By the 1970s the unsustainability of the Bretton Woods System (BWS) became increasingly apparent. Evaluate the factors which led to the collapse of the BWS and its impact on the subsequent evolution of the international political economy Following the Second World War, the Bretton Woods system was implemented as a means of monetary management among independent nation states. It was based on Keynesian economics and a shared belief in capitalism. Bretton Woods, BWS, was considered a necessary response to the anarchic protectionist and neomerchantilist policies favoured in the great depression of the 30s.
It was used to stop nation states using currency devaluations to increase competitiveness. Due to a lack of scale and coordination, these policies stagnated foreign direct investment and international trade volume. Bretton Woods created a fixed exchange rate system pegged to the dollar, maintained by other countries selling or buying their own currency and in turn keeping its value linked to that of the dollar. For more than a decade the system was associated with steady growth and trade.
However, by the late 60s,as a result of a power shift away from the hegemony of the USA, as well as the misuse of both fiscal and monetary policy and the outflow of capital ‘the system was on a trajectory headed towards collapse. ‘1 A prominent factor in the system’s decline was the USA’s existence as a dominant hegemony. Following the Second World War many countries were left with depleted capabilities. Not only in terms of military force, but also politically weakened and economically exhausted, which left the USA as a prominent power with control over half of the world’s manufacturing capacity, and half the world’s gold.
This gave it the ability to pressure previously dominant countries, such as the UK and France, into accepting the Bretton Woods system, especially since these countries realised they could not effectively compete with the USA in an open market. While the USA remained dominant the system was successful. However the mid 60s and the growth of multinational industries saw the rise of both the European Economic Community (EEC) and Japan as international economic powers. Collectively their total reserves, growth and trade outranked that of the USA.
As the distribution of power became increasingly pluralistic, dissatisfaction with the system grew. The USA began to loose control over its fiscal and monetary policy in the late 60s, and the dollar became overvalued. Within a few years the USA asked Germany and Japan to revalue their undervalued currencies, due to their significant surplus and to stimulate demand for the dollar. This was inevitable, as ‘no matter how reserves are distributed initially, they will eventually be redistributed to the surplus countries. 2 The diluting effect to their surpluses and its impeding impact on their exports meant there was no incentive for Germany or Japan to revalue, and the IMF had no power to enforce it. This undermined the essence of the system: that it could be used to provide stable national currencies. The emergence of developing and restabilising countries opened a new stance, led by growing powers in Europe, that perhaps the dominance of both the dollar and the USA was not certain and acted as a significant stimulus away from the BWS.
Furthermore relations strained between the USA and the USSR and fear of communism cooled resulting in less reason to cement a very Western monetary system. As Europe and other states’ GDPs grew and security issues became less of a concern the transatlantic defence ties loosened and economic tensions resulting from policy misuse within the USA began to surface. The power shift away from US dominance and its impact on Bretton Woods had serious implications for IPE.
The inherently economic system had been challenged, at the least, by political forces and a shift in power. This highlights the influence both politics and economics have on each other, which is central the to the basis of IPE. The stabilisation of Europe and Japan, as well as developing economies dissolved the structure of US dominance that BWS was built on. While this was underpinned by other economical factors, such as the US deficit and inflation, it is evident that the change in international relations was at the centre of the collapse of the BWS.
As the hegemonic status of the USA wavered, its fiscal position became a decisive structural factor in the collapse of Bretton Woods. The US went from maintaining international liquidity to becoming unable to manage its spending’s influence on the dollar. The USA used its trade balance, through achieving a deficit, to perpetuate international liquidity and suppress global inflation. As long as other countries held dollars in reserves the USA could carry out massive foreign expenditures without the constraint of the balance of payments.
While the USA was the dominant power, other countries could be trusted to sustain the USA’s deficit, however when other countries began to develop and grow, it served in their interests to sell their dollar reserves causing the deficit and vast expenditure of America to become a concern. Following President Johnson’s election in 1963, the Great Society program was introduced as a prime example of this expenditure. Tax was used to increase the outflow of dollars to pay for military spending and to cope with rampant inflation resulting from misuse of monetary policy.
However, as the expansionary fiscal policy, in order to fund projects such as the space race, welfare and the Vietnam War, which President Johnson refused to pay for, the dollar shortage became a dollar overhang. This was due to a decline in confidence in the dollar, further deteriorating the trade balance. This spurred countries to exchange their dollars for gold as well as an outflow of US citizens both spending and moving abroad – creating a negative multiplier effect and furthering the deficit dangers the USA was now facing.
No mechanism in the BWS had been finalised for such an unmanageable deficit, and while other countries could announce devaluations this would be likely to stimulate deflation and should be kept to a minimum to maintain global price stability, another objective of the BWS. America itself was reluctant to announce a devaluation of the dollar and instead used measures to attempt to control the deficit. These varied from capital controls to retain US spending within the US, to tied aid, which utilised credits, loans and guarantees offered by the US import-export bank in order to finance more exports.
The impact was temporary, reflected in a low deficit in 1965. Nevertheless, President Johnson’s unbalanced fiscal spending continued, furthering the excess of the dollar and the deficit deepened. In an attempt to stabilise both, in 1968 the USA stopped people from being able to redeem privately held dollars for gold, and left the markets to freely determine the price of gold, thereby creating a two tier gold system. the deficit grew nevertheless, until the USA had only 16% of international reserves, leaving it with a difficult choice – to shrink its economy or impose exchange controls.
As a result and in contrast to the initial Bretton Woods agreement the exchange of dollars for gold was closed to central banks in 1971. The speed with which the deficit had gone from manageable to disastrous, not only in the collapse of the BWS, but also for the position of the USA highlights how the control of the US was for its economic policy. As a result of the deterioration of US power, the deficit had suffered. Although there was some improvement in the mid 60s, the extent of this was not enough to redeem the issues caused by the over-expenditure seen in Johnson’s presidency.
The uncontrollable deficit was an eventuality that there had been little preparation towards, based on the assumption of US power, and was a clear and cumulative issue as the 60s went on. Another structural problem stemming from the provision of international liquidity is the role of US monetary policy and inflation. Previously in the early 60s, President Kennedy used expansionary monetary policy to achieve targets of full employment coinciding with the already high levels of economic expansion in the USA.
However the policy tradeoff resulted in price instability as ‘persistent inflation eroded the value’3 and by Johnson’s presidency in the mid 60s dollars reserves had accumulated rapidly. In such an inflationary environment the cost of liquidity rose subsequent to a rise in the cost of holding reserves and worries surfaced about the state of the BWS. Johnson sought to stifle inflation by imposing a temporary 10% income tax surcharge in 1968 but it continued to rise steadily emphasised by the rapid productivity growth seen in Germany and Japan.
New forms of credit lines, such as GABs and SDRs were employed in efforts to suppress inflation. SDRs were introduced in 1969, an internationally acceptable reserve unit fixed to the value of the dollar, attempted to increase liquidity to meet foreign demand for liquid dollar claims. It aimed to stop the purchase of pegged gold and give nations a reason to hold dollars, as well as fund government expenditure. However they only acted as a new form of paper money and amplified monetary depreciation and the inflationary tendency intrinsic in the system.
Another danger with SDRs is that they monetized the relationship between the US and other states. The Bretton Woods agreement, as previously mentioned, hinged on the dominance of the US and their defence policy. As the US took unpopular actions, such as the Vietnam war, and other states saw more dominance and growth the consensus subsided. By monetizing the relationship, as the power of the US, both economic and political, began to wain, by the late 60s it had furthered stimulus for other states to challenge and move away from the US and the BWS.
Inflation continued to grow, as the dollar became more overvalued and in excess. The extent of how central this inflation was for the BWS can be characterised by President Nixon’s final desperate endeavours to salvage the situation in the final years of the BWS. Import quotas on oil were lifted to reduce energy costs, but as in prior attempts, the reality compounded. In order to target the deficit, he printed more dollars, approximately $22 million in the first few months, to be pushed abroad to fund government expenditure in 1971.
This left the dollar further overvalued and it seemed impossible for him to achieve any balance with either fiscal or monetary policy. The final attempt later that year was a 90 day period of severe wage and price control-from 10% import surcharge to closing the gold window, previously mentioned, with no consolation of international monetary system members known as the Nixon shock. The extent of the US’s monetary mismanagement is not highly significant as a single event, but inevitably the repeated and increasingly frenzied attempts and failures at resolving the challenges facing the BWS only highlighted its multitude of flaws.
Over time this cumulative effect was as a pivotal factor aggregated and amplified by several occurrences, such as the prevention of redeeming private held dollars for gold in 1968, the invention of SDRs in 1969, and through to the Smithsonian agreement in 1971. These events and the numerous attempts at defending the value of the dollar, and the BWS itself stress how key the cumulative impact of this factor is in its collapse. These incessant attempts as reviving the BWS, especially as they became increasingly futile led to another difficulty as it created frequent cause for doubt.
As confidence began to spiral downwards due to policy errors within the US in the 60s, another factor underpinning the speculative negative turn was the outflow of capital. Internationalisation of capital controls began in the 50s, and Keynes, whose economic stance was the basis of Bretton Woods, warned that these were a necessary part of maintaing a fixed exchange rate system. Heavy controls on Europe exports pre-WW2 had been used to minimise speculation, and to limit it further in BWS each country used regulations to balkanise various capital markets domestically, against the desires of investors.
Nonetheless the growth of multinational industries and the limits of deposit interest put in place by the US lead to a rise in the Euro-dollar market from $20 billion in 1964 to $305 billion by 1973. This growing capital lead to increasing actual and potential movements in exchange rates and the fate of the dollar became more volatile and unpredictable. This acted as another factor, along with the challenges the dollar saw from both fiscal and monetary policy being ‘rendered infeasible by speculative pressures’3 about the future of the dollar and the BWS.
By the late 60s the value of the dollar began to no longer reflect reality, following the change in the international relationship of the US, the decline of confidence began to intensify the challenges the system was already facing, meaning any revaluation used by surplus countries in order to sustain the currency rates would be undermined by the knowledge that this did not give a genuine reflection of the situation. The confidence in the dollar was also undermined by the continuously growing deficit held by the US in order to fund their expenditure and perpetuate liquidity, as well as the continuing inflation flooding the dollar.
This was key for creating distrust in the dollar, supported by Warren, 4. Despite attempts to stimulate the dollar such as the voluntary capital control program, which discouraged US businesses from investing and spending abroad, confidence fell and more investors turned their dollars into gold. The situation was exacerbated to the point where, as previously mentioned, the US prevented people from converting their dollars to gold in a desperate attempt to re stimulate demand for the dollar as the US’s gold reserves fell.
This lead to a speculative attack and the only means of controlling this would be with strong use of both fiscal and monetary policy, which were already exhausted. The falling confidence only cemented the reality that the collapse of Bretton Woods was inevitable. Its influence is arguably drawn from the imbalance of the US’s international role, however as the end of the BWS drew near, it began in itself a cause for collapse.
The outflow of capital was based on the emergence of a globalised economy and led to money and citizens shifting away from the USA meaning the already existing policy issues became harder to control. This once again shows the relevance of the shift in power and how it created a change in economic flow. The USA reacted poorly to this, instead of using small devaluations to target export-led growth which would have improved both their deficit and power stance, they tried to resolve their issues domestically and overlooking the role of economic interdependence.
This was particularly negative as the BWS was based on anti-protectionist policies. This response aggregated and created a decline in US position and in turn confidence throughout the early 70s. As a result the speculative attacks continued to deteriorate the state of the BWS. The collapse of the BWS, due to this speculation and ‘the enormous increase in money capital divorced from the exploitation of labour’5 had future implications both economically and politically. The late 70s saw the removal of capital controls and the majority of transactions became capital related.
This made it an important focus point and is highly central to IPE. IPE is a rapidly developing approach that revolves around the interconnectedness between economics and politics. It emerged as a heterodox approach to international relations during the 70s. The collapse of the BWS, as previously mentioned, drew focus to the relationship that IPE is based around. Bretton Woods was a international financial structure, and while economic policy helped to outline its failure, politics and the position of the US played a key role.
This for the first time highlighted the interdependence between economic and politics. A pivotal implication for IPE was Nixon’s actions in the final years of BWS, which increasingly showed that he was putting national interests above his international responsibilities by ‘abusing its (the US’s) seigniorage privileges as issue of the key currency in the system’5 to solve domestic concerns such as the deficit and inflation. This agrees with work done by Veseth, 6, that ‘economic arrangements create political obligations and hence are subject to political manipulation’.
In Nixon’s case, when his incentives were no longer compatible with those internationally, he used the system to resolve national issues, eventually at the cost of destruction of the system. Hence Bretton Woods was undermined by both economic and political sources. This linked the two in history clearly to make ground for the theory that is now IPE and the concept of a ‘globalised world economy’7 Another implication from the collapse of Bretton Woods for IPE, is the role of international governing bodies, such as the IMF, IBRD and GATT. The IMF, still in play, was created to promote international monetary cooperation as part of Bretton Woods.
It promoted economic growth through cooperation of an international party. This was derived from the interdependence of not only states, but their relations impact on economic success. This can still be seen in the World bank, which provide $16 billion in loans annually and is the largest source of development assistance. There are several factors that lead to the collapse of BWS. The most obvious are the policy errors by the US. Overly expansionary fiscal policy in the late 60s, to fuel aid, the Vietnam war and other expenditure, created instability for its economy and the value of the dollar.
Simultaneously, expansionary monetary policy by the US created uncontrollable inflation, which further devalued the dollar and undermined the BWS. However this could have been controlled if the US had maintained their dominant global position. Without the power to enforce revaluations of other currencies, and a minimum level of dollars held by other countries, the system began to fail. This created numerous ineffective attempts to provide a resolution causing a multiplier effect and cumulative speculative attacks. This downwards spiral lead to an inevitable collapse, given the power shift away from the US.
It’s clear there are several aspects that led to the collapse of the BWS, not only through direct policy issues by the US-both fiscal and monetary, but also the shift in the hegemonic stability of the US and the speculative attacks that followed. This highlights the interdependence of the relationship, which is clearly a delicate balance, and has serious implications for the essence of IPE. Not only did Bretton Woods created the concept of international governing bodies central to cooperation and IPE, but IPE is based on the very relationship that lead to the destruction of Bretton Woods system. Peter Garber, 1993, The Collapse of the Bretton Woods Fixed Exchange Rate System page 461 2 Bordo, Eichengreen, 1993, A Retrospective on the Bretton Woods System: Lessons for International Monetary Regimes 3 Mason, Asher, 1973, The World Bank Since Bretton Woods, page 366 4 Eric Helleiner, 1996, States and the Reemergence of Global Finance:From Bretton oohs to the 1990s, page 90 5 Bonefeld, Holloway, 1995, Global Capital, National State and the Politics of Money, page 35 6 Introduction to International Political Economy, 2008, Balsaam, Veseth, page 7 7 Agnew, 1995, Mastering Space:Hegemony, Territory and International Political Economy, page 23
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