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The legends of Bretton Woods - monetary system - Economic Myths Explained
ORBIS, Spring, 1996 by Francis J. Gavin
Only in December 1958 did the major Western European economies establish current-account convertibility. Some argue that this marked the true beginning of the Bretton Woods system. It was also the beginning of the massive U.S. payments imbalances that were to plague the system until its collapse. The American deficit was first identified as a cause for concern towards the end of 1958, when U.S. secretary of the treasury Robert Anderson became alarmed at its growing size. An American deficit was not news; deficits had been run throughout the 1950s. It was the size of the deficit, and the fact that excess dollars were being turned in for gold instead of being held as reserves, that concerned Anderson. He worded that the amount of dollars held abroad would soon be larger than the value of the gold stock promised to back those dollars. That would make the dollar vulnerable to a speculative attack in the event of a political or economic crisis, and a run on the dollar would surely undermine confidence in the whole monetary system at a critical moment in the cold war.
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The Eisenhower administration debated various policies to reduce the deficit until the matter came to a head during the summer and fall of 1960. The price of gold on the London free market increased to over $40 an ounce, providing an enormous incentive for anyone abroad holding dollars to buy gold from the U.S. Treasury at $35 an ounce, then sell it in London for a substantial profit. But by 1960 there was not enough U.S. gold to cover these overseas dollars. America's promise to sell gold at a fixed price, a promise that was the foundation of all international monetary rules, thus became a magic money machine for overseas holders of dollar liabilities. The reasons that gold had been bid up included the tensions over Berlin, the burgeoning American payments deficit, and the fear of loose monetary and fiscal policies under a Kennedy presidency. But instead of recognizing the flaws in the system, American policymakers wrongly blamed the market. After 1960, the United States introduced measures to protect the dollar, and the system it upheld, from future attack. Capital controls, at first mild and "voluntary" but eventually quite obtrusive, were introduced. Restrictions on tourism were initiated. As noted, various stopgaps were instituted in Western countries to restrict and control currency and gold markets. That the world's largest and apparently healthiest economy had to take such steps seemed strange, but the gold guarantee and fixed exchange rates could be maintained only by increasingly complex controls. What was perhaps most alarming was the impact that these monetary matters had on U.S. foreign policy and relations with NATO.
By any measure, the United States during the 1960s possessed overwhelming economic strength, commanding a larger share of the world's wealth than any modem nation in history. That wealth was convincingly exhibited by the American ability to dispense billions of dollars in aid to its allies and station hundreds of thousands of troops in foreign countries. Yet the United States's whole foreign policy - including the global containment of communism - was absurdly endangered by movements in the price of gold in London. After the gold crisis of 1960, it seemed logical to policymakers to blame the U.S. payments imbalance and shortage of gold on two factors: speculators operating in a free market and American overseas commitments. After all, the United States still consistently maintained a sizable current-account surplus (positive balance of trade) throughout this period.
