Bretton Woods system

Based on Wikipedia: Bretton Woods system

The Last Time the World Agreed on Money

In July 1944, while soldiers were still dying on battlefields across Europe and the Pacific, seven hundred delegates from forty-four countries gathered at a grand hotel in the mountains of New Hampshire. They weren't there to discuss military strategy. They were there to prevent the next world war.

Their weapon? A new system for managing money between nations.

This might sound absurdly bureaucratic given the circumstances—economists arguing about exchange rates while tanks rolled through France. But these delegates understood something that seems obvious in hindsight: the Second World War had grown directly from the economic chaos of the 1930s. If they couldn't fix how countries traded and managed their currencies, they'd be fighting again within a generation.

What emerged from those three weeks at the Mount Washington Hotel in Bretton Woods would govern international finance for nearly thirty years. It created institutions that still shape the global economy today—the International Monetary Fund and the World Bank. And its collapse in 1971 ushered in the floating currency system we now take for granted, where the dollar in your pocket isn't backed by gold or anything else except faith in the United States government.

The Catastrophe They Were Trying to Prevent

To understand why these delegates thought currency management could prevent wars, you need to understand what happened after the First World War.

The Treaty of Versailles in 1919 created an impossible financial situation. Britain owed massive debts to the United States, money it had borrowed to fight the war. But Britain couldn't pay because it had loaned most of that money to France and other allies, who couldn't pay Britain back either. The Allies' solution was to demand that Germany pay for everything through war reparations.

This created a chain of debt that existed mostly on paper. Banks around the world held assets that looked valuable but were actually uncollectable loans. When this house of cards finally collapsed in 1931, it triggered a banking crisis that spread globally.

Then came the currency wars.

When your economy is collapsing and your people are unemployed, there's a tempting quick fix: devalue your currency. If the British pound suddenly becomes cheaper relative to the French franc, British goods become cheaper for French buyers. Exports go up. Factories reopen. Workers get jobs.

The problem is that this only works if you're the only country doing it. When France responds by devaluing the franc, and Germany devalues the mark, everyone ends up back where they started—except now international trade has become chaotic and unpredictable. Economists call this "beggar thy neighbor" policy because you're essentially trying to improve your situation by making your neighbors worse off.

Throughout the 1930s, countries threw up trade barriers, manipulated their currencies, and retreated into economic nationalism. Global central bankers tried to coordinate, but they struggled to communicate effectively across borders and often didn't fully understand the cascading effects of their decisions. Simply having competent, hardworking people running central banks wasn't enough. The system itself was broken.

Britain's Empire Trap

Britain found itself in a peculiar bind. The British Empire gave it a trading bloc where countries used the pound sterling—places like South Africa, India, and Australia. When Britain imported more from these countries than it exported, the extra pounds tended to flow back into London banks. This created a nice arrangement where trade deficits were balanced by financial surpluses.

But this system only worked if people trusted the pound. If South African businessmen holding pounds thought the currency might lose value, they'd move their money elsewhere. Britain couldn't devalue its currency to boost exports without destroying the financial arrangement that kept its empire economically unified.

Germany, meanwhile, developed a more coercive version. By 1940, Nazi Germany forced its trading partners to spend any surplus they accumulated by buying German products. It was less a trading system than economic subjugation.

The United States watched all this with concern. American planners worried that when the war ended, the sudden drop in military spending would throw the country back into depression-era unemployment. They wanted Europeans and the Sterling-using countries of the British Empire to be able to buy American goods. That meant free trade and currencies that could be reliably converted into dollars or gold.

Two Visions at Bretton Woods

The conference brought together economists who had watched the disasters of the 1930s unfold and were determined not to repeat them. Their guiding principles were simple: no more beggar-thy-neighbor currency manipulation, and strict controls on speculative money flows that could destabilize entire economies.

But how to achieve this?

Two plans competed for dominance, championed by two brilliant and very different economists.

John Maynard Keynes represented Britain. By 1944, Keynes was already famous as perhaps the most influential economist of the twentieth century. His ideas about government spending to counter economic downturns had transformed how democracies thought about managing their economies. He was also witty, connected to London's artistic elite through the Bloomsbury Group, and dismissive of people he considered intellectual inferiors—a category that included most people he met.

Keynes proposed something radical. He wanted to create a new international currency called the "bancor" that would be used only for settling accounts between nations. More controversially, he wanted to force countries running trade surpluses to spend that money—either by importing more goods, building factories in deficit countries, or simply giving money away. If a country accumulated too much bancor, it would be taxed.

This "use it or lose it" mechanism targeted what Keynes saw as the real problem: creditor countries that hoarded wealth and demanded repayment from debtor countries that couldn't possibly pay. Germany had been crushed after World War One partly because France, Britain, and the United States insisted on collecting debts that could never realistically be repaid. Keynes wanted a system where surpluses automatically flowed back to deficit countries.

Harry Dexter White represented the United States. He was a senior Treasury official, less famous than Keynes but representing a country that held two-thirds of the world's gold reserves. White rejected Keynes's plan entirely.

White proposed the International Monetary Fund instead—an institution that would monitor exchange rates and lend money to countries facing balance-of-payments problems. Crucially, his version would have operated automatically, providing stabilizing funds without political conditions attached. If speculative money started flowing dangerously out of France, the fund would simply provide counterbalancing support.

The United States had the leverage, so the American vision won. But in a twist of irony that would become clear decades later, the system that emerged imposed conditions on borrowers that Keynes had warned against—and on virtually every point where Keynes was overruled, economic historian Brad DeLong argues, events proved him right.

How the System Actually Worked

The Bretton Woods system that emerged was built on a simple foundation: the United States would guarantee that anyone holding dollars could exchange them for gold at thirty-five dollars per ounce. Other countries would fix their currencies to the dollar at agreed exchange rates. If a country's economy weakened and it couldn't maintain its exchange rate, the International Monetary Fund would provide short-term loans to help it stabilize.

This created a pyramid of trust. At the bottom sat gold, the ancient store of value that humans had prized for millennia. The dollar sat on top of gold, convertible at a fixed rate. Every other currency sat on top of the dollar.

Why did it work? The economist Barry Eichengreen identified three crucial factors.

First, international capital couldn't flow freely. Governments tightly controlled how money moved across borders. You couldn't easily speculate against a currency or rapidly move investments from one country to another. This prevented the kind of sudden capital flight that had devastated economies in the 1930s.

Second, financial systems were heavily regulated. Banks couldn't make the risky bets that might destabilize the system. This was the era of boring banking—savings accounts, home mortgages, and business loans, not complex derivatives or high-frequency trading.

Third, and perhaps most important, the United States dominated the global economy. American industry had emerged from the war intact while European and Japanese factories lay in ruins. American gold reserves dwarfed everyone else's. When the dollar served as the foundation of the system, it rested on genuine economic supremacy, not just international agreement.

The Institutions That Survived

Bretton Woods created two major institutions that continue operating today, though in forms their creators might not recognize.

The International Monetary Fund was designed to be a kind of emergency lender for countries facing currency crises. If France was running short on foreign exchange reserves and couldn't maintain its fixed exchange rate, the International Monetary Fund would provide temporary loans to bridge the gap. The idea was to prevent countries from having to impose painful austerity measures or competitive devaluations just because of short-term balance-of-payments problems.

The International Bank for Reconstruction and Development—now part of the World Bank Group—was created to help rebuild war-devastated Europe and later to finance development in poorer countries. It would make long-term loans for major infrastructure projects that private banks wouldn't finance.

The Soviet Union sent representatives to Bretton Woods but never ratified the agreements. Soviet officials declared that these new institutions were nothing more than "branches of Wall Street"—a characterization that, whatever its ideological motivation, captured something real about American dominance of the system.

The Economic Philosophy Behind the System

The architects of Bretton Woods weren't just solving technical problems about exchange rates. They were implementing a new philosophy about how governments should manage economies.

The Great Depression had shattered faith in unregulated markets. In country after country, governments had responded to mass unemployment by taking on new responsibilities for economic management. Full employment became a political promise. Social safety nets expanded. The idea that governments should simply let markets work themselves out seemed not just wrong but dangerous.

Cordell Hull, the American Secretary of State from 1933 to 1944, believed he had identified the fundamental cause of modern wars: economic competition and trade barriers. In his view, when countries couldn't trade freely, they became "deadly jealous of another." Living standards stagnated. Economic dissatisfaction bred political extremism. Eventually, grievances exploded into military conflict.

Hull's prescription was more trade, fewer barriers, and economic interconnection that would make war too costly to contemplate. This became the American vision for the postwar world—not just at Bretton Woods but in the broader project of building international institutions like the United Nations.

Unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war. If we could get a freer flow of trade—freer in the sense of fewer discriminations and obstructions—so that one country would not be deadly jealous of another and the living standards of all countries might rise, thereby eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.

Harry Dexter White, despite his bureaucratic rivalry with Keynes, shared this underlying philosophy. He warned that without economic cooperation among leading nations, the result would be "economic warfare that will be but the prelude and instigator of military warfare on an even vaster scale."

The Contradictions That Killed Bretton Woods

The system contained a fatal flaw that economists recognized almost from the beginning. It even had a name: the Triffin dilemma, after the Belgian-American economist Robert Triffin who formally identified it in 1960.

Here's the problem. The world economy was growing, which meant the world needed more dollars to conduct international trade. But the only way to get more dollars into international circulation was for the United States to run trade deficits—spending more abroad than it earned. Every year, more dollars flowed out of America and into foreign hands.

Meanwhile, the American gold supply stayed roughly constant. At some point, there would be more dollars in foreign hands than the United States could possibly redeem for gold at thirty-five dollars per ounce. When that happened, the system's foundation—the promise that dollars were as good as gold—would become obviously hollow.

Through the 1960s, this slow-motion crisis accelerated. The Vietnam War was expensive. President Lyndon Johnson's Great Society programs were expensive. The United States was spending far more than it was taking in, and dollars were piling up in foreign central banks, particularly in Europe.

France, under President Charles de Gaulle, began loudly demanding gold for its dollars. De Gaulle saw American monetary dominance as a form of imperialism—the United States could print money to pay for wars and social programs while other countries had to actually earn their foreign exchange. By exchanging dollars for gold, France was calling America's bluff.

The Eurodollar Market

Meanwhile, a new development was undermining one of the system's key supports: capital controls.

American dollars held in European banks—called Eurodollars—began circulating outside any government's control. If you were a corporation wanting to move money internationally, Eurodollar markets offered a way around capital controls. This pool of unregulated money grew throughout the 1960s, making it increasingly difficult for governments to manage currency flows the way Bretton Woods required.

The system worked when governments could control how capital moved across borders. Once that control eroded, the fixed exchange rates became increasingly difficult to maintain.

Nixon Closes the Gold Window

On August 15, 1971, President Richard Nixon went on television and announced that the United States would no longer redeem dollars for gold. He called it temporary. It wasn't.

The immediate trigger was a run on American gold reserves. Britain had requested conversion of three billion dollars into gold, and other countries were preparing similar requests. The United States simply didn't have enough gold to honor these demands.

Nixon's announcement effectively ended Bretton Woods, though the formal death certificate wasn't signed until the Jamaica Accords in 1976. Within a few years, most major currencies were floating—their values determined by market forces rather than government agreements. The dollar remained central to international trade, but it was now a fiat currency, backed by nothing except faith in American economic and political stability.

What Bretton Woods Reveals About Global Order

The Bretton Woods system lasted less than three decades, a remarkably short period for something designed to permanently prevent economic warfare. But its story illuminates several enduring truths about international economics.

First, monetary systems require power to enforce them. Bretton Woods worked as long as the United States had overwhelming economic dominance. When that dominance eroded—when Europe and Japan rebuilt their industries, when American spending outstripped American production—the system couldn't survive.

Second, the interests of creditor countries and debtor countries are fundamentally opposed. Keynes wanted mechanisms to force creditors to recycle their surpluses. White wanted mechanisms to help debtors adjust. These remain the battle lines in every international financial crisis, from the Latin American debt crisis of the 1980s to the European sovereign debt crisis of the 2010s.

Third, international financial systems reflect international power relationships. Critics of Bretton Woods institutions have long argued that the International Monetary Fund and World Bank serve American interests, imposing policy conditions on developing countries that benefit Western banks and corporations. The Soviet accusation that these were "branches of Wall Street" was ideologically motivated but not entirely wrong.

Fourth, and perhaps most importantly, economic arrangements and political stability are deeply intertwined. The architects of Bretton Woods believed that currency manipulation and trade wars led to military wars. Whether or not this precise causal chain is correct, the insight that economic and political stability reinforce each other has proved durable.

The Ghost of Bretton Woods

We still live in Bretton Woods' shadow. The International Monetary Fund continues intervening in currency crises, though now with the "conditionality" that White's original proposal lacked—detailed requirements about government spending, privatization, and market liberalization that borrowing countries must accept. The World Bank still finances development projects, though its role and approach have been repeatedly contested.

The dollar remains the world's primary reserve currency, even without gold backing. When governments and corporations around the world hold foreign exchange reserves, they mostly hold dollars. When commodities like oil are priced internationally, they're mostly priced in dollars. This gives the United States what the French once called an "exorbitant privilege"—the ability to borrow cheaply and run persistent trade deficits without the consequences other countries would face.

But this privilege is contested. China has worked to internationalize its currency. Various countries have experimented with alternatives to dollar-denominated trade. The question of what will replace dollar dominance—if anything—remains one of the great uncertainties of twenty-first-century economics.

Meanwhile, the tensions that Bretton Woods tried to manage remain unresolved. Countries still engage in what critics call currency manipulation, keeping their currencies artificially weak to boost exports. Trade imbalances still generate political conflict. Capital flows still destabilize economies. The speculative financial flows that the Bretton Woods architects tried to suppress now move trillions of dollars around the world every day.

Those delegates in New Hampshire were trying to solve a problem that may be unsolvable: how to maintain stable international economic relations among sovereign countries with conflicting interests. Their system lasted a generation. Whatever comes next will face the same fundamental challenges.

In the meantime, the story of Bretton Woods offers a reminder. The financial systems we take for granted—floating exchange rates, the dollar's global role, the International Monetary Fund's intervention in crises—aren't natural features of the world. They're the products of specific historical moments, designed by people trying to prevent catastrophes they had personally witnessed. Understanding where these systems came from is the first step toward understanding where they might be going.