“The dollar and gold are synonymous,” Harry Dexter White, the architect of the Bretton Woods international monetary system, told Congress in 1945. “There is no likelihood that . . . the United States will, at any time, be faced with the difficulty of buying and selling gold at a fixed price freely.”
Under the Bretton Woods system, currencies were tied to the U.S. dollar at a fixed rate, and the dollar was in turn tied to gold GCZ6, -0.61% at $35 an ounce. Today there is much nostalgia about Bretton Woods — a belief that the quarter-century from 1946 to Aug. 15, 1971 (when the system collapsed) was a golden era of monetary stability. But the reality was very different.
Although the International Monetary Fund was inaugurated in 1946, the first nine European countries to meet the requirements of its Article VIII — that their currencies be freely convertible into dollars at a fixed rate — didn’t do so until 1961. And by then, the system was already coming under enormous strain, as the U.S. — contrary to White’s assurances — was losing gold reserves.
The fundamental problem was that the United States couldn’t simultaneously keep the world adequately supplied with dollars and sustain the large gold reserves required by its gold-convertibility commitment. The logic was laid bare by economist Robert Triffin in his now-famous 1960 congressional testimony. There were, he explained, “absurdities associated with the use of national currencies as international reserves.” It constituted a “‘built-in destabilizer’ in the world monetary system.” The European dollar-convertibility pledges, far from representing the final critical step into a new monetary era, “merely return[ed] the world to the unorganized and nationalistic gold exchange standard of the late 1920s.”
When the world accumulated dollars as reserves, rather than gold, it put the United States in an impossible position. Foreigners lent the excess dollars back to the U.S. This increased U.S. short-term liabilities, which implied the U.S. should boost its gold reserves to maintain its convertibility pledge. But here’s the rub: if it did so, the global dollar “shortage” persisted; if it didn’t, the U.S. ultimately wound up hopelessly trying to guarantee more and more dollars with less and less gold. This became known as “the Triffin dilemma.”
If concerted international action wasn’t taken to change the system, Triffin explained, a deadly dynamic would set in. The United States would need to deflate, devalue, or impose trade and exchange restrictions to prevent the loss of all its gold reserves. This could cause a global financial panic and trigger protectionist measures around the world.
What could prevent this? President John F. Kennedy, who took office soon after Triffin’s testimony, wouldn’t countenance a dollar devaluation; austerity, likewise, wasn’t in the cards. Instead, the U.S. resorted to plugging the dikes with taxes, regulations, gold-market interventions, central-bank swap arrangements, and moral suasion directed at banks and foreign governments — just as Triffin had anticipated.
Under Richard Nixon, inflation climbed rapidly, reaching nearly 6% in 1970, and world dollar reserves rose sharply. In tandem, American monetary gold stocks tumbled to a mere 22% of dollars held by foreign central banks, down from 50% a few years prior.
By May 1971, Germany could no longer hold its currency peg. The deutsche mark was being driven up by relentless capital inflows as the world dumped dollars. After a bruising internal debate, the German government floated the mark on May 10. While this succeeded in curbing speculative flows into Germany, it did not halt the flow out of the U.S.
Nixon’s Treasury secretary, John Connally, angrily rejected suggestions from IMF Managing Director Pierre-Paul Schweitzer that the U.S. raise interest rates or devalue the dollar. Instead he blamed Japan, the newest destination for speculative capital in the wake of the mark’s float, for its “controlled economy.”
Dollar dumping accelerated. France sent a battleship to take home French gold from the New York Fed’s vaults.
Finally, Nixon opted for what Connally convinced him would be seen as a bold and decisive move. On Aug. 15, he went on national television to announce his New Economic Policy. In addition to tax cuts, a 90-day wage and price freeze, and a 10% import surcharge, the gold window would be closed; the U.S. would no longer redeem foreign government dollar holdings. Connally followed on by making the president’s priorities brutally clear to a group of European officials, telling them that the dollar was “our currency, but your problem.”
The Bretton Woods monetary system was finished. This should, Harry White had believed, have meant the end of the dollar’s international hegemony. “There are some who believe that a universally accepted currency not redeemable in gold . . . is compatible with the existence of national sovereignties,” he wrote in 1942. “A little thought should, however, reveal the impracticability of any such notion.” Countries, he said, would never “accept dollars in payment of goods or services” unless they were “certain [they] could convert those dollars in terms of gold at a fixed price.”
The world would face rough waters before it would find out whether he was right. Would the world lapse into a 1930s-style spiral of protectionism? Or could an international monetary system of sorts be made to work without gold?
For all its problems, the current dollar-based non-system has been far more resilient than the Bretton Woods gold-exchange standard, which never operated as White intended. And the real alternatives — a classical gold standard, in which interest rates are driven by cross-border gold flows; or a supranational currency, like Keynes advocated at Bretton Woods — are likely to remain too radical politically. We are, therefore, almost surely stuck in a fiat dollar world for some time to come.