on the other side of it the IMF and WB emerged necessarily wearing a significantly different complexion. Instead of having the gold standard as reserve currency, it was decided that the USD would stand between any other currency and the gold standard. In other words, other countries’ currencies were pegged to the USD at a rate of USD35.00 per ounce of gold. In order to access gold, countries needed to first have the American dollar in order to use it to gain equivalent in gold at the said rate 9 This effectively made the US dollar the reserve currency which sustained the new international monetary system.

Arguably, it was also at this point that seeds of demise were sawn that led to the system’s sudden collapse one day in August of 1971. What emerged post Marshall Plan was a Bretton Woods system heavily dependent on the United States. This was no coincidence as we shall seek to demonstrate on discussing covert reasons behind the 1944 New Hampshire gathering. Overall, it was thought the economic stability and prosperity secured by a system such as envisaged under the Bretton Woods Institutions would prevent war and promote peace among nations. Seeing the devastation of war on European economies and societies very few were unprepared for this kind of salvation promised and offered by the IMF and the WB.

Covert reasons behind creation of the Bretton Woods Institutions

The foregoing discussion highlights the more general and often referenced reasons behind the formation of the Bretton Woods Institutions. More elaborately, what took place behind the scenes on the road to the creation of the Bretton Woods system is nothing short of drama 10 Prior to the IMF and World Bank becoming an idea subscribed to by all and sundry it was first an intense transatlantic contestation of ideas between particular characters in Washington and London.

One of these key individuals was the renowned popular economist John Maynard Keynes from Great Britain. The other was American senior Treasury Department employee Harry Dexter White serving under Secretary of Treasury, Henry Morgenthu Jr himself a temporary President of the Bretton Woods Conference. 11  Looking for ways first and foremost to economically sustain Britain after WWII, in light of an apparent post war currency problem, Keynes with support from the British government as early as 1941 began working on a concept paper putting across ideas of creating a single worldwide monetary system. This on his end would be known as the Clearing Union 12  

On the other hand, the American government through White was working on their own plan of the post-war world economic order which Harry Dexter White had termed the Stabilization Plan. It was his idea that this would have two institutions namely the Stabilization Fund and the Bank for Reconstruction and Development. The former became the World Bank and the latter became the IMF both of which celebrated 75 years in existance in July 2019.

It is apparent that the early stages of the formation of the Bretton Woods system was an exclusive, highly charged and competitive process driven by respective national interests as embodied in British and American economists. These became the chief architects of a new world order in economic terms. As Keynes and White exchanged notes up until the eve of the 1944 Conference the process was highly exclusive and rather secretive. It was only in 1943 that the proposals for the envisaged Clearing Union (Bristish idea) and Stabilization Fund (American idea) were made public13 Through-out the Anglo-American discussions on the two plans, Keynes and Dexter apparently sort to outdo the other. Steil (2013) captures the drama as follows;

Keynes would apply his insight in the design of the new global monetary architecture, built around a new international reserve currency – one that would be a threat to the global supremacy of the U.S. dollar and which White was determined to keep from seeing the light of day.

According to Steil, Washington was firmly focused at keeping Britain at bay even at the conference itself so much so that Secretary Mongenthau laid claim to the meeting’s presidency as a way of containing the British economist – Keynes. There was intense national interest at play in Washington which eventually for the greater part consumed Keynes’s Clearing Union and other initial ideas in his blueprint through rigorous negotiations that ushered in the American preferred design of a new economic order14

Considering events prior and during the Bretton Woods Conference, it is clear that the creation of the Bretton Woods system was more than a surface idea of ensuring worldwide peace and prosperity post WWII.  Of course peace and prosperity was good but it was not all. Leading American minds such as White, a very influential figure in American foreign policy at the time, had made their object of pursuit guaranteeing American hegemonic power in a new economic order to emerge out of WWII.

As it successfully managed to do, the United States was determined to ensure that to serve its interests the American dollar had to be named as the currency of this new international monetary system in order to serve and protect long term American interests. Again Steil gives remarkable insight on how White played this out at the 1944 New Hampshire conference noting “White had substituted dollars for ‘gold-convertible currency’ behind the back of other conference delegates precisely because he knew many would have fought it, as Keynes had in the years leading to the conference”.

This ruse aimed at avoiding raising eyebrows plainly worked as later the Americans managed to make dollars synonymous with gold, tethering the fate of the rest of the world to a disaster waiting to happen in 1971. This would be at the instigation of an apparently gradual but certain American fiscal indiscipline. The creation of the Bretton Woods Institutions also implied the dismantling of the British vast colonial hegemony allowing the United States to gain access to previously closed British trade markets, according to Steil. This was not openly discussed as the objective but was intended.

It would appear at many levels based on its desperate situation because of the war that had ravaged European economies, Great Britain was in many ways at the mercy of American benevolence. This caused even the highly regarded Keynes at home and abroad to cave in to America’s demands during ensuing negotiations. There was a vigorous pursuit of American interest which White sort the rest of the world to endorse. In order to help the United States recover from the Great Depression, he argued internally that more opportunities abroad had to be found for American companies supported by a new model of international monetary stabilization15

In the end Harry Dexter White got much of what he had sort which included having the American dollar as the worldwide reserve currency, a fixed exchange rate and gaining markets previously controlled by Great Britain as the sterling nor Keynes’ envisaged ‘bancor’ currency lost any hope of becoming the common currency of the new international financial system16 White also secured the overall stewardship of the system given that the IMF leadership was firmly in American control with the World Bank day-to-day leadership voluntarily given to Europe in a manner, according to Steil’s account, that appeared to be an appeasement.

In effect, through the Bretton Woods system, America gained unprecedented power to regulate world economic and certainly political policy the latter became the precursor to China sponsored Asian Infrastructure Investment Bank (AIIB) 17 Baylis and Smith (2001) note  that “unsurprisingly, by the time the IMF, World Bank, and GATT began to function in the 1950s, they were distinctly Western bloc organisations which depended heavily on the United States” 18.

The Nixon Shock

On August 15 1971, United States President Richard Nixon stunned the world when he went on live television to announce a new American policy which effectively collapsed what had been known as the Bretton Woods system for at least two decades. His policy change statement as below ushering in the so called New Economic Policy was direct and to the point and eventually became to be known as The Nixon Shock;

The strength of a national currency is based on the strength of that nation’s economy and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take every action necessary to defend the Dollar against the speculators. I have directed Secretary Connelly to suspend temporarily the conversion of the Dollar into gold or other reserve assets except in amounts and conditions determined to be in the interest of monetary stability and in the best interest of the United States.

Nixon’s statement confirms America’s objective of first and foremost securing its long term national interest before the interests of the collective that had participated in setting up the system in the first place. Although the Bretton Woods system involved other great powers and countries, the demise of the gold standard which impacted all was itself squarely an American issue out of its own flawed domestic public policy. Steil sheds light on this:-

When the United States printed money without regard to its plummeting gold stock during the Vietnam War and Great Society program build-ups of the 1960s, it triggered a run on American gold, a fall in the dollar, and an end to fixed exchange rates. Dollars were not synonymous with gold, as White had contended; only gold was gold.

Clearly American politicians and technocrats furthered their own national interest at the expense of the rest of the world through printing American dollars to fund a demanding foreign policy (Vietnam War) and a burdening domestic initiative (Great Society program) regardless of limited gold stocks to back these actions. Under responsible fiscal expenditure these enormous expenses were to be supported by taxes instead of increasing money supply thrugh printing. Harry Dexter White a man later to be suspected but never charged of spying for the Soviets 19 of misleading his country’s Congress that America was free to do what it wished in spending while convincing the rest of the world it couldn’t.

Since the demise of the Bretton Woods system more than 40 years ago the world has not been able to find any standard as good and rigorous as the gold standard 20. In its place, so called fiat or float currencies with no intrinsic value were created all around the world with many failures including the Zimbabwean dollar which eventually fell in 2009 and has since been resurrected with great difficulty. Further effects of the fall of the gold standard was a return to trade protectionism by many countries and serious difficulties in containing subsequent world economic challenges among other long term effects.

The Bretton Woods Institutions themselves were forced to significantly change tact post 1971 by revising scope and focus in view of a sudden pulling of the rug, as it were, from under the core of their mandate particularly on the part of the IMF. One of the major changes, courtesy of the Nixon Shock, was a shift by IMF from maintaining a fixed exchange rate which disappeared with President Nixon’s announcement to looking after a floating exchange rate despite the fact that the former remained for a time in the organisation’s Articles of Agreement 21

The ITO Still-birth

We earlier mentioned the ITO. Causes of the Great Depression are generally agreed to be centred around trade protectionism. It followed naturally that the architects of the Bretton Woods  system and the delegates to the conference were equally anxious to avoid a repetition of another ‘beggar-thy-neighbour’ episode post WWII. The creation of an ITO was an idea that began gaining traction between 1945 and 1948. As the United Nations whose mandate centred on world peace came to life, Western great powers considered that a similar international organisation but concerned with trade would be ideal.

The creation of an ITO only went as far as the drafting of what came to be known as the Havana Charter out of the 1948 Havana Conference which was to give effect to an ITO. The idea lost steam when it became clear that the United States would not be party to it due to growing hostilities towards liberal trade policies at Congress level. This threatened the  ratification of the Charter for fear the Charter would give too much power to the President and therefore temper with US domestic interests 22 Had the idea sailed through at Congress, it makes sense to predict that many other western countries would have ratified the Charter. In this case, it was only developing countries with little influence that were interested in the Charter as it appeared favourable. In the end an already talked about and American backed general agreement on tariffs and trade became a reality in the form of GATT in 1947.  

GATT succeeded were ITO failed because efforts were made on the part of the United States to avoid making GATT appear as an organisation hence “contracting parties acting jointly” was added to the final text of the agreement. This meant, by law, the U.S. President did not require congressional approval to be party to the agreement. According to Ball (2000), the United States was interested in certain aspects, namely the commercial policy rules, of the failed ITO which they persuaded others to be incorporated into the general agreement on tariffs and trade. This gave birth to the GATT which ran between 1947 and end of 1994 giving way to the current World Trade Organisation (WTO) on 1 January 1995.

References

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