Bretton Woods

Bretton Woods was an international monetary agreement signed in 1944 near the end of WWII. It established a system of fixed exchange rates anchored by the US dollar, which was pegged to gold at $35 per ounce. Other currencies were pegged to the dollar. The system created the International Monetary Fund (IMF) and the World Bank. It collapsed in 1971 when the US abandoned gold convertibility.

The Bretton Woods conference

In July 1944, representatives of 44 Allied nations met in Bretton Woods, New Hampshire, to design a post-WWII international monetary system. The goal was to avoid the competitive devaluations and trade wars that had helped cause the Great Depression and WWII.

The solution: a system of fixed exchange rates centered on the US dollar, which would be pegged to gold. The US was the only major power whose economy and gold reserves were intact after the war, so the dollar was the natural anchor.

Structure of the system

• US commitment: The US dollar was fixed at $35 per ounce of gold. The US Treasury stood ready to redeem dollars for gold on demand (at least, on demand from foreign central banks; domestic demand was restricted).

• Other currencies: All other currencies were pegged to the dollar at fixed (but adjustable) rates. For example, the pound sterling was initially 4.03 dollars; the French franc was 49.5 cents.

• Adjustable pegs: Unlike the rigid pre-WWII gold standard, Bretton Woods allowed “fundamental disequilibrium” as grounds for adjusting the peg. The UK could devalue the pound if circumstances truly required it (though devaluations were rare and fought hard).

• IMF and World Bank: New institutions were created. The IMF could lend to countries in temporary payments crises, bridging gaps until they adjusted. The World Bank would finance development. Both used the dollar as their unit of account.

Capital controls

Bretton Woods assumed countries would impose capital controls — restrictions on the ability to move money across borders. This limited speculative attacks on the pegged rates. You could not easily borrow pounds and sell them for dollars if the pound was pegged and you could not move dollars out of the country.

This was a radical shift from the pre-WWII gold standard, which assumed open capital flows.

The fatal flaw: the Triffin dilemma

Bretton Woods worked well in the 1950s and 1960s. The world needed dollars (for trade and investment), and the US supplied them. The dollar was “as good as gold.”

But a problem emerged: the US needed to supply enough dollars to lubricate world trade (and the Cold War), but this meant issuing more dollars than the US had gold to back them. By the late 1960s, foreign central banks held more dollar claims than the US had gold reserves. Mathematically, the system was insolvent.

This is the Triffin dilemma: the country providing the world reserve currency must run persistent deficits to supply liquidity, but these deficits undermine confidence in the currency itself.

The collapse

In the late 1960s, US inflation and persistent trade deficits eroded confidence. Foreign central banks began demanding gold. US gold reserves fell. By 1971, it was clear the US could not redeem all dollars for gold at the fixed rate.

On August 15, 1971, President Nixon announced that the US would no longer redeem dollars for gold (“We are closing the gold window”). This ended Bretton Woods. Over the next couple of years, fixed rates were abandoned and currencies began to float.

Legacy

Bretton Woods established the IMF, the World Bank, and the framework for international economic cooperation that persists today. It provided 27 years of fixed-rate stability that facilitated post-WWII reconstruction and growth.

But it collapsed because the anchoring mechanism (gold) could not sustain the system. Modern floating rates offer more flexibility, though less certainty.

See also