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The legends of Bretton Woods - monetary system - Economic Myths Explained
ORBIS, Spring, 1996 by Francis J. Gavin
There were certainly disadvantages for the United States in the system. As the reserve currency country, the United States was to a certain extent trapped by the system in ways other countries were not. From 1958 on, there was a constant fear that the ratio of dollar liabilities to American gold would increase to a level that might cause a loss of foreign confidence in the dollar and a run to the Treasury Department's gold window. A mass conversion to gold would force the United States to suspend convertibility, which would wipe out the dollar's value as a reserve and transaction currency. The ensuing competition among central banks for scarce gold could subject the international economy to paralyzing deflation. The resulting collapse of liquidity could freeze world trade and investment, but ending the American payments deficit could have an equally disastrous impact on the international economy. While in hindsight this fear derived from a misunderstanding of the liquidity issue, it was real in the minds of American statesmen.(19)
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U.S. policymakers had to worry constantly about the payments deficit and felt they had to sacrifice important domestic-policy goals and even foreign-policy imperatives in order to maintain the dollar's value. It angered them that much of the deficit was caused by expenditures made to defend Europe and Asia from the Soviet Union. And what seemed particularly outrageous was the fact that the United States could be pressured for political reasons by the countries in the system, the most obvious example being Charles de Gaulle's policy of converting dollars into gold, even when it made little economic sense to do so.
So why did the United States not abandon the system sooner? One important factor was the intellectual influence of the conventional wisdom about the history of monetary relations between the wars. It was a widely held belief that the economic collapse of the 1930s was due to a failure of international monetary cooperation. Most postwar economists and policymakers believed that speculation-driven capital flight had ruined the gold standard and destroyed international liquidity. The collapse of the rules of the game unleashed a vicious competition, whereby countries pursued beggar-thy-neighbor policies of competitive devaluations and trade restrictions. To most, the enemy was a free market "out of control." What these policymakers failed to realize is that competitive devaluations and beggar-thy-neighbor actions were caused by government policy, not the workings of the market. The free market was made the scapegoat for disastrous political decisions. In the postwar world, by contrast, the market would be tamed and national interest replaced with international cooperation based on enlightened rules and institutions. And few economists seemed to understand how chaotic and inefficient the Bretton Woods system actually was, since massive American aid and intervention tended to obscure its failings. The only voice calling for free exchange rates during the 1950s was Milton Friedman's, but his ideas were completely ignored until the 1960s, when other economists finally started to doubt the wisdom of the Bretton Woods system.(20) Hence, a deeply flawed intellectual framework guided postwar planners in most Western countries, especially the United States, and still commands disciples even today.
