the bretton woods system class 14 – tuesday, 1 november 2011 j a morrison 1 jm keynes & hd...
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Lec 14: The Bretton Woods System
I. Keynes’ Revolutionary VisionII. Creation of the Bretton Woods
SystemIII.History of the Bretton Woods
System
3
Lec 14: The Bretton Woods System
I. Keynes’ Revolutionary VisionII. Creation of the Bretton Woods
SystemIII.History of the Bretton Woods
System
4
You’ll remember that JM Keynes had been a virulent critic of the gold standard
since the early 1920s.
By the mid-1930s, the gold standard had once again
become “dead as mutton.”5
But Keynes knew that the revolution might prove only
temporary.
Throughout the 1930s, Keynes worked to refine his perspective and sharpen his
criticisms.6
“The problem of maintaining equilibrium in the balance of payments
between countries has never been solved…So far from currency laissez-
faire having promoted the international division of labour, which is the avowed goal of laissez-faire, it has been a fruitful source of all those
clumsy hindrances to trade which suffering communities have devised in their perplexity as being better than nothing in protecting them from the
intolerable burdens flowing from currency disorders.”
-- Keynes (1941)8
Reconciling the Balance of Payments Under the Gold
Standard
16
1. Adjustment of Reserves2. Adjustment of Internal Prices &
Incomes 3. Exchange Rate (ER) Adjustment4. Exchange Controls
1. Capital Controls: Limit convertibility2. Commercial Policy
But world gold supply is limited.
Alleviating Imbalances of Payments
17
Method Gold Standard
Adjust ReservesLimited Stock of Gold
Adjust Domest Price Level
Yup: Price-Specie-Flow
Adjust ERs No: Violates Rules
Exch Control: Capital Controls
No: Violates Rules
Exch Control: Commercial Policy
Yup: Not against the Rules
Given the finite supply of gold, policymakers on the
GS are essentially forced to choose between sacrificing
control over domestic macroeconomic policy and
enacting commercial policy…
18
“[I]n an economy subject to money contracts and customs more or less fixed over an appreciable period of
time, where the quantity of the domestic circulation and the domestic
rate of interest are primarily determined by the balance of
payments...there is no orthodox means...for countering unemployment
at home except by struggling for an export surplus and an import of the monetary metal at the expense of
their neighbours…”
-- Keynes, General Theory (Ch 23)19
“Never in history was there a method devised of such efficacy for setting
each country's advantage at variance with its neighbours' as the
international gold (or, formerly, silver) standard. For it made domestic
prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious
metals. ”
-- Keynes, General Theory (Ch 23)
20
21
In other words, the gold standard
creates enormous incentives for
states to enact commercial policy.
Is the gold standard worth sacrificing free
trade?
“It is the policy of an autonomous rate of interest, unimpeded by international
preoccupations, and of a national investment programme directed to an
optimum level of domestic employment which is twice blessed in the sense that it helps ourselves and our neighbours at the
same time. And it is the simultaneous pursuit of these policies by all countries together which is capable of restoring
economic health and strength internationally, whether we measure it by
the level of domestic employment or by the volume of international trade.”
-- Keynes, General Theory (Ch 23) 23
Alleviating Imbalances of Payments
24
Method Gold StandardKeynes’
Proposals
Adjust ReservesLimited Stock of Gold
1944
Adjust Domest Price Level
Yup: Price-Specie-Flow
NEVER!!!!!!
Adjust ERsNo: Violates Rules
1923-1926, 1931-1940
Exch Control: Capital Controls
No: Violates Rules
1944
Exch Control: Commercial Policy
Yup: Not against the Rules
1929-1931
Keynes always prioritized internal stability over
external stability…
Find some way—any way!—to alleviate imbalances of
payments other than through domestic macroeconomic
adjustments. 25
During the interwar period, foreign economic policy was
made unilaterally and on an ad hoc basis.
The result was not just a lack of cooperation, but many of
the policies were cross-cutting.
The difficulties of the 1930s were exacerbated. 26
The very rocky experiences of states during the
interwar period increased their willingness to consider
alternatives.
But what were the robust alternatives to the gold
standard?27
Lec 14: The Bretton Woods System
I. Keynes’ Radical VisionII. Creation of the Bretton Woods
SystemIII.History of the Bretton Woods
System
28
II. Creation of the BWS
1. Keynes and White2. Keynes versus White3. The Bretton Woods Conference4. Another Gold Standard System?
29
In the summer of 1941, with the United States far from entering the war and the Axis rolling through the
Soviet Union, JM Keynes and HD White (independently) drafted their plans for the postwar monetary order.
30
John Maynard Keynes (GB)
• 5 June 1883 – 21 April 1946
• Represented British Treasury at Versailles (1919)
• Battled 1925 Return to Gold
• Called for Abandonment of Gold in 1930s
31
Harry Dexter White (US)
• 1892 – 1948• Represented US
Treasury• Possibly authored
Morgenthau Plan• Possibly leaked plan
to Soviets• 1948: HUAC tried
him as Soviet Spy
32
Both HDW & JMK proposed creating an international institution to manage the international monetary
system.
(JMK: International Clearing Union)(HDW: International Stabilization Fund)
33
Functions of the Proposed International Institution
• Multilateral Clearing Mechanism: Centralize Currency Exchange
• Orderly Exchange Rate Regulation• International “Banking” – Distribute
Liquidity– “Creditor” countries acquire extra
reserves– “Debtor” countries lose reserves– Int’l Institution will loan to debtors from
creditors’ accounts 34
Essentials of Proposed Institution
• ER Stability– ERs fixed to gold or currency backed by gold
(e.g. US $)– ERs flexible within very narrow bands– Limited Adjustment: members vote to
determine if there is “fundamental disequilibrium”
– “Scarce currency” exception
• Capital Controls– States encouraged to limit “speculative
flows”
• Facilitator: Make loans for temporary imbalances
35
Alleviating Imbalances of Payments
36
Method Gold Standard Bretton Woods
Adjust ReservesLimited Stock of Gold
IMF will redistribute
Adjust Domest Price Level
Yup: Price-Specie-Flow
Unnecessary!
Adjust ERsNo: Violates Rules
10%, more with authorization
Exch Control: Capital Controls
No: Violates Rules
Please do!
Exch Control: Commercial Policy
Yup: Not against the Rules
No: Promote free trade
Keynes and White broadly agreed on the purpose and
scope of the proposed institution.
But they didn’t agree on all of the specifics of implementation…
37
II. Creation of the BWS
1. Keynes and White2. Keynes versus White• The Bretton Woods Conference• Another Gold Standard System?
38
Points of Disagreement• Rigor of Capital Controls– JMK: more capital controls– HDW: fewer capital controls
• Size of Quotas for Borrowing– JMK: large quota– HDW: small quota
• Ultimate Adjustability of ERs– JMK: States should more freely adjust
their ERs– HDW: ERs should remain fixed
39
Simply put, Keynes wanted a more radical departure
from the gold standard than did White.
Why?
Partly because the US had all of the gold!
40
The US agreed to redistribute the gold
through the International Bank for Reconstruction and Development (IBRD)—which
later became the World Bank.
41
White & Keynes Timeline• 1935: HDW & JMK first meet• Summer 1941: HDW & JMK draft plans• Jul-Aug 1942: Plans Exchanged– JMK: “[The White Plan] obviously won’t work.”
• Oct 1942: HDW visits GB Treasury• Fall 1942-Spring 1943: Jockeying for
Position– Competing plans published– Int’l conferences
• Summer/Fall 1943: JMK & HDW draft “Joint-Statement”
42
Ultimately, things looked more like White’s Plan than
that of Keynes.
This isn’t surprising given the asymmetry of bargaining power.
43
“the Harry White Plan is not a firm offer.
The real risk is that there will be no plan at all and that Congress will run
away from their own proposal. No harm…if the Americans work up a
certain amount of patriotic fervour for their own version. Much can be done in detail hereafter to improve it. The great thing at this stage is that they should get thoroughly committed to
there being some plan…”--Keynes to Phillips, April 1943
45
II. Creation of the BWS
1. Keynes and White2. Keynes versus White3. The Bretton Woods Conference• Another Gold Standard System?
46
By the autumn of 1943, Britain and the United States had sorted out
essentially all of the details for the International
Monetary Fund.
47
After GB and the US had reached agreement, the
rest of the world was invited to Bretton Woods, NH, in July 1944 for the United Nations Monetary and Financial Conference.
48
Keynes and White dominated the conference.
Essentially nothing was changed from their earlier
agreement.
And all but 1—the USSR—of the 45 invited nations eventually signed on. 50
The International Monetary Fund and the International
Bank for Reconstruction and Development (precursor to
the World Bank) were created with a ceremonial
signing 27 December 1945.51
II. Creation of the BWS
1. Keynes and White2. Keynes versus White3. The Bretton Woods Conference4. Another Gold Standard System?
52
Keynes had originally proposed that gold be replaced with a new international currency (“unitas”).
Unitas could be linked to gold but its supply would be regulated by
the IMF.
Combined with IMF reserve management and periodic ER
adjustments, Keynes believed this would prevent states from fighting
over a limited supply of gold. 53
The US, however, liked the idea of continuing to use gold or “any
currency backed by gold” as the Nth Currency.
After all, the US had all of the gold!
The US did not want to cede control over its extensive reserves
to an international regime.
As with trade, the US got its way.54
The textbooks suggest that “under the Bretton Woods
system, the world was on a gold standard once
removed.” (Colander 2006, 482)
So, was the BWS really just a modified GS?
55
The BWS formally preserved a special role for gold.
But it substantively recognized—for perhaps the
first time—the priority of internal over external
stability.57
Remember Keynes’s insight: the informal “rule of the gold standard game” was that states would use their monetary policies to initiate internal adjustment to maintain
external balance.
By contrast, the informal “rule of the BWS game” was that the IMF
would facilitate external adjustment, freeing monetary
policy to focus on internal macroeconomic objectives. 58
Lec 14: The Bretton Woods System
I. Keynes’ VisionII. Creation of the Bretton Woods
SystemIII.History of the Bretton Woods
System
59
Notice the familiar pattern with the creation of the
postwar order:
Great Britain and the United States forge an agreement
(biased towards the US) and the countries outside the
Soviet orbit sign on…60
The Anglo-American Postwar Order
• Money: International Monetary Fund & World Bank– Agreements between White and Keynes
• Trade: General Agreement on Tariffs and Trade– Anglo-American Negotiations on Trade
Liberalization
• Security: United Nations– Roosevelt & Churchill’s Atlantic Charter
(Aug 1941) 61
Britain’s Postwar Financial Position
• 1938-1947– British money supply tripled– But GDP only doubled (to £10.5bn)
• Private and official gold & dollars down 50%
• Overseas sterling balances > £3.5bn• UK Reserves: Just over £0.5bn
In sum: maintaining convertibility at the prewar parity was going to be very, very difficult
63
Restoring Convertibility
• US feared Imperial Preference• US demanded Britain restore
convertibility ensure level field for US exporters
• Keynes resisted– GB needed Imperial Preference to resolve
BoP– Negotiated US loan to build up reserves
• JMK: getting the loan was “absolute hell”• Easter Sunday, 1946: Keynes died– (First heart attacks had been at Bretton
Woods)64
Sterling Crisis of 1947
• Anglo-American Loan– GB gets $3.75bn loan from US – But GB must restore convertibility
immediately (5 years earlier than required by BWS)
• 15 July 1947: Pound is convertible at $4.03– Devalued from pre-WWI parity of $4.86; but
still overvalued
• Results– Loan exhausted within weeks (not decade as
planned) GB suspended convertibility again
65
The 1947 Sterling Crisis unambiguously confirmed the financial weakness of western
Europe.
The BWS required countries to have either gold or dollars, but
Europe had neither.
The postwar order depended on the US remedying this
“dollar gap.” 66
The Sterling Crisis inspired political pressure in US to (1) allow greater devaluations in Europe; and (2) furnish more
robust aid.
67
Bretton Woods in Europe
• 1948: Marshall Plan provides $13bn aid• 1948: Franc devalued from 119 to 214• 1949: Sterling devalued 30%– 23 more countries followed Sterling within
a week
• European Payments Union created to manage European imbalances
• 31 December 1958: Europe fully restores current-account convertibility
• 1961: IMF says Europe is finally in compliance with BWS
68
Throughout the 1950s, the US pressed Europe to fully adhere
to the Bretton Woods Agreements.
The US attempted to remedy the “dollar gap” by printing
money.
It spread this money abroad with the Marshall Plan,
wartime expenditure, and bilateral aid.
69
The Changing US Position• Changing Reserves– 1948: US has 2/3rds of global reserves– 1958: US has ½ of global reserves
• 1949-1950: US current-account surplus dropped by > 50%, to $3bn/year
• By early 1960s, US is consistently running trade deficits
• 1960: US foreign monetary liabilities exceed US gold reserves
• 1963: US liabilities to foreign monetary authorities exceed US gold reserves
70
The Vietnam War and the Great Society deepened these
trends.
By the late 1960s, “dollar gap” had given way to “dollar glut.”
The market price of gold rose well above $35/oz and the holders of dollars became
concerned. 71
Nixon
• Initially promised not to leave gold• Resisted by using price controls;
increased restrictions on convertibility
• August 1971: Nixon “closed the gold window,” the dollar was no longer redeemable in gold
The Bretton Woods System was finished.
72
(1) Adjustment of Reserves
• By directly intervening in the foreign exchange market, states can directly affect market price (exchange rate)• Asymmetry: lower limit to
reserves but no upper limit States might pursue positive
BoP12
(2) Adjustment of Internal Prices & Incomes
• Uses price-specie-flow– imbalance inflation/deflation– Change in price levels counters
imbalanced demand
• Problem: domestic price levels are subjected to global economic forces– Politicians don’t like saying they
can’t/won’t redress unemployment problems!
13
(3) Exchange Rate Adjustment
• Here, price-specie-flow does not work– Imbalanced demand pressure on ER– Change in market ER change in cost
of imports/exports– Change in relative price levels counters
imbalanced demand
• Potential Problems: –Minimum: creates ER instability and ER
“risk”–Maximum: “undisciplined” governments
hyperinflation 14
15
(4) Exchange Controls
Balance of Payments
Current Account
Capital Account
Trade in G&S Income Receipts Unilateral Transfers
Direct Investment Securities Purchases Checking Accounts
Commercial Policy
Capital Controls
Remember that one of the principal motivations for
pegging a currency to gold was to tie policymakers’
hands—to make the monetary system “knave-
proof”—to prevent excessive monetary growth.
74