Table of Contents
1. INTERNATIONAL ECONOMIC RELATIONSHIPS AROUND THE TURN OF THE CENTURY
1.1. Pax Britannica and the Gold Standard
1.2. ECONOMIC CONSEQUENCES OF THE FIRST WORLD WAR
1.3. The Interwar Period - Return to the Gold-Standard
1.4. The Great Depression and its Consequences for International Economic Policies
2. THE DEVELOPMENT OF THE BRETTON WOODS SYSTEM
2.1. The Historic Background of the Drafting
2.2. The Keynes versus the White-Plan
2.3. After the Negotiations: The Bretton-Woods-System
2.4. Reactions to the White- and Keynes-Plan
2.5. Why White and not Keynes
In the year 2012 it has become almost impossible to open a newspaper and not find an article about the economic crisis that is affecting most of the Western World. Initially an ill regulated banking system and bad investment strategies nearly caused the banking sector to collapse. The affected financial institutes then required massive financial support by national states. This resulted in higher national debts. Today we have reached the point, where sovereign nations are so deeply indebted that they stand a chance to lose any capacity to act if other countries do not subsidize them. This support is accompanied by demands for a strict fiscal policy that holds hardships for the people.
Observing this development one might find it hard to believe that only about sixty years ago we had a financial world order that was founded on the idea that finance has to be the "servant" (Gardner 76) of the economy and of society as a whole. The Bretton-WoodsConference in 1944 set out to regulate finance in a way that promotes trade while protecting national states from damage caused by monetary problems. The focus lay on the domestic economies, which the new system would strive to safeguard. The national states were, in the thinking of the makers, to be the "masters" (76) of international economy and the international financial system was to work in their best interest.
The way of thinking of economists and policy makers at the time did not originate out of thin air. After the turn of the 19th to the 20th century the world experienced two devastating World Wars and the Great Depression, which brought unemployment and poverty to millions of people and basically destroyed parts of the economy in the western hemisphere. These events resulted in the wish to create a system of international rules and regulations that could guarantee stability. Problems that called for a remedy included fluctuating exchange rates, extensive balance of payment deficits and destructive mercantilist trade policies, like competitive devaluations and foreign exchange regulations (McQuillan).
Still, to understand the foundations on which John Maynard Keynes and Harry Dexter White, the chief economists behind the Bretton-Woods-System, drafted their initial plans for an economic world order, it is necessary to go even further back in time. The starting point for the analysis in this paper will be a period of relative stability, namely the end of the 19th century when most economic activity gravitated around Great Britain, at the time the hub of the financial world. The system in place was the so-called gold standard, which guaranteed the convertibility of different currencies and ensured that balance of payments deficits were evened out.
We will see how in times of economic instability this system did not seem fit to restore the international economy into a state of equilibrium. We will examine the developments that finally led to the abandonment of the gold standard and called for the establishment of a new system that was thought to keep the world from sliding back into economic peril.
In the last part of this paper the attempt will be made to outline how the historic developments influenced the works ofKeynes and White and are ultimately reflected in the resolutions that stood at the end of the Bretton-Woods-Conference.
1. International Economic Relationships around the Turn of the Century
1.1. Pax Britannica and the Gold Standard
Around the beginning of the 20th century most of international trade and finance was centered on Great Britain. This meant that influential companies and banks were situated in London, where most commodity trade and stock exchange took place. Because the industrial revolution had its inception in Britain, the industry had a comparative advantage in productivity over other industrialized nations. From the 1880ies those countries tried to protect their economies from the powerful trade partner by implementing protectionist measures. Germany raised tariffs in 1879 in the course of the "Zolltarifreform" under Bismarck and in the United States the "Morill-Tarif" was the beginning of a phase of a high tariff policy that lasted until the 1930ies (Limbers 6 -7). Despite those policies, the years 1885 till 1913 were a time of relative economic prosperity. Germany for example experienced only five years of economic downturns in this period (Plumpe 69).
These same years can be seen as the "era of the international gold standard" (Friedman, Melzer). The gold standard ensured the convertibility of paper money into gold and vise versa at a relatively fixed rate. Bank deposits could be exchanged for paper money, that could then itselfbe converted into gold.
Basically this meant that there was a single world-money that was called by different names in different countries. Consequently exchange rates would be influenced only by the cost of shipping gold. When for example the price for the pound sterling in New York exceeded the expenses for a transport of gold by ship, someone who owed money to a creditor in London would opt for an exchange into gold rather than to buy the currency. After the transport to London the gold could then be converted into pound sterling to pay off the debt. The possibility of such an exchange set an upper limit to the exchange rate while the transport in the other direction set a lower limit. These limits were referred to as "gold points" (Friedman, Melzer).
The convertibility of currency was not the only beneficiary effect of the gold standard. The German economistAndreas Predöhl described it as the "monetary correlate to free trade" (Predöhl, 262) in 1949. A historic problem in international trade was that the equilibrium between nations was in danger when a country experienced a considerable balance of payments deficit or surplus, meaning either the cost for imports exceed the income from exports or the other way around. The consequence of a structural trade deficit is cash flow out of the country. Possible reactions are protectionist measures like the raising of tariffs to lower the demand for commodities from abroad or devaluating the currency to boost exports. Another way to go is financing the ensuing deficit by taking up credits from abroad, which ultimately leads to a raise of the national debt. All those measures however are harmful to free trade as they affect the flow of goods and can evoke other countries to take similar steps (Limbers, 7).
Under the system of the gold standard such a polarization in trade deficits and surpluses was counteracted by a process called price-specie-flow adjustment mechanism, that would facilitate a balance of payments while preventing fluctuating exchange rates. This worked as follows: When a country experienced a trade surplus (more exports than imports) the quantity of money was raised and subsequently domestic prices went up relative to those in other countries. Consequently the demand for imports was raised (as goods from abroad were cheap). At the same time exports decrease as commodities were comparatively expensive for foreign buyers, so less foreign currency entered the country while the demand for foreign currency was raised to pay for imports. When the price for foreign currency reached the upper gold point, gold left the country via ship. This development produces a reduction in the total amount of money and prices were lowered again (Friedman, Melzer).
It is interesting to note that this system prioritizes a balance in foreign trade over the domestic economy. The monetary policy of a country was determined by the international trade balance rather than by the domestic economic situation. This fact made it hard to return to the gold standard after the First World War (Limbers 8).
1.2. Economic Consequences of the First World War
With the beginning of the First World War an era of prosperous economic exchange came to an end. This brought about substantial changes in the economic and political landscape, which made it difficult to return to the old system. Countries that were not involved in the war, which had previously relied on imports from the European nations, had developed economic facilities that worked to substitute for the interrupted flow of goods. In some countries this development triggered processes of industrialization. At the same time countries like the USA, Argentina and Australia expanded their agricultural capacities in part to be able to deliver food to Europe (Plumpe 71- 72). According to the Treaty of Versailles Germany was obliged to pay reparations, but also France and Great Britain, the beneficiaries of these payments, had lost economic power and had taken up loans from the United States to pay for the costs of the war. Similarly Germany paid the bulk of the reparations on the basis of American credits. Thus a large part of Europe fell into economic dependence on the USA (Limbers 9).
During wartime the convertibility of currency to gold had been suspended. The economies of the European states concentrated all their energy on the production of war material. Export and import bans also hindered any possible growth. As most of the expenses for the armament were based on loans, the national debts grew drastically. An increase in the quantity of money and increasing prices for commodities lead to inflation. After the war had ended, the biggest challenge was to restructure the economy for the production of civil goods (Plumpe 75).
Some contemporary analysts like Nikolaus Wolf stress that, although Europe suffered from the destruction that the war had brought, it was still nothing close to an economic wasteland. In the period after the war modernization took place in different areas. This included "mass motorization, advances in electrical engineering, the construction of an extensive road network, the emergence of commercial aviation, and crucially the electrification oflarge parts of the European economy" (Wolf 4). At the same time some businesses attempted the introduction of the new style Fordist mass-production like it was promoted in the United States. Those technologies brought new challenges for the European governments. Their introduction was "capital intensive, required extensive new network-infrastructures and large markets to become profitable" (Wolf 4).
As we can see there certainly was incentive for renewed economic cooperation and coordination.
1.3. The Interwar Period - Return to the Gold-Standard
After the end of war the idea of returning to a system that had ensured economic stability for almost twenty years seemed appealing to many policymakers. The main goal was to regain access to international capital markets while at the same time ensuring price stability. However, it seemed that it was not going to be an easy task to reach an agreement on an international level. The monetary conference in Brussels did not deliver the desired results. The Genoa Conference 1922 recommended a partial return to the gold standard, meaning that paper money should only be exchangeable for large gold bars that were impractical in everyday use. The main question was how to deal with the price levels that still differed a great deal among the nations (Wolf 8).
The reasons for the difficulties in international coordination were threefold. First of all the political landscape had changed considerably. The creation of new states led to heated international debate concerning border disputes and the question on how to deal with national minorities. While the end of the war had brought more democracy, a lot of the governments were less stable than before. Both the losers of the war like Germany and Austria, and the winning nations such as France and Britain experienced an increase in political tribalism. This development led to delays in the forming of political decisions.
The aforementioned reparations and war debts discussed in chapter 1.2. were the second source of instability. Thirdly, governments were struggling to remedy the rampant inflation. Germany for example experienced a hyperinflation from 1922 to 1923, which was the most radical devaluation of a currency that any industrialized nation has ever experienced. Poland experienced a similar development. Most countries were preoccupied with problems in all these three areas, leading to a concentration on national interests rather than international cooperation (Wolf 12 - 17).
In the 1920ies the world saw an economic upturn. The Dawes-Plan in 1924 led to a reduction in the reparations that Germany had to pay, subsequently bringing about a period of economic uplift. Germany partly regained its financial standing and the introduction of the Reichsmark in the same year brought an end to the inflation (Plumpe 76 - 77).
Great Britain chose to return to the gold standard. This decision was accompanied by heated political debate. Following the prevailing financial opinion, Churchill decided to return to the prewar parity. The result was that, as a consequence of the new exchange rates, the pound was largely overvalued. Hereupon a flow of gold out of the country followed. A development that amplified this trend was that France, returning to the gold standard in 1928, chose deflation and undervalued the Franc. At the end of the 1920ies most of the important currencies had returned to gold standard (Friedman, Melzer).
While the United States were the only country to return the gold standard right after the World War, it had introduced a newvariable to the system. In 1913 the Federal Reserve System was established, which had a substantial influence on the specie-flow principle. It could suspend the mechanism that an increase in gold was followed by an increase of the quantity of money. How Friedman and Melzer put it, this institution had the ability to "sterilize the monetary effect".
2.4. The Great Depression and its Consequences for International Economic Policies
The reasons why the world economy experienced a Great Depression beginning in 1929 is still subject to scientific debate. The contributing factors are manifold. One key question of the debate is whether the crisis was brought about by a decline of aggregate demand or a fall in money supply (Mundell 329). An area where it is possible to pin down the proceeding of the crisis is the stock market in the United States. Stock prices had risen by four times from 1921 to 1929. This increase was rooted in the uplift, which the American economy had experienced after World War I. In 1929 42,2 % of industry production worldwide fell to the USA while Germany made out only 14,3 % and Great Britain, formerly the World's center of finance and industry, covered 9,4 % (Plumpe 73).