What constitutes the ideal international monetary system? To this reviewer, and presumably most readers of The Freeman, it would be a system which could not be manipulated by governments and central bankers, thus subject to neither inflationary expansions nor deflationary collapses. Its various currencies would all be fully convertible into a base money that would be free of exchange rate risks which might impede the free flow of goods and capital between nations. Indeed, under the ideal system, exchange between people in different nations would be no more complicated than trade between people in different states.
A Retrospective on the Bretton Woods System makes obvious just how far we are from achieving this ideal and showcases many of the attitudes responsible for our current problems. The volume consists of twelve papers plus two panel discussions at a conference held under the auspices of the National Bureau of Economic Research on the twentieth anniversary of the breakdown of the Bretton Woods par value system.
The standard interpretation of the international monetary system parallels the standard interpretation of Keynesian economics, which, as this volume often reminds us, inspired Bretton Woods. Just as Keynesianism was thought to have “saved” capitalism by removing the balanced-budget constraint which had prevented governments from dealing with the otherwise intractable problem of the business cycle, so the Bretton Woods system was seen as “restoring” the liberal international trading system by uncoupling international and domestic policymaking. The rapid pace of growth of global output and trade in the post-war period through 1973 is usually trotted out as evidence to this effect, although several contributors at least consider the possibility that the Bretton Woods system was not responsible for that performance. In fact, the shortcomings of both Bretton Woods and the system’s underlying Keynesian theories prevented either from lasting a whole generation. A large part of A Retrospective discusses the factors which led to the system’s demise.
The book is divided into three main sections, dealing with Bretton Woods’s origins, operations, and legacy, plus a conclusion. The initial article, written by editor Michael Bordo, traces the evolution of the Bretton Woods system from its initial arrangements through its inglorious replacement by floating exchange rates in 1973. Bordo weaves a wealth of historical and statistical detail into a coherent narrative. He also compares the macroeconomic performance of the system with the classical gold standard, the inter-war gold exchange standard which degenerated into a free-for-all of floating rates, and the post-Bretton Woods set-up.
Bordo’s characterization of Bretton Woods as exhibiting “the best overall macro performance of any regime,” including the gold standard, rests on his judgment that price stability should be accorded lower priority than per capita growth of real GDP. It also leads him to find it paradoxical that the Bretton Woods system was so short-lived (the U.S. shut the gold window, effectively ending the par value system, only thirteen years after the European currencies achieved de facto convertibility).
He believes part of the solution to this paradox to be the occurrence of events, particularly the rapid recovery of Europe from the war and the subsequent replacement of a dollar shortage with a dollar glut which the Bretton Woods planners could not foresee. He attributes the rest to either flaws in the system or inappropriate policies by member countries, especially the United States. He points, for example, to the built-in instability of any gold exchange standard plus the fact that capital mobility made it too costly for nations to adjust their exchange rates in the way permitted by the system. As inappropriate policies he cites America’s inflationary course taken after 1965 and the failure of countries with a dollar surplus to adjust. I question this dichotomy between systemic flaws and bad policies: a system which metes out no effective penalty for bad policies is for that reason a flawed system. Maurice Obstfeld makes this same point in his paper, noting that “a well-designed system should provide incentives that ensure successful operation.” Bordo himself admits that Bretton Woods was, in some ways, a failure. Except for deflation, he writes, “the problems of the interwar system that Bretton Woods was designed to avoid re-emerged with a vengeance.”
Despite providing some rather incisive analysis of the problems with Bretton Woods’ attempt to devise a workable international monetary system, the book’s authors are by and large enamored of fiat money and the right of nations to inflate their currencies at their own pace. Among the most egregious examples of this viewpoint are Bordo’s and Obstfeld’s citing as a problem the failure of countries with surplus dollars to adjust (i.e., to inflate as rapidly as their trading partners), Genberg’s and Swoboda’s calls for a world currency and central bank, and Garber’s statement that “There need be no inherent problem with a fiat monetary system with one country’s central bank providing the liquid funds.”
The one common denominator of these views is that the international monetary system must never permit the slightest hint of deflation. Thus, any kind of true gold standard, in which gold actually circulates as money and constitutes reserves into which all other forms of money are convertible, is anathema to the volume’s contributors. Keynes himself described the system put in place at Bretton Woods as “the exact opposite of [a gold standard].” The aversion to gold might be defensible if the uninterrupted inflation which has characterized the last sixty years (with gold demonetized for the last twenty) had freed us from the business cycle. The record, however, clearly shows that the business cycle has continued, with neither gold nor deflation anywhere in sight to shoulder the blame.
Ultimately, the international monetary system set up at Bretton Woods was an attempt to shield nations from the consequences of irresponsible fiscal and monetary policies, in sharp contrast to the pre-war gold standard, which penalized such behavior. Bretton Woods did this by using exchange rate devaluations in an attempt to short-circuit the mechanism that normally triggers the slumps that follow inflationary booms. To the extent that governments and central banks believed that such a strategy would succeed, they were encouraged to engage in more inflationary policies. But since the laws of economics prevent nations from escaping boom-induced slumps, countries ended up with more downturns as well.
The primary value of A Retrospective lies in laying out enough facts about the Bretton Woods system to permit readers to draw this conclusion. The book’s greatest failing lies in the reluctance of its contributors to make the same judgment. Instead, they stubbornly adhere to the belief that the problem is not with politically managed currencies, but rather only with the particular framework of management which was developed at Bretton Woods.