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The Bretton Woods System

The Bretton Woods System. JM Keynes & HD White. Class 14 – Tuesday, 27 October 2009 J A Morrison. Admin. Tonight, 7 PM: Screening of Niall Ferguson's The Ascent of Money (2009 ) Location: RAJCON (?) Thursday: Deadline for 2 nd Discussion Post. The Bretton Woods System.

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The Bretton Woods System

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  1. The Bretton Woods System JM Keynes & HD White Class 14 – Tuesday, 27 October 2009J A Morrison

  2. Admin • Tonight, 7 PM: Screening of Niall Ferguson's The Ascent of Money (2009) • Location: RAJCON (?) • Thursday: Deadline for 2nd Discussion Post

  3. The Bretton Woods System • Left Over: Gold in the Great Depression and War • Keynes’ Revolutionary Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

  4. The Bretton Woods System • Left Over: Gold in the Great Depression and War • Keynes’ Revolutionary Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

  5. The Abandonment of Gold • Abandonment • Britain: September 1931 • 1932: 24 more countries suspend convertibility • US: 1933 • France: 1936 • 1933 London Economic Conference: Attempt to Agree on Concerted Action (like the G20 today) • France: no devaluation here! • Britain and US: reflate, damn it!

  6. Most economists have agreed that the devaluations of the 1930s were part of the solution.

  7. But the question remains, how do we explain this sudden abandonment of the GS ideal?

  8. Fragility of New Gold Standard Regime • All Gold Standard Regimes Depend on: • Leadership of Major Economies (Kindleberger) • Supporting International Norms (Eichengreen) • Committed, Compliant Populace (Polanyi) • Luck: Increase in Gold; No Exogenous Shocks (Keynes) • “New” Gold Standard was even further from GS Ideal than Prewar Gold Standard

  9. (1) Failure of Leadership • Late 1920s, US raised interest rates to cool overheating stock market • Attracted foreign capital • Decreased lending to Germany • Stock market crash precipitated “orthodox” monetary policy: “Great Contraction” of US money supply • Kindleberger: US had all of the gold; the US needed to provide the world with liquidity but did the opposite!

  10. (2) Eichengreen: Collapse of International Norms • Prewar Gold • Countries cooperated (a la Broz on France & England) • Markets bet with banks  by moving ahead of banks, markets helped to do the job of banks • WWI shattered consensus: banks saw interests at odd; cooperation ceased • New Gold Standard • Markets bet against banks  markets exacerbated disequilibria, making banks’ job harder

  11. (3) Polanyi: Empowered Populace • Due to balance of payments constraint, GS ideal sacrifices MPA • Practical Implications • Deflationary bias • Price decreases brought about by unemployment • Why would a state give up MPA?  Serves capital at the expense of labor! • Polanyi’s Historical Shift: democratization • Prewar: poor weren’t represented  GS • 1920s: poor stop putting up with GS

  12. (4) Keynes: Luck ran Out • Keynes dreaded deflationary bias of gold standard • In 19th C, world was lucky: • there was enough gold to go around • following GS “orthodoxy” didn’t create catastrophe • In 20th C, the world would not remain lucky • Global economy requires liquidity • Don’t depend on gold mines! Create an international institution and a new global currency to do this!

  13. So, which explanation was correct?  Actually, they’re all correct! All four explanations can be combined to create one rich explanation.

  14. Key Points about Interwar Gold Standard • States always possessed political incentives (read: policy autonomy!) to compromise on GS Rules/Ideal (convertibility & ER stability) • Prewar GS was compromised; but New GS was even more so (e.g. France & US) • Several exogenous changes made adhering to gold more difficult in 1930s than before • Interpretations of interwar period governed perspectives on international monetary system for decades

  15. The Bretton Woods System • Left Over: Gold in the Great Depression and War • Keynes’ Revolutionary Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

  16. 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.”

  17. But Keynes knew that the revolution might prove only temporary.Throughout the 1930s, Keynes worked to refine his perspective and sharpen his criticisms.

  18. Let’s turn, then, to consider precisely why Keynes despised the gold standard so vigorously…

  19. “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)

  20. So, for Keynes, the central issue was the balance of payments.

  21. What are states’ options for dealing with imbalances of payments?(Hint: Friedman in Class 6!)

  22. Remember this slide? Lecture 6: Balance of Payments (Slide #41)

  23. (1) Adjustment of Reserves • By directly intervening in the foreign exchange market, states can directly affect market price (exchange rate) • But reserves have a lower limit • Result: easier to maintain an undervalued currency than overvalued

  24. (2) Adjustment of Internal Prices & Incomes • Here, price-specie-flow works • Imbalanced demand  capital flows • Capital influx/efflux  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!

  25. (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

  26. Balance of Payments Current Account Trade in G&S Income Receipts Unilateral Transfers Capital Account Direct Investment Securities Purchases Checking Accounts (4) Exchange Controls Commercial Policy Capital Controls

  27. Reconciling the Balance of Payments Under the Gold Standard But world gold supply is limited. • Adjustment of Reserves • Adjustment of Internal Prices & Incomes • Exchange Rate (ER) Adjustment • Exchange Controls • Capital Controls: Limit convertibility • Commercial Policy

  28. Alleviating Imbalances of Payments

  29. The gold standard creates enormous incentives for states to enact commercial policy. Is the gold standard worth sacrificing free trade?

  30. Over the course of his life, Keynes favored different proposals but one thing never changed…

  31. Alleviating Imbalances of Payments

  32. Keynes always prioritized internal stability over external stability…Find some way—any way!—to alleviate imbalances of payments other than through domestic macroeconomic adjustments.

  33. 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.

  34. 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?

  35. The Bretton Woods System • Moving Beyond Gold • Keynes’ Radical Vision • Creation of the Bretton Woods System • History of the Bretton Woods System

  36. III. Creation of the BWS Keynes and White Keynes versus White The Bretton Woods Conference

  37. In the summer of 1941, with the United States far from entering the war and the Germans rolling through the Soviet Union, JM Keynes and HD White (independently) drafted their plans for the postwar monetary order.

  38. 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

  39. 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

  40. Both HDW & JMK proposed creating an international institution to manage the international monetary system.(JMK: International Clearing Union)(HDW: International Stabilization Fund)

  41. 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

  42. Essentials of Proposed Institution • ER Stability • ERs fixed to gold or currency backed by gold (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

  43. Alleviating Imbalances of Payments

  44. 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…

  45. III. Creation of the BWS Keynes and White Keynes versus White The Bretton Woods Conference

  46. 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

  47. 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!

  48. The US agreed to redistribute the gold through the International Bank for Reconstruction and Development (IBRD)—which later became the World Bank.

  49. 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”

  50. Ultimately, things looked more like White’s Plan than that of Keynes. This isn’t surprising given the asymmetry of bargaining power.

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