The role of the Dollar in the Bretton Woods Agreement

The decisive change that led to the Jamaica agreement was President Nixon’s suspension on 15 August 1971 of the convertibility of the dollar into gold. Until then this had been the keystone of the financial system created in July 1944, the Bretton Woods Agreement, the chief architects of which had been Lord Keynes (despite his distrust of gold) for the British and Harry Dexter White for the Americans.  On 1 October 1971 the general assembly of the IMF asked the board of trustees to study and propose a comprehensive reform of the international money system.  This would be adopted by member States during a meeting held in Kingston, Jamaica on 7-8 January 1976, and included a set of provisions which put an end to the reign of gold.  The decisions taken focused on two main points:

1. The new exchange rate system

Member countries had to refrain from manipulating their exchange rate for competitive reasons and had to choose between three possibilities:

1. Not to assign parity to their currency which was to float freely on the foreign exchange markets;

2. To fix the value of their currency by pegging it to another currency or a Special Drawing Right* not to gold;

3. To link the value of their currency to one or various other currencies as part of cooperative mechanisms.

2. The role of gold

The solution presented was a compromise between the French argument that pushed for gold to remain part of the organization and running of the international monetary system and the American policy that had for a long time wanted gold to be withdrawn from its supreme position.  The agreement withdrew the status of the IMF and all references to gold and replaced it and its core functions with SDR whose dollar value is posted daily on the IMF website.  The consolation for gold was that central banks were given back the freedom to carry out transactions with metal without restrictions on them or the market.

This desire to remove gold as the standard of parity and to abolish the official price of the metal was completed by abolishing obligatory payments in gold for operations between the IMF and member countries and obliging the IMF to get rid of a third of its gold holdings (50 million ounces) by returning half to member states at the old price ($35 an ounce) and by selling the other half through public auctions.

Again we must add that the abolition of the official price of gold resulted in central banks being able to carry out transactions at a price derived from the market and to reassess metal stocks in their possession (as was very quickly the case with France and Italy).

Even if the United States made it known that they would continue to assess their reserve at the old official price of $ 42.22 an ounce and even if the first auction by the IMF lowered the price of gold on the world markets, at least for short periods, we can say that in the fact the results expected by the American policy and the IMF were a long way from being achieved.  The price of gold and gold itself still remain important elements of a vast political game: all things considered, if gold has survived, it’s because it has not stopped being the official metal that governments didn’t want it to be and wanted to forget.

Today, the dollar struggles and the new gold giants Russia, China and India are all looking in different ways towards gold as the international medium to back commitments or in the long term to oust the dollar as the international reserve currency. Closer to home the crisis that rose to the surface in 2008 has caused us to once again look at the stabilisation that resulted in the Bretton Woods agreement, which collapsed, partially due to economic expansion in excess of the gold standard’s funding abilities on the part of the United States and other member nations.

However, the problems of currency systems not pegged to gold lead to economic problems far worse.

Both France and Britain have envisaged such a stabilization. French President Nicolas Sarkozy and British Prime Minister Gordon Brown were recalling the previous success and called for a “new Bretton Woods” agreement in October 2008. What Sarkozy and Brown envisaged was a new multilateral agreement to stabilize international finance in the 21st century, the way the 1944 conference, which established the International Monetary Fund and the World Bank, stabilized financial relations among countries in the second half of the 20th century. The summit meeting of world leaders held in Washington, D.C., in November 2008 started a process that could lead to such an agreement. What would that take to succeed? What kind of leadership, and what kind of commitment, would be needed? History offers some useful lessons.

On several occasions throughout the Twentieth Century, political leaders in major countries sought international agreements on the global economic or financial architecture. Many of those efforts failed, Bretton Woods being the major exception. The central lesson that emerges from these efforts is that successful reform in response to a crisis requires three ingredients:

1. Effective and legitimate leadership combined with inclusive participation;

2. Clearly stated and broadly shared goals

3. A realistic road map for reaching those goals.

Of these desiderata, only number two, of course, is feasible: many things are easily said and agreed to, goals have a marvelous capacity for being broadly shared – at conferences. While these may be the central lessons learned by advisers and politician, because for such people diplomacy is all (as indeed witness the inability of the eurocrats to get beyond agreements and actually act to solve the eurocrisis); indeed it is possible that diplomacy in itself generates the lack of concerted action because there always has to be something to discuss at the next summit.

Gold the Real Lesson

The most obvious question to arise is: why in Kingston was a decision made to undo the successes of the Bretton Woods system? The immediate answer would probably be that the dollar was able to behave in ways that undermined other nations – but this was entirely because the gold-dollar peg was not a true gold standard even if it seemed to act like one most of the time. Nevertheless, this link did cause imbalances in favour of the United States, which the French, de Gaulle in particular, drew attention to during the sixties.

In spite of the success of Bretton Woods, that success was insufficient to prevent unilateral action by the American government, culminating in Nixon’s decision to abolish what was left of a gold standard in 1971. Henceforth, the goals and achievements of the new system, as much as what was deferred became dependant overtly on the behaviour of the participant countries. New rules in finance can only be devised by those who are the major players in the financial, industrial and emerging markets. Therefore any pretence of stabilizing the world economy was in fact abandoned in favour of powerful nations and cliques, the perfect recipe for currency wars.

In other words the lesson of Bretton Woods which ought to have been learned was that financial stability can only come about with a return to the classical gold standard (1870-1914). Kingston, Jamaica was a staging post on the way to the brink, the edge of which came into sight in 2008.

* The SDR is an international reserve asset, created by the IMF in 1969 to supplement member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204.1 billion (equivalent to about $ 321 billion). It should be borne in mind that this is a paper reserve, and for that reason is liable to all the defects of paper money.

This is a revision by Mark Rogers of an article posted earlier on this site by Maurice Hall redacted from L’Or [Gold] by Jules Lepidi and an article by J.M. Boughton (IMF Historian).

For the raison d’être of these articles on read: GOLDCOIN.ORG: MIXING POLITICS AND NUMISMATICS

For background on the writer: CONFESSIONS OF A LAW AND ORDER ANARCHIST

For a series of articles on the pernicious effects of progressive tax regimes: THE MORAL DILEMMA AT THE HEART OF TAXATION

For a review of one of the most important books on the financial crisis published last year: THE MESS WE’RE IN: WHY POLITICIANS CAN’T FIX FINANCIAL CRISES

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