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A new international Bretton Woods system?

By Bill Lucarelli - posted Friday, 10 July 2009


The only solution to the current crisis lies in the transformation of the existing international monetary and financial architecture. Unfortunately, economic theory has become disconnected from history. Much of the present malaise has been the result of historical amnesia and myopia. As the historical memories of the Great Depression have receded, so too have the lessons of that era been forgotten. Yet history can only solve those problems for which there are some precedents. It seems that the bitter lessons of the 1930s depression will need to be revisited. This implies that the prevailing economic orthodoxies should be subjected to an imminent and comprehensive critique. The myth of the free market can no longer be legitimised. Equally, prevailing neoclassical and monetarist theories have lost most of their credibility in the face of the present crisis. As long as these orthodoxies continue to inform economic policies, these recurrent crises will inevitably re-appear with even greater destructive consequences.

The guiding principles to this transformation should be the “socialisation of investment” and the “euthanasia of the rentier”. This implies the re-regulation and nationalisation of the financial system.

In other words, the time has come to overthrow the ruling neoliberal order and reinstate state intervention and forms of indicative planning to re-activate a sustained recovery and restore full employment as the cornerstone of macroeconomic policy. The restoration and maintenance of full employment, however, presupposes that each nation cannot engage in “beggar-thy-neighbour” type policies by running successive balance of payments surpluses and thereby “exporting” unemployment onto its rivals.


This problem was quite rampant during the 1930s depression and its solution formed the basis of Keynes’s proposals for an international clearing union, or the “Bancor” regime during the Bretton Woods negotiations in 1944. A very brief analysis of these trade and payments imbalances and the collapse of the gold standard regime during the 1930s might provide a useful context and also reveal some striking parallels with the asymmetries afflicting the existing international monetary system.

Keynes’s original “Bancor” regime

The collapse of the international monetary system under the aegis of the gold standard was the central event in the prolongation of the 1930s depression. Deprived of a universally accepted means of payments and reserve asset, the international financial system experienced a period of anarchy, which spilled over into the rise of economic nationalism and autarchic trading blocs.

After the stock market crash of 1929, a scramble for liquidity ensued in which US investors recalled their funds from abroad. This action merely triggered a vicious cycle of protectionist “beggar-thy-neighbour” policies as the indebted countries of Europe and the primary producing countries sought to protect their own domestic markets. A cumulative process of severe deflation, accompanied by a sudden collapse in income and output, characterised this depressive spiral as each country imposed import restrictions and capital controls. The outbreak of this “tariff mania” after the Hawley-Smoot Tariff enacted by the US authorities in 1930, culminated in the emergence of protectionist trading blocs and the ascendancy of national autarchic policies. In the words of H.W. Arndt (in The Economic Lessons of the 1930s, 1963):

The combined effect of the fall in world prices, the contraction of international trade, the recall of short-term funds and the failure of continued American long-term investment brought about financial and economic crises in almost every country and in most of them set going cumulative processes of decline similar to that which was going on in the USA. The worst hit were the overseas primary producing countries which were brought to the verge of bankruptcy by the fall in agricultural and commodity prices, and the European debtor states, whose economic prosperity had been built up on continued foreign borrowing. Pressure on its gold and foreign exchange reserves forced one country after another to protect its currency by exchange rate depreciation or exchange control. At the same time, the efforts of every country to maintain its exports and protect its balance of payments by imposing increasing tariffs and import restrictions still further diminished the flow of international trade and increased the difficulties of every other country. The American slump and depression cannot be said to have caused the world depression, but they upset the unstable economic equilibrium of the world and gave the impetus to a similar economic decline in other countries. (Arndt, 1963: 19)

The existence of the gold standard regime made it more difficult for deficit countries to adjust to these external shocks. Under this regime it was not possible, in theory at least, for countries to adjust their respective exchange rates in the event of a capital flight or adverse terms of trade. Since the relative value of all currencies was kept stable in terms of the gold standard, any imbalances in their international payments could not be corrected by an adjustment in the exchange rate but had to be corrected by an adjustment of national price or income levels.

In other words, the fixed exchange rate pegged to the gold standard, tended to impart a powerful deflationary tendency in the deficit countries. The whole edifice of the gold standard had been constructed on the foundations of a competitive market economy. In this regime, the price mechanism constituted the sole means of exchange rate adjustment. Before World War I, the gold standard had functioned quite smoothly as the free convertibility of national currencies fostered a multilateral settlement of international payments. If a country incurred a trade deficit, it would automatically experience a deflationary adjustment and an outflow of gold reserves. Conversely, a trade surplus would attract an inflow of gold reserves and a rise in nominal incomes and prices.


After World War I, however, this international trade and payments equilibrium had disappeared. The United States emerged as the principal creditor nation to replace Britain as the major international investor. Despite the emergence of the United States as the principal creditor nation, its status as a reserve currency nation and “central banker” for the international payments system did not evolve until after World War II with the signing of the Bretton Woods Agreements which established a fixed, though flexible exchange rate system based on gold/dollar convertibility.

During the inter-war years, however, the decline of Britain and the gold standard had only accentuated the chronic instability in international monetary relations. The UK itself had become a net debtor country and could no longer act as the “central banker” for the international capitalist economy. The inevitable breakdown of the gold standard in 1931-33 was caused by the acute disequilibrium in the international balances of payments as countries resorted to autarchic “beggar-thy-neighbour” policies and competitive devaluations.

The Keynes plan proposed during the Bretton Woods negotiations in 1944 involved the creation of an International Clearing Union, which would act as an international central bank and issue its own currency, the bancor, the value of which would be determined at a fixed price to gold. Each member country would establish a fixed but adjustable exchange rate in relation to the bancor. International payments balances would be settled by using the bancor as a unit of account. The bancor would have very limited convertibility; countries could purchase bancors but could not convert them into gold. In other words, bancor reserves would remain within the system to avoid the possibility of a drain on reserves. Each country would also be allocated a quota of bancor based upon their levels of imports and exports.

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About the Author

Bill Lucarelli is senior lecturer in the School of Economics and Finance at the University of Western Sydney.

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