From Bretton Woods to world crisis

Press, 20 September 1982, Page 16

From Bretton Woods to world crisis

Thanks to Mr Muldoon's activities .in London and Toronto. New Zealanders are now well aware that their own country's difficulties in external finance are shared bv many others. (Politicallyminded readers may suspect that it was Mr Muldoon's intention that they should be made aware of this.) The international monetary system is under quite severe threat from the possibility of widespread default on loans made through the international banking system. This, however, is only one of the things which justifies a substantial fear of a world slump of 1930 s proportions; amongst the others are the apparent inability of major economies to get growth going again without provoking inflation, the persistence of high and rising levels of unemployment, and a widespread return ot protectionism as each country tries to protect its own balance of payments and levels of employment at the expense of others. We may doubt whether defects in the international monetary system itself, as opposed to the use made of that system, are to blame in any significant degree for these problems. Some commentators who have tried to provide a background to Mr Muldoon's initiatives have shown little understanding of post-war international financial developments. The International Monetary Fund's contribution over the period since the Second World War has been grossly overrated. The Fund was one of the institutions set up following the Bretton Woods conference of 1944. a conference intended to set the stage for post-war economic recovery and prosperity.

trols and inconvertible curren cies.

Third, it was hoped that countries would be able to combine independent monetary policies, allowing them to sustain high levels of employment, with exchange stability and convertible currencies. The I.M.F. was supposed to help them bv providing a source of short-term lending when countries encountered balance-of-payments difficulties. In the event, the I.M.F. played a minimal role in world recovery, at least until the 19605. Its reserves were too small for it to give much help to countries with balance-of-payments problems, especially in view of the grave worldwide shortage of U.S. dollars. The Fund was unpopular in Europe and in the Third World, being viewed as a rather doctrinaire organisation dominated bv the U.S.

During the 1950 s the European Payments Union, a sort of “mini-1.M.F.." made a much larger contribution to the recovery of trade and international finance in Europe and, indirectly, in the rest of the world. New Zealand at that time shared the rather jaundiced view of the 1.M.F., which it refused to join until 1961. Mr Muldoon has told us (in "The Rise and Fall of a Young Turk,” pp. 53-55) that he shared this view, and was converted to the belief that New Zealand should join only at the last minute.

The restricted role played by the I.M.F. was not the only way in which the full Bretton Woods system did not operate during the 19505.

Because of the shortage of dollars, many countries were unable to make their currencies convertible into that currency until the end of the decade, when the huge American balance-of-payments surplus finally disappeared thanks to the recovery of Western Europe and Japan. Major countries made their currencies convertible into dollars in stages between 1958 and 1961.

In the international monetary area the Bretton Woods agreements had three main aims.

First, it was hoped to establish a regime of fixed exchange rates, with alterations permitted only at rare intervals and under I.M.F. supervision to meet major balance-of-pay-ments problems.

The full Bretton Woods .system operated only between 1958, or perhaps 1961, and its downfall in 1971 — a mere 10 or, at best, 13 years of the 37 since the war ended. Moreover, by 1958 the very rapid economic growth and expansion ot world trade characteristic of the 1950 s and 60s had already been under way for several years. Indeed, it is closer to the

Second, currencies were to be freely convertible, one into another. These proposals sought to remove impediments to world trade and transactions which had been introduced following the breakdown of the old gold standard in 1931, a breakdown followed by competitive devaluations, widespread use of exchange con-

J. D. Gould, Professor of Economic History at Victoria University of Wellington, looks at the present crisis in the international economy in the light of changes in the international monetary system since 1945.

truth to say that the expansion of trade and rapid economic growth permitted the Bretton Woods system to become fully operative, than to say that the Bretton Woods monetary system permitted rapid trade and economic expansion.

and to seek to convert its dollars and sterling either into gold or into one or other of the new strong currencies, such as the German mark, which were becoming attractive. Their fear became pronounced when it was realised, towards the end of the 19605. that U.S. liabilities abroad exceeded U.S. reserves of gold, so that if everyone holding dollars had demanded payment in gold at the same time, the U.S. would have had to default.

Another shortcoming of Bretton Woods which became more and more apparent in the 1960 s was that there was no mechanism for guaranteeing an appropriate expansion of international liquidity. International trade, like all trade, needs "till money" and reserves to cope with inevitable ups and downs. The quantity of monetary gold, which had been the ultimate reserve under the old gold standard system, barely increased after the war, and reserves in the form of drawing rights on the 1.M.F., even after the introduction of Special Drawing Rights in 1970, contributed only a small addition to international liquidity.

The main form of international reserves, especially after the mid-19605, increasingly consisted of "key” currencies, the U.S. dollar and the pound sterling. If international reserves were to grow, as the rapid increase in the value of world trade required, this could only be by the U.S. and the U.K. running persistent balance of payments deficits, thus feeding increased dollar and sterling liabilities info the rest of the world which other countries could hold as their reserve assets.

Sterling, the weaker key currency, was the first to go when it was devalued in 1967. and this brought the dollar into the firing line. In 1971 the United States was obliged to shut the “gold window." making the dollar inconvertible, and had to persuade other countries to allow it to devalue its currency in an attempt to improve its balance of payments.

Obligingly, the U.K. and the U.S. ran such deficits, the U.K. because of its generally poor economic performance, and the U.S. because its initial post-war lead was gradually overtaken, because of the large sums it disbursed in international aid, and especially because of its massive overseas expenditures on the Vietnam War.

This 1971 breakdown of Bretton Woods, for that is what it was. was quickly followed by a regime of "floating" or "managed" exchange rates, and many smaller countries abandoned the dollar and sterling in favour of basing their exchange rates on a "basket" of currencies, as New Zealand did in 1973. The devaluations of the dollar in 1971 and again in 1973 did not immediately improve the U.S. balance of payments, and the flood of dollars increased. swamping the world financial system in the early 1970 s and causing, as many economists believe, the acceleration in world inflation rates which occurred at that time.

The I.M.F. played only a minor role in these developments, and finally rather passively ratified the new exchange rate regime at a meeting in Jamaica in 1976.

It is. therefore, quite wrong to claim that the Bretton Woods system was killed by the first of the oil price hikes in 1973-74; it had collapsed because of its own weaknesses two years before that.

Thus in the 1960 s the world acquired the liquidity which expanding trade needed, but only because of the persisting and increasing weakness of the two countries whose currencies supplied those reserves.

However, it is perhaps fair to say that even had Bretton Woods survived the 1971 crisis, it would not long have withstood the higher and widely differing inflation rates, and the acute balance of payments

This system was one in which, at some stage, the rest of the w'orld was bound to lose confidence in such reserves.

problems, which the oil shock brought in its train. We can draw two inferences from this potted history of events up to 1974. First. the international monetary arrangements forged at Bretton Woods played a far less important and more shortlived role than usually thought, and this must cause us to assess Mr Muldoon's call for a second Bretton Woods-type conference on monetary reform with somewhat less enthusiasm.

world, buying leading London hotels or farms in New Zealand's Coromandel Peninsula. But much of the O.P.E.C. surplus was "recycled" in the form of lending'back to the rest of the world through the international banking system. These international banks had already greatly expanded their lending on the basis of the dollars floating round in the system in the early 19705; and following the first oil price hike the same facilities were extended to "recycle" the O.P.E.C. surpluses. The bankers congratulated themselves on managing this task with great technical flair. They were so preoccupied with the technical problems of handling these large sums that they failed to see the dangers in onlending such large amounts, much of it to countries which merely used what they were borrowing to pay the interest on existing loans or to finance oil imports.

Second, it would be impossible. and probably undesirable, to restore fixed exchange rates, at least until inflation has been brought under control and the present policies of restricting output and of protectionism have been clearly reversed. How far. then, are the Bretton Woods system and its breakdown to blame for the dangers of widespread international debt default and bank collapse which seem to threaten today 9 The answer must be. very little. The situation which has developed has two major causes. First, the many lower-income countries which became dependent on regular injections of foreign aid during the 1960 s have long been headed for a situation in which they have to go on borrowing merely to pay the interest on their existing debt.

For example, a report of the Commission on International Development published as long ago as 1969 ("Partners in Development." pp. 74-75) forecast that, on reasonable assumptions, many of the aid-dependent countries of Africa. Latin America. East Asia and even Europe would be in a situation in which their debt-servicing obligations exceeded their new borrowings by as early as the later 19705.

Second, the additional balance of payments strains caused by the massive increases in crude oil prices in 1973-74 and 1979-80 have greatly aggravated these problems. The poorer countries have had even greater difficulty in coping with these increases than has the industrial world.

Following the first oil price hike, many O.P.E.C. countries found themselves with huge surpluses which they had either to spend or to invest. Some of them spent most of their profits on increased imports; other sought safe investments in real estate in the developed

The situation is much like that in which a supermarket owner, finding that • his customers cannot pay their weekly grocery bill's, lends them money out of his profits at high interest rates so they can go on buying at his shop — and this is obviously a strategy which cannot be continued for long without threatening disaster both for the supermarket owner and for his customers. The only difference is that in the real world it is the international bankers who have acted as intermediaries in this "recycling" who are under imminent threat, rather than the ultimate owners of the funds, the O.P.E.C. countries. The situation is certainly threatening; but from what has been said it is not clear that a reform of the monetary system is what is required to ease the problems. Creating new facilities for further borrowing may be the very worst thing that could be done. What is really needed is what has been needed all along, namely some genuine improvement in the economic viability of the world's poorer nations. This, rather than mere monetary reform, requires a fundamental improvement in their productivity and exportearning capacity. This in turn means for starters that the developed world must somehow pull itself out of the recession in which it is languishing, and reverse the protectionist trends which thwart the exporting ambitions of lessdeveloping countries.