Bretton Woods Fail

This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research

Volume Title: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform Volume Author/Editor: Michael D. Bordo and Barry Eichengreen, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-06587-1 Volume URL: http://www.nber.org/books/bord93-1 Conference Date: October 3-6, 1991 Publication Date: January 1993

Chapter Title: The Collapse of the Bretton Woods Fixed Exchange Rate System Chapter Author: Peter M. Garber Chapter URL: http://www.nber.org/chapters/c6876 Chapter pages in book: (p. 461 - 494)

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The Collapse of the Bretton Woods Fixed Exchange Rate System
Peter M. Garber

The collapse of the Bretton Woods system of fixed exchange rates was one of the most accurately and generally predicted of major economic events.’ Hindsight, of course, sharpens the perception of the inevitability of events and makes great prophets of those members of the spectrum of analysts who happened to get their predictions right. But the general outlines at least of the key events from 1967 through 1971 were foreseen, starting from the work of Triffin (1960), whose warnings provided the compass to policymakers implementing serious changes in the provision of liquidity and the administration of capital controls in a vain attempt to preserve the system. The heyday of Bretton Woods, during which the system actually operated as envisioned under full convertibility, lasted only from 1959 through 1968. Associated with steady growth in world production and trade, these nine years and the preceding decade of movement toward currency convertibility are considered something of a golden age in contrast to the six-year debacle of the interwar gold standard. Yet, from the moment of full convertibility on current account transactions in 1959, the steady growth of official and private liquid dollar claims in the hands of foreigners and the

References: Buiter, Willem H. 1986. Fiscal Prerequisities for a Viable Managed Exchange Rate Regime. In Wisselkoersen in Een Veranderende Wereld, 99-1 17. Leiden: Stenfert Kroese. . 1987. Borrowing to Defend the Exchange Rate and the Timing and Magnitude of Speculative Attacks. Journal o International Economics 23:221-39. f . 1989. A Viable Gold Standard Requires Flexible Monetary and Fiscal Policy. Review o Economic Studies 56(January):101-18. f Flood, R. P., and P. M. Garber. 1983. A Model of Stochastic Process Switching. Econometrica 3537-5 1. . 1984a. Collapsing Exchange Rate Regimes: Some Linear Examples. Journal o International Economics 17:1-1 3. f . 1984b. Gold Monetization and Gold Discipline. Journal of Political Economy 92(February):90-107. . 1989. The Linkage between Speculative Attack and Target Zone Models of Exchange Rates. NBER Working Paper no. 2918. Krugrnan, Paul. 1979. A Model of Balance of Payments Crises. Journal of Money, Credit, and Banking I 1:311-25. Krugman, Paul, and Julio Roternberg. 1990. Target Zones with Limited Reserves. NBER Working Paper no. 3418. August. Muth, J. F. 1961. Rational Expectations and the Theory of Price Movements. Econometrica 29(July):3 15-35. Obstfeld, M. 1986. Rational and Self-Fulfilling Balance of Payments Crises. American Economic Review 76:72-8 1. Salant, S. W. 1983. The Vulnerability of Price Stabilization Schemes to Speculative Attack. Journal o Political Economy 91:l-38. f Salant, S . W., and D. W. Henderson. 1978. Market Anticipations of Government Policies and the Price of Gold. Journal o Political Economy 86:627-48. f Townsend, R. M. 1977. The Eventual Failure of Price Fixing Schemes. Journal o f Economic Theory 14:190-99. General Discussion Fred Bergsten, Paul Krugman, and Robert Solomon took issue with the paper for focusing on the liquidity and confidence problems. Bergsten argued that the key problem of Bretton Woods was adjustment. Although the Triffin dilemma was a problem, the true factor precipitating the collapse of Bretton Woods was that the United States finally decided that it wanted to adjust-it wanted to strengthen its economy by reducing the trade imbalance. It was also felt that adjustment would head off growing protectionist pressure. The U.S. monetary authorities perceived that the Bretton Woods system precluded them from adjusting by devaluing the dollar, leaving only the option of breaking with gold. The authorities used the dollar overhang, threats of runs, and British requests for a gold value guarantee as excuses. Paul Krugman argued that 494 Peter M. Garber speculative attack models should be viewed only as parables that may be relevant for the recent experiences of capital flight in Latin America. These models, he stated, are not useful for the analysis of the collapse of Bretton Woods-which was driven by the adjustment problem, not liquidity issues. Peter Garber replied that he did not view the adjustment problem and speculative attacks as inconsistent. The adjustment problem just means that there are many things to finance, including the fixed exchange rate. What leads to a speculative attack is that there is a limit on the amount of financing that the monetary authority is willing to use to maintain the fixed exchange rate system. Maurice Obstfeld pointed out that, in principle, there need not be a confidence problem, even if the outstanding stock of dollar liabilities grows very large relative to the U.S. monetary gold stock. A gold standard could operate on a very slim reserve as long as there is a limit on the amount of fiduciary money issued by the center country. He argued that, if the other G10 countries wanted to stage a run on the U.S. monetary gold stock, they could easily do so by borrowing reserves abroad and just buying gold. So where the critical threshold occurs in speculative attack models is not clear. Alexander Swoboda disagreed with Dale Henderson’s remark that the Gold Pool arrangement can be viewed as a commitment by the other major countries to share the burden of supplying gold to the rest of the world. The Gold Pool was only a temporary commitment because ultimately the members of the Gold Pool could correct outstanding dollar liabilities and recoup the gold sold. Bennett McCallum argued that the formation of the Gold Pool was an indication that the United States was unwilling to let its price level be dictated by the commitment to the $35.00 fixed price of gold.