As a result of the economic disasters of the 1930s and the failure of the inter-war international gold exchange standard, the delegates at the Bretton Woods Conference recognised that a successful replacement had to be established through international co-operation. During the conference Britain and America dominated the discussions and a stable monetary and payments system was seen as the necessary path for a successful multilateral trade regime. But this plan reflected the approach forwarded by the American delegates, submitted by Harry D White of the US Treasury, rather than the plan drawn by John M Keynes, who headed the British delegates.
However, the outcome of the negotiations provided successful framework for international financial system and capital mobility. The delegates devised a payments system and exchange rate mechanism based on fixed but flexible exchange rates system where all nations’ currencies were pegged to the US dollar, which in tern was linked to gold. This was because the US dollar was valued at $35.00 per ounce of gold. The dollar was convertible into gold on demand, therefore the dollar became a substitute for gold: the dollar was ‘as good as gold’ (McConnell, 1987). The exchange rate of those currencies would move 1 per cent above or below the par value and within the band of fluctuation, the nations’ exchange rates were determined by market forces and each nation’s government would intervene using monetary and fiscal policies to keep their exchange rate within the 1 per cent band.
During the interwar years, nations practised on devaluing their currencies in the hope that it would stimulate domestic employment and the export market, but there was no adequate international control or co-ordination. As a result, any one could practise currency devaluation in hope of gaining international competitiveness and at the end no one benefited from devaluation, because these ‘beggar-thy-neighbour policies inevitably provoked foreign retaliation and often left all countries worse off’, (Krugman, 1991).
Therefore, delegates at the Bretton Woods Conference agreed to establish the IMF in order to provide overall exchange rate stability, whereby disruptive currency devaluation could be avoided. As well as eliminating competitive currency devaluation, the IMF embarked on ‘a multilateral system of payments based on a world-wide convertibility of currencies was to be achieved through the elimination of exchange controls’ (Kenwood, 1992), where there were no restrictions on the conversion of one nation’s currency into another for current account purposes.
The IMF’s Article of Agreement was also to empower member nations to pursue domestic policies aimed at achieving full employment and balance of payment surplus through the application of monetary and fiscal policies. However, in the case of any members suffering from payments difficulties and related exchange rate problems were allowed to borrow short-term loans from the Fund to finance their economic activities. This money had to be repaid by surrendering ‘domestic currency to the Fund equal in value to the foreign currencies drawn’, (Kenwood, 1992). As the system evolved, a number of conventions were established concerning the operation of the Fund. If borrowing began to exceed a nation’s original quota, increasingly serious conditions would be imposed on any further borrowing and would be enforced by the Fund’s officials. This made the IMF a highly complex system and some would argue for it to be made more decentralised.
The second institution that was set up at the UN’s Conference in Bretton Woods during 1944 was the International Bank for Reconstruction and Development (IBRD), otherwise know as the World Bank. Although the Bank was set up during 1944, it did not commence operation until 1947. The Bank was responsible for providing long-term finance and ‘investment for productive purposes’ (Ashworth, 1962), such as post-war reconstruction and development to member nations, so that they could rebuild their economic infrastructure such as roads, irrigation and energy intensive industries, etc., but finance was only available if the Bank’s officers felt that the finance would strengthen the economy of that country. This Bank was hardly used by the European and the North American countries, because the western countries received help from the US through the Marshall Plan, which was also known as the European Development Programme (EDP). This EDP helped the western nations to develop their economy.
However, the effort of the World Bank in helping to ‘finance post-war reconstruction, the Bank was later to help extend aid to the developing nations’, (Kenwood, 1992).
The Bank was looked upon as the last resort to obtain finance for the purpose of reconstructing a nation’s economy after it had been destroyed from political or natural disasters such as war, flood and famine etc. Therefore, in the case of any economic disasters prevailed from any of the forces mentioned above, the Bank ‘provided a means of mobilising international capital and directing it to productive projects’ (Ashworth, 1992), thereby rebuilding that economy and improving the welfare of the general public of that nation. However, there was a catch as nothing comes with risk free. These development finance available from the Bank were to be repaid in dollars, and borrowers were charged rates of interest determined by the prevailing rates in capital markets where the Bank’s bonds were sold.
The Bank’s objective was ‘to conduct its operations so as to effect a smooth transition from a war to a peace economy’ (Ashworth, 1962), allowed member nations with economically sound projects to obtain loans at a reasonably low rates of interest from the Bank in cases where they found it difficult to do so from private Banks for a period of 5 to 20 years. The Bank had established global reputation for its operations; where now (2000) it has over 155 member nations involved in smooth functioning of the Bank’s activities. The Bank has been completely transformed from financing mainly large capital infrastructure projects, through addressing basic needs of its members, especially in rural areas, to conditional lending in support of structural adjustment programmes.
The Bretton Woods agreement also included plans for an International Trade Organisation, but the plan was abandoned. However, the UN’s Geneva Conference during 1947 led to the establishment of the General Agreement on Tariff and Trade (GATT) in 1948. This organisation is now known as the World Trade Organisation (WTO) after the GATT was transformed following the conference in Geneva during 1995. Why was a trade organisation so important for the post-war reconstruction and development? Well, it was probably because international co-ordination in reducing tariff as a trade policy dates back to the 1930s, when the US passed an inadequate tariff law, the Smoot-Hawley Act as it was known. This Act was responsible for steep increase in US and EU tariffs that in result affected international trade. Many people still believe that the Smoot-Hawley Act increased the disharmony of the 1930s. Realising the negative effects of the Act, the US embarked on bilateral trade negotiations with its trade partners. This helped to reduce the import tariffs ‘from 59 per cent in 1932 to 25 per cent shortly after World War II’ (Krugman, 1991), and although bilateral trade may seem a forward approach, it did not have the full advantage of multilateralism. However, benefits from a bilateral trade had spill over to countries that failed to provide any concessions.
The establishment of GATT was to transform international trade policies so as to benefit all nations. It did this so by agreeing to set principles, the first principle was non-discrimination, where unconditional acceptance of the most favoured nation was forbidden. But members were allowed to practice preferential trade agreements between former colonies and dominions.
The second was the elimination of import tariffs and quotes, through international tariff bargaining and a shift towards freer trade. The final principle of GATT was to solve trade disputes among nations within the GATT framework. The GATT was originally sighed by 23 nations, now at this present day the organisation has over 124 member nations agreeing to its principles for free trade through multilateral trade negotiations.
The IMF and the World Bank, accept for GATT, evolved from the Bretton Woods agreement helped to provide a foundation and a backbone for America to manage the international economy towards the Pax. The Bretton Woods agreement allowed the dollar to become the international reserve for two reasons. First America emerged from the war as the world’s strongest economy. Second, from 1934 onwards, America accumulated large quantities of gold and maintained its monetary authority of buying and selling gold, where the dollar was valued at $35 per ounce. Therefore, the world economy relied on America for financial assistance in settling their balance of payments deficits. The US was able to carry on leading the world economy through its gold reserves even when during the 1950s and 1960s it was under persistent balance of payments deficits. It was able to do this by extracting gold from the earth. But even this method did not help to increase the gold reserve, because the supply of US gold was inadequately short to meet the demand for the rapidly expanding volume of international trade and finance. This lead America to draw down its gold reserves to finance its balance of payments deficits. It also financed the deficits through growing foreign holdings of American dollars which was ‘as good as gold’ (McConnell, 1987) until 1971, the end of ‘Pax Americana’. With the US persistently running balance of payments deficits, people questioned, whether the dollar was really ‘as good as gold’ (McConnell, 1987), and if the dollar was to remain the main medium of exchange, the payments deficits had to be eliminated. ‘But success in this endeavour would limit the expansion of international reserve or liquidity and therefore tend to restrict the growth of the international trade and finance’ (McConnell, 1987).
Today we learn that the end of the ‘Pax Americana’ with respect to the management of the international economy came following the collapse of the Bretton Woods system during 1971, when President Nixon allowed the US dollar to freely float on the international money market, thereby, allowing its value to be determined by market forces. Hence, the withdrawal from the Bretton Woods system ended the prolong periods of balance of payments difficulties with respect to the American economy.
References
Bannock. G & et all, ‘Dictionary of Economics’, 6th Edition, Penguin, 1998.
Ashworth. W, ‘A Short History of the International Economy’, 2nd Edition, Longmans, 1962.
Kenwood. G. A and Lougheed. L. A, ‘The Growth of the International Economy 1820-1990: An Introductory Text’, 3rd Edition, Routledge, 1992.
Krugman. R. P and Obstfield. M, ‘International Economics: Theory and Policy’, 2nd Edition, Harper Collins, 1991.
Harvey. J, ‘International Economics’ 2nd Edition, MacMillan, 1972.
Salvatore. D, ‘International Economics’ 6th Edition, Prentice Hall, 1995.
McConnell. R. C, ‘Economics’, 10th Edition, McGraw-Hill, 1987.
