In July 1944, as Allied military planners focused on winning the war, a group of economists and policymakers from around the world focused on winning the peace. While World War II still raged, delegates from 44 countries met at a bucolic resort in Bretton Woods, N.H., to hammer out the framework of a new global financial system.
The delegates forged an agreement called the Bretton Woods accord, which they hoped would create a mechanism of international economic cooperation that could prevent the kind of disastrous policies that contributed to the Great Depression.
Before World War II, nations had imposed crippling trade barriers and engaged in competitive devaluations of their currencies. Such “beggar-thy-neighbor” policies were blamed for exacerbating the global economic downturn.
The Deal Established a Global Exchange Rate System
Under the deal reached in July 1944, countries would set their currency to the U.S. dollar at a fixed, but adjustable rate, while the dollar would then be pegged to gold at a rate of $35 per ounce. Pegging the dollar to gold provided assurances that the U.S. would keep its economic house in order; central banks in other countries could convert their dollars into gold if they lost confidence in the U.S. dollar.
“What we have done here in Bretton Woods is to devise machinery by which men and women everywhere can freely exchange, on a fair and stable basis, the goods which they produce through their labor,” U.S. Treasury Secretary Henry Morgenthau Jr. said at the close of the conference (PDF). “And we have taken the initial steps through which the nations of the world will be able to help one another in economic development to their mutual advantage and for the enrichment of all.”
Given the severity of World War II, the Bretton Woods system of freely convertible currencies wouldn’t go into effect until 1958. This system of stable exchange rates would last until August 1971, when President Richard Nixon—facing inflation and a run on gold—ended the convertibility of dollars to gold. A December 1971 attempt, called the Smithsonian Agreement, tried to preserve the Bretton Woods system, but by 1973, the agreement was officially dead as nations began to float their currencies against each other.
Bretton Woods’ Legacy Includes the Eurodollar Market
Though the Bretton Woods agreement collapsed 50 years ago, its legacy is still felt today. The International Monetary Fund and the World Bank, global lending institutions, originally emerged out of Bretton Woods. Even the huge eurodollar market—dollar-denominated accounts held in banks abroad—grew out of the need to get around the scarcity of dollars created by the Bretton Woods system, as authors Paulina Restrepo-Echavarria and Praew Grittayaphong outlined in a January 2022 blog post.
Dealing with the ghost of Bretton Woods has long been a research interest of Restrepo-Echavarria, a senior economist at the Federal Reserve Bank of St. Louis. She spoke about her work on Bretton Woods during a Twitter Q&A in 2021. Her comments below have been edited for clarity and length.
Q: Was the collapse of Bretton Woods inevitable?
Restrepo-Echavarria: I think it probably was. And it probably was because the agreement as we know it implied that the U.S. dollar was the currency of reference and it was paired to gold. So there was parity between the U.S. dollar and gold, and then all the rest of the exchange rates of the other 43 countries were fixed relative to the U.S. dollar.
It turns out that in the 1960s, the U.S. started experiencing some inflation. What that means is that the U.S. dollar started losing purchasing power. But gold did not lose any value. Basically, the government, which had to honor this parity, was the one that could lose a lot by keeping the parity to gold. So in 1971, President Nixon announced that the [dollar’s] parity to gold was ending. And this was the start of the end of the Bretton Woods agreement.
We could have thought about a modification of the agreement to make it sustainable—maybe a way to keep the capital controls such that capital flows were still in place and there were no speculative capital flows, which was the fear of the time. But it’s kind of hard to say how that would have been implemented when you have a currency of reference that is losing purchasing power due to inflation and the anchor, which was gold, is no longer there.
Q: Who were the winners and losers after Bretton Woods initially and who won/lost over time?
Restrepo-Echavarria: In my research with Lee Ohanian, Mark Wright and Diana Van Patten, we split the world into three different regions:
- The U.S.
- Northern and Western Europe
- The rest of the world, which is mainly constituted by East Asia, Latin America, Canada, Australia and New Zealand
We find that Europe and the rest of the world were the big winners of the Bretton Woods agreement, both in the period during the agreement and from then onward. Those were winners in the sense of consumption equivalence, which is a way we measure welfare in economics. So basically, we think about how much larger their consumption was because they were participating in the Bretton Woods agreement.
We see that Europe and the rest of the world gained in terms of consumption while the U.S. was the big loser. And the U.S., during the agreement and over time, lost around 4.5% of consumption because of participating in the agreement.
Q: Is Bretton Woods still a drag on the world’s economy today?
Restrepo-Echavarria: That’s a very good question and kind of a hard one to answer. But the bottom line is that if I just stick to the purely technical details of what we find in our results, what we see is that Bretton Woods had a long-run impact in terms of the level of output.
We looked at output in our counterfactuals, which are basically experiments where we assume that Bretton Woods did not exist. And within our model, we can run a counterfactual where we say, well, let’s imagine for a second that Bretton Woods did not exist. What would have happened? And what we find is that actually output would have been higher in level over time. So there’s a difference in the level of output that is pretty much constant over time. So in that sense, yes, there’s kind of a long-lasting effect of the Bretton Woods agreement in terms of output loss around the world when we look at it in that way.
