EP15: The Golden Promise of Bretton Woods

The Golden Promise of Bretton Woods

In July 1944 the war was not yet won. The Normandy beaches were five weeks old. And in a hotel in the mountains of New Hampshire, delegates sat down to decide what money would be afterwards. The Bretton Woods conference ran from 1 to 22 July 1944 at the Mount Washington Hotel, with 730 delegates from forty four nations and the American Treasury Secretary Henry Morgenthau Jr in the chair. What they built rested, in the end, on a single promise about gold.

They had reason to be careful. Twice in living memory the world's money had come apart: the gold standard switched off in 1914, restored badly, and collapsed again into depression, currency war and trade war. Nobody in that hotel wanted a third round.

Two men, two blueprints

The contest came down to two economists. For Britain, John Maynard Keynes, the most famous economist alive, proposed a genuine world currency. His International Clearing Union would have issued a new international money called bancor to settle imbalances between nations, with countries discouraged from running surpluses as well as deficits. Money belonging to no single state.

For America, a Treasury official named Harry Dexter White proposed something narrower: a Stabilization Fund with no new currency at all, funded instead with a finite pool of national currencies and gold. The institution that emerged from Bretton Woods reflected White's design rather than Keynes's.

It is worth being honest about why. Not the elegance of the argument. The gold decided it. America had come through the war holding the overwhelming share of the world's monetary gold, and the creditor writes the rules.

The machinery, and the nail it hung from

The system itself was simple enough to state in three sentences. Gold at thirty five dollars a fine ounce. The dollar fixed to gold at that price. Every other currency in the system fixed, but adjustable, to the dollar, held within a one per cent band. Sterling, francs, lire and yen were pegged to the dollar, and the dollar was pegged to the metal.

The nail holding all of it was a promise. Any foreign central bank could bring its dollars to the United States Treasury and walk away with gold, on demand, at thirty five dollars an ounce. Not citizens: as we saw in The Day They Took the Gold, an American had not been able to swap dollars for gold since 1933. Only foreign central banks could ask the Treasury for metal. But it was that promise that made the machine credible. The dollar was as good as gold because, on paper, it was a claim on gold.

Two institutions were built to tend the arrangement: the International Monetary Fund, to lend reserves to countries defending their pegs, and the International Bank for Reconstruction and Development, which became the World Bank. Congress passed the Bretton Woods Agreements Act in July 1945, and the IBRD's Articles of Agreement were ratified that December. The system only became fully operational in 1958, when the major currencies became convertible. Then trade boomed, Europe rebuilt, and for a quarter of a century it worked.

The mountain of metal

It worked because the metal was really there. Sources differ on exactly how dominant America's position was, and the range is worth showing rather than resolving. The Federal Reserve puts the United States at about three quarters of the world's official gold reserves; the Federal Reserve Board's own statement on gold reserve requirements records that at the September 1949 peak the American gold stock came to about seventy per cent of the free world's monetary gold. Either way it was a hoard without precedent. The Federal Reserve Bulletin records the stock rising from 20.1 billion dollars at the end of 1945 to a peak of 24.8 billion dollars in August 1949, at a time when that figure meant something almost unimaginable.

The flaw was in the blueprint

One man saw the problem almost immediately. The economist Robert Triffin told Congress in 1959, and then set out in his 1960 book Gold and the Dollar Crisis, why the system had to fail. His argument, summarised by the Bank for International Settlements, was that if the United States eliminated its balance of payments deficits it would starve the world economy of the liquidity that world trade needed to grow. But every dollar that left America was another claim on the same finite pile of metal. The dollars abroad could pile up without limit. The gold could not.

Liquidity or confidence. You could have one. Not both. It was not a risk of the system, it was the design of the system, and it arrived on schedule: by 1961 the dollar claims outstanding began to exceed the American government's stock of gold. From that year the promise was arithmetically larger than the metal behind it.

Defending the price instead of the arithmetic

The response was not to fix the arithmetic but to defend the number. On 1 November 1961 eight central banks, those of Britain, West Germany, Switzerland, the Netherlands, Belgium, Italy, France and the United States, formed the London Gold Pool, agreeing to pool reserves and sell gold into the market whenever the price pushed above thirty five dollars. Consider what that is: the richest governments on earth selling their own gold to stop the world noticing what gold was worth.

Meanwhile the metal drained away. Over the period from 1949 through 1964, the Federal Reserve Board records, net sales of American gold to foreign monetary authorities reduced the gold certificate reserve by 8.4 billion dollars.

The Pool bought seven years. France withdrew in 1967. Sterling devalued that November and the buying became a stampede. On 15 March 1968 the London gold market closed its doors, and the seven remaining members replaced the Pool with a two tier system: an official price of thirty five dollars for governments, and a free private market price that floated, drifted upward, and did not come back. A rationed promise is a promise already half broken.

The promise and the metal

By the summer of 1971 the dollars held abroad dwarfed the gold remaining, and central banks were converting. What happened next, at Camp David that August, is the subject of The Night the Window Closed.

But hold on to what Bretton Woods actually proves. In 1944 the cleverest people alive rebuilt the world's money from a blank sheet, with the wreckage of two catastrophes in front of them, and the strongest foundation they could imagine was gold. They simply tried to stretch it: one ounce of metal carrying thirty five dollars of promise, then more, then far more.

The world rebuilt money on a promise to turn paper into gold. The promise held exactly as long as the metal did.

Chapman Gold deals in the metal the promise was written against. See The Vault, or if you have gold of your own, sell with Chapman Gold.