The Breakdown of Bretton Woods
It came about this way. From the end of World War II to about 1965, U.S. domestic monetary and fiscal policies were conducted in such a way as to be noninflationary. As world trade expanded during this period, the relative importance of Germany and Japan grew, so that by the end of the 1960s it was unreasonable to expect any system of international finance to endure without a consensus at least among the United States, Germany, and Japan. But after 1965, U.S. economic policy began to conflict with policies desired by Germany and Japan. In particular, the United States began a strong expansion, and moderate inflation, as a result of the Vietnam War and the Great Society program.
When it became obvious that the DM and yen were undervalued with respect to the dollar, the United States urged these two nations to revalue their currencies upward. Germany and Japan argued that the United States should revise its economic policy to be consistent with those in Germany and Japan as well as with previous U.S. policy. They wanted the United States to curb money- supply growth, tighten credit, and cut government spending. In the ensuing stalemate, the U.S. policy essentially followed the recommendations of a task force chaired by Gottfried Haberler. This was a policy of officially doing nothing and was commonly referred to as a policy of "benign neglect." If Germany and Japan chose to intervene to maintain their chosen par values, so be it. They would be allowed to accumulate dollar reserves until such time as they decided to change the par values of their currencies. That was the only alternative if the United States would not willingly change its policy. It was clearly understood at the time that a unilateral action on the part of the United States to devalue the dollar by increasing the dollar price of gold would be matched by similar European devaluations.
In April 1971, the Bundesbank took in $3 billion through foreign exchange intervention. On May 4 it took in $1 billion in the course of the day. On May 5 the Bundesbank took in $1 billion during the first hour of trading, then suspended intervention in the foreign exchange market. The DM was allowed to float upward. On August 15 the U.S. president, Nixon, suspended the convertibility of the dollar into gold and announced a 10 percent tax on imports. The tax was temporary and was intended to signal the magnitude by which the United States thought the par values of the major European and Japanese currencies should be changed.
An attempt was made to keep the Bretton Woods system going by a revised agreement, the Smithsonian agreement, reached at the Smithsonian Institution in Washington on December 17-18, 1971. Called by President Nixon "the most important monetary agreement in the history of the world," it lasted only slightly more than a year, but beyond the 1972 U.S. presidential election. At the Smithsonian Institution the Group of Ten agreed on a realignment of currencies, an increase in the official price of gold to $38 per ounce, and expanded exchange rate bands of 2.25 percent around their new par values.
Over the period February 5-9, 1973, history repeated itself, with the Bundesbank taking in $5 billion in foreign exchange intervention. On February 12, exchange markets were closed in Europe and Japan, and the United States announced a 10 percent devaluation of the dollar. European countries and Japan allowed their currencies to float and, over the next month, a de facto regime of floating exchange rates began. The floating rate system has persisted to the present, with none of the five most widely traded currencies (the dollar, the DM, the British pound, the Japanese yen, the Swiss franc) in any way officially fixed in exchange value with respect to the others. (Briefly, from October 1990 to September 1992, the DM and the British pound were nominally linked in the Exchange Rate Mechanism of the European Monetary System.) With the breakdown of Bretton Woods, there began a slow dismantling of the array of controls that had been erected in its name. This included gold.
As part of the Jamaica agreement in 1976 (which ludicrously proclaimed a "New International Economic Order"), IMF members agreed to demote the role of gold. But few central banks subsequently followed up this agreement in practice. One associated change that did come about, however, affected the private gold market in the United States. On January 2, 1975, after forty years of prohibition, U.S. citizens were allowed to purchase gold bullion legally. The Comex in New York subsequently became an important center for the trading of gold futures. |
