for the signing of the Bretonwoods Monetary
Agreement authorized by President Truman to sign for the United States. Fiat currency, money backed
by nothing but the threat of state violence. It’s valuable just because they say it is, but we know
they’re going to just print and print until our savings turn to dust. Dust. This is of course as
opposed to the good old days when money was backed by solid gold in a monetary system that everyone
could believe in, right? Well, about that. Today, we investigate the system that came before fiat to
find out how it worked, how it changed the world, and just how much better or worse it really
was. My name is Guy, and you’re watching the Coin Bureau. Ah, New Hampshire. That charming
little wedge between Maine and Vermont is home to Breton Woods, a picturesque resort community
nestled in the White Mountains. Travelers flock to Breton Woods for its worldclass ski trails
and breathtaking views. And on occasion, they’ve also convened at the Mount Washington
Resort for 22 days of negotiations to establish a new international monetary order and found the
International Monetary Fund and the precursor to the World Bank. Okay, that was just one occasion,
but it was pretty important and not just for the locals. In July 1944, hundreds of delegates from
44 allied nations gathered in Breton Woods for the United Nations Monetary and Financial Conference,
where they agreed to undertake a radical joint experiment in global monetary policy. In
hindsight, though, their new system was doomed from the start, and it didn’t last all that long.
But while it was in place, it profoundly changed the world, and its unceremonious ending in 1971
has cast a long shadow over the global financial system ever since. Federal Reserve Chair Jerome
Powell recently acknowledged as much in a speech to his colleagues at the Fed. He told them, quote,
“The Bretonwoods agreement placed the US and the Fed in a central position in the global economy
and its ending quote fundamentally changed the conduct of monetary policy as policymakers had
to understand the effects of potentially more volatile movements of the US dollar.” So what
exactly was agreed at Breton Woods and why? Well, the goal of the Bretonwoods Conference was to
establish a stable and orderly international monetary system that would foster global trade
and promote economic stability and prosperity after the Second World War concluded. You see,
the international treaties that followed the end of the First World War had been an absolute mess.
So bad, in fact, that they paved much of the road that led to World War II. So, the major powers
and their allies were determined to get it right. this time and understandably placed a great
emphasis on the need to replace chaos and conflict with stability and order. That all makes perfect
sense. But as we’ll soon find out, the system that they agreed on at Breton Woods was fated to fail
from the beginning. In hindsight, it’s kind of amazing how they overlooked the fatal flaw in its
design. But since there were 730 delegates from 44 countries at the conference, well, let’s give them
the benefit of the doubt. It’s not like they were a bunch of buffoons who just came for the skiing.
To understand the agreement they came to, let’s first take a look at the road that led them to
Breton Woods in the first place. So during World War I, the classic gold standard was suspended by
the major powers who wanted to be able to print money to finance their war efforts. At the end
of the war, some like France, Italy, and Great Britain tried to restore the gold standard in the
1920s with limited success. One of the problems they faced was a lack of coordinated cooperation
as central banks now distrusted one another’s currencies. As a result, they simply hoarded gold
rather than recycling it through international credit. And this turned into a deflationary
system. This all got a whole lot worse from 1929 as the Great Depression kicked off. In the
early stages of the depression, post-war inflation was still fresh in the memory and central banks
were reluctant to loosen monetary policy. Printing money was taboo as the lesson of the 1920s was
that this led to currency collapse and loss of international confidence. As a result, some
central banks were even raising interest rates as the economy was crumbling. To make matters worse,
in 1930 the US introduced the Smoot Holy tariffs, starting a trade war that’s credited with cutting
world trade by 2/3 in just 4 years. This turned out to be the final straw for central bankers
who eventually caved and called it quits on the gold peg. The first domino fell in 1931 when the
Bank of England abandoned the gold standard and devalued the pound by about 25%. This boosted its
exports, but very much at the expense of everyone else who was still on the gold standard. They
suddenly found their exports undercut by Britain and therefore uncompetitive, and they weren’t
going to take that lying down. So, countries everywhere followed Britain’s lead, ditching the
gold peg and devaluing their currencies to regain competitiveness. In reality, all of them were
trying to export their own economic pain because this is a strategy of protecting your economy
by throwing your neighbors under the bus. The result was a race to the bottom that destroyed
all trust in the post-war international monetary arrangements and made the Great Depression
considerably worse for everyone. Germany, Japan, and Italy increasingly turned to militarism
while others formed currency blocks. The tensions in Europe led to significant capital flight to
the US during the 1930s as despite the US economy being in the toilet like everywhere else’s. It
was at least at arms length from warp prone Europe and its currency and markets appeared safe by
comparison. Investors and even some central banks started converting assets into gold and shipping
it to the US. The Federal Reserve Act of 1934 then turbocharged gold inflows in the US by raising the
official price of gold from around $20 to $35 per troy ounce. This incentivized gold miners globally
to expand production and for other countries and investors to sell their gold to the US at the new
higher dollar price. As if that wasn’t enough, European rearmament also increased demand for US
goods, leading to net merchandise exports from the US, which were often settled in gold. So this
led to the US sitting on some 20,000 metric tons or 75% of the world’s gold reserves by 1944. Add
to this the fact that Europe then blew itself to smitherines all over again in World War II and the
small matter of the US leading the nuclear arms race and you have a recipe for post-war American
hegemony. Apologies for the interruption folks, system was basically dictated by the United
States and accepted by the other 43 countries at the conference. Although the Soviet Union ended
up not joining the system because they recognized it as a tool of US economic hegemony. This suited
the US just fine though because this meant there would be no one within this new global order who
could challenge them. So what exactly was this system? Well, in a nutshell, Breton Woods was a
model of international monetary policy that placed the US at the center of the economic universe and
every other country in its orbit. If you’ve ever wondered why the dollar is the world’s dominant
reserve currency, well, the short answer is Breton Woods. Under this system, the dollar’s global
role was institutionalized by a new gold exchange standard. The dollar was pegged to gold at a fixed
rate of $35 per troy ounce and the US government guaranteed the convertability of dollars into gold
at this price for foreign governments and central banks. Meanwhile, every other country within the
Bretonwood system pegged their currency to the US dollar at fixed parity rates. They were obliged
to maintain these exchange rates with a narrow band of plus or minus 1% through intervention
in foreign exchange markets. As such, buying and selling dollars to defend exchange rates became
a major preoccupation of central banks, and this encouraged them to hold dollars in reserve. By
1944, the US was the world’s largest economy, creditor, and exporter. And this meant that a lot
of international trade ended up being settled in dollars. And since the dollar was as good as gold
and a lot more practical to store and transport, it became the world’s primary reserve currency.
and principal medium for international trade and investment. There was a big element of
trust involved here though as countries had to believe that Washington was willing and
able to honor its promise to convert any amount of dollars into gold at the request of central
banks and foreign governments. To realize this new economic and financial order, the Bretonwoods
Agreement created the International Monetary Fund and the International Bank for Reconstruction
and Development, which later became part of the World Bank. The World Bank was established
primarily to finance post-war reconstruction in Europe and promote economic development in member
countries by providing loans for infrastructure and development projects, paid almost entirely
in US dollars. Of course, the INF, meanwhile, was Bretonwoods’s cop on the beat. It was set up
to monitor member count’s economic policies and exchange rates and ensure adherence to the
fixed par system. Currency devaluations or revaluations exceeding 10% required IMF approval
and were permissible only in cases of fundamental disequilibrium. And if you don’t know what that
means, well, you’re not alone because it’s a term that was never formally defined and remains a
mystery to this day. Meanwhile, another primary function of the IMF became to provide credit
in US dollars to member countries experiencing temporary balance of payments difficulties,
allowing them to correct imbalances without resorting to measures that the IMF disapproved
of, like say currency devaluation. Now, these institutions were supposedly designed to
promote stability and international cooperation, but they suffered from the perennial problem
facing international governance bodies, enforcement. The IMF’s ability to compel policy
changes was limited, especially in the US, which was not going to let anyone tell it
what it could or couldn’t do. And since the US enjoyed the unique privilege of being able
to issue the world’s reserve currency at will, perhaps you can see where this is all going. The
Bretonwoods agreement and the IMF demanded that countries actively manage their exchange rates
to maintain their pegs to the US dollar. However, the US, whose domestic, economic, and monetary
policies had profound global implications, was not subject to the same degree of IMF discipline
and didn’t actively manage its own exchange rate. As a result, the burden of adjustment to maintain
the Bretonwoods system disproportionately fell on countries other than the US. And this lack of a
robust mechanism to compel the reserve currency issuer to align its policies with global stability
requirements was a critical flaw in the design and one of the reasons it wasn’t to last long.
Meanwhile, the US didn’t make much of an effort to maintain the credibility of the dollar’s peg
to gold and instead printed dollars like nobody’s business. This was due to among other things the
massive expansion of the US military empire and its wars in Vietnam, Cambodia, Laos and elsewhere,
as well as President Johnson’s Great Society policy program, all of which were very expensive.
Wherever there was tension between the IMF’s mandate to maintain global monetary and fiscal
discipline and the policy priorities of the US, the latter won out every time. And this did not
go down too well in some of the other countries who had signed up to Breton Woods. French
President Shaul later described this dynamic as a quote exorbitant privilege bestowed on the
US by Breton Woods. The US was able to finance its own balance of payments deficits by issuing
its own currency which other nations needed to hold as reserves. And yeah, when you put it like
that, the word rigged does indeed come to mind. So, was the Bretton Woods system doomed by
America’s refusal to play by the rules? Well, to some extent, yes. But that’s not the whole
story. The system’s reliance on a national currency as the primary source of international
liquidity was an inherent contradiction that would gradually prove fatal. The problem was first
described by Belgian American economist Robert Triffin in the early 1960s. He argued that for the
international monetary system based on a single goldbacked national reserve currency to have
sufficient liquidity, the issuer of that currency would need to supply an everinccreasing amount
of it to the rest of the world. As international trade flows increase and economies grow, so
too does the demand for the reserve currency. This demand is typically met as a result of the
issuer of the reserve currency running balance of payments deficits. But if net outflows continue
indefinitely, the stock of the reserve currency held abroad will eventually exceed the issuing
country’s gold holdings. This erodess confidence in the convertability of the reserve currency
into gold, which becomes increasingly tenuous. If enough participants in the system take issue
with the possibility that the issuer may not be able to redeem the supposedly gold pegged currency
for gold, it could trigger a run on the currency and ultimately lead to the collapse of the
system. Now, in theory, this could be avoided if the issuing country eliminates its deficits and
maintains confidence in the system through fiscal discipline. But in reality, this is hardly a
better option because it implies starving the rest of the world of liquidity, potentially leading to
deflation and recession. This is why this dynamic came to be known as the Triffin dilemma, sometimes
the Triffin paradox, because it’s an inescapable bind that makes the whole structure fundamentally
unsustainable. In practice, this paradox played out pretty much exactly how Triffin called it. A
key feature of the post-war global economy was the US running persistent balance of payments deficits
that effectively flooded the rest of the world with dollars. With the exception of the countries
at the sharp end of US military spending, these outflows were initially welcomed as they provided
the international liquidity needed to finance expanding global trade and allow other countries
to rebuild their reserves. But as the dollar liabilities held by foreign banks and private
entities continued to pile up, it became hard to ignore the fact that the supply of dollars backed
by gold was increasing while the gold needed to actually back them was not. The everinccreasing
demand for dollars to fuel economic growth abroad could only be met if the US kept printing more
dollars. But this made a mockery of the dollar’s gold peg. Now, under a system of free floating
exchange rates, the increasingly shaky ground on which the dollar stood would likely have led to
a swift depreciation in value. But the Bretonwood system prevented this due to the dollar’s unique
role and the obligation of everyone else to maintain their own tight pegs to it. The investor
and author Lynn Alden argues that Bretonwoods therefore led to a persistently overvalued dollar,
making American exports more expensive and imports cheaper. This in turn tended to worsen the US’s
trade deficit, further increasing the supply of dollars abroad and therefore making the triffin
dilemma a self-reinforcing mechanism. For the US, Alden posits that the exorbitant privilege of
issuing the world’s reserve currency came with a quote unmentioned exorbitant burden, namely the
gradual erosion of its domestic manufacturing base and a growing net international investment
position deficit. And although most of this erosion and investment position deficit
post-date the end of Breton Woods, it’s nevertheless Bretton Woods that is responsible for
making the dollar the world’s reserve currency. So perhaps you can see what a huge shadow this
system continues to cast over the US and the world even long after it was terminated. And speaking
of which, how did Bretton Woods end? Well, as you might have guessed, the world figured out
that this system was full of holes and hopelessly unsustainable fairly quickly. Through the system
of fixed exchange rates, Breton Woods enabled the US to export domestic inflation created by
its rampant dollar printing. It was like a free money glitch for the US at the expense of everyone
else. And unsurprisingly, everyone else got sick of this pretty fast. Countries including France,
Germany, Japan, and Switzerland saw the writing on the wall and decided to swap their dollars for
gold. France alone repatriated around 3,000 tons of it from vaults in the US between 1965 and 1971.
This led to an awkward picture where there was an increasing amount of outstanding dollar claims
against a decreasing amount of gold held in the US. Unsurprisingly, the rate of US gold depletion
only accelerated over time as central banks and foreign governments raced to avoid becoming a
bag holder of dollars pegged to non-existent gold. As the pretense of gold convertability wore
thinner, the dollar was shorted relentlessly on the foreign exchange markets as speculators
anticipated an inevitable devaluation of the dollar or a fundamental change to the system.
For the US, devaluing the dollar was politically untenable and technically challenging and other
countries were not in any hurry to revalue their currencies higher against the dollar either as
this would make their exports less competitive. This rigidity prevented the system from adapting
to the reality of divergent economic policies and performance among member nations, allowing
imbalances to grow to unsustainable levels. By the summer of 1971, the game was clearly up.
The artificially strong dollar had severely undermined the US’s international trade position,
and the US was running out of gold amid a renewed run on the dollar. But this didn’t make it any
less shocking when on the 15th of August 1971, President Richard Nixon abruptly announced on TV
that Breton Woods was cancelled. To be precise, he announced a series of measures that he said
were to quote stabilize the dollar, including a not so temporary end to gold convertability.
Now, Nixon hadn’t consulted anyone but a small secret meeting of economists and advisers from
the White House Treasury and Federal Reserve just two days earlier. There was much debate about
what Nixon should do, but he ultimately went with Treasury Secretary John Conny’s suggestion to
just can the whole thing. And yes, that’s the same John Connelly of JFK assassination
motorcade fame. Anyway, later that year, Connelly told an astonished meeting of the G10
nations that quote, “The dollar is our currency, but your problem quite.” And that, folks, is how
fiat currency was born. Leaving money with no backing but the issuers monopoly on violence.
Within a few years of Nixon’s announcement, most countries called it quits on trying to
back their currencies with anything else. They let the value of their currencies float
freely leading to a terminal decline in their value over time. Thankfully, of course, we now
have Bitcoin to offer at least some relief against the downon price action of fiat currency. And this
has come with greater awareness about the problems of fiat currency, which is particularly salient
in our era of quantitative easing or programmatic money printing and impending sovereign debt
crises that are likely to just be inflated away. But then again, it’s probably best not to imagine
too fondly the good old days when dollars were backed by gold and everything else was backed by
dollars because, well, what a mess that all turned out to be. The more things change, the more they
stay the same, eh? Anyway, I’ll leave it for today there folks. As always, thank you for watching and
I’ll see you next time. This is Guy. Over and out.
