To recap from the last post, the big countries had been trying and failing to get back onto the Gold Standard since the beginning of the First World War.

During the Interwar Period

There was a brief period of time when the various governments got together and established a “Gold Exchange Standard”. The general idea was that the UK and the USA would hold all the gold reserves, and the other countries would hold reserves in either pounds or dollars (because these were already backed by the gold reserves of the UK and the USA).


But as a result of the competitiveness issue that I mentioned yesterday, most of Britain’s gold was being shipped across the Atlantic as everyone preferred to hold dollars over pounds.

20130619-123535.jpgAt which point, the UK suspended the Gold Standard, which made the American dollar the currency of reserve…

Sound familiar?

But the US dollar hegemony only lasted two years. It ended when FDR took the USA off the Gold Standard as well (more or less); when it was decided that the anchoring of the money supply to gold was making it difficult for the USA to exit the Great Depression.

The apparent conclusions to be drawn from this little foray into a Gold Exchange Standard:

  1. When a reserve currency country lose trade competitiveness, the Gold Exchange Standard fails.
  2. When a reserve currency country is in financial crisis, the Gold Exchange Standard can prolong it.

Also, more to the point, the conclusion should have been that Gold Exchange Standards are not sustainable – because at some point, the world will be relying on the reserve country (or countries, in this case) to jeopardise its domestic economy to the benefit of everyone else.

Enter and Exit World War II

Not long after this, the economic debate was interrupted by Hitler. And while World War II was still ongoing, John Maynard Keynes began to devote his time to this issue of the Gold Standard and what to do about it when the war was eventually over. And to put this in perspective: Keynes was making plans around it as early as 1942 (talk about confidence in the Allies winning the war!).

By the time the Bretton Woods conference took place in 1944, Keynes had some very clear ideas about what would not work. Included on that list was a return to a Gold Exchange Standard.

Keynes, Bretton Woods and Bancor

The Bretton Woods conference was arranged to discuss what would happen to the world (and trade) in the aftermath of World War II. The general consensus among the Allies was that the treatment of the losers of the previous war had somehow contributed to the Great Depression of the 1930s – so there was real concern that a disconcerted array of monetary policies from the Allies would throw the world economy back into a similar state.

If ever you’ve heard the phrase “Beggar Thy Neighbour” in reference to economic policies, this is what the Bretton Woods economists were trying to avoid:

  • The free-floating exchange rates that arose after both Britain and the United States suspended the Gold Standard allowed countries freedom to devalue their currencies.
  • It didn’t take long before some of them realised that if they devalued outrageously, then their neighbouring countries would find it cheaper to import that country’s products rather than make their own.
  • This was highly threatening, because the destruction of local industries (unable to compete with their cheap foreign rivals) meant economic collapse.
  • In order to protect their domestic economies, these countries too would be forced to devalue outrageously, which could cause internal inflation if those countries had become reliant on foreign imports in the interim.
  • Which is the very definition of a currency war.

So Keynes did not arrive at Bretton Woods encouraging a return to the Gold Standard. Instead, he made the following observations (my interpretation thereof):

  1. The real global problems with exchange rates arise when international trade and capital flows get out of control.
  2. For example, countries that export a lot more than they import are creating debtors out of other nations (ie. other nations end up running trade deficits), and they themselves end up massive creditors (ie. running corresponding trade surpluses).
  3. This is not sustainable.
  4. And neither is asking one country to carry all the responsibility of being the only country linked to gold. After all – being the global reserve currency AND having an internal monetary policy are a significant conflict on interest.
  5. So let’s dispense with a global currency that sits in the hands of one nation.
  6. Rather, let’s create an international trading unit (the bancor) that no country will control, and that no one has the power to print.
  7. We’ll establish an international settlement house, through which all international trade must settle.
  8. We’ll allow each trading nation to settle on a fixed exchange rate relative to the bancor, and we’ll grant them a “trade allowance” as an overdraft facility (being the amount by which their international trade can be out of balance*).
    *imports > exports ~ trade deficit; exports > imports ~ trade surplus.
  9. When they breach that allowance either way (ie. they exceed their surplus limitation, or they exceed their deficit limitation on the other side), then we’ll punish them with interest until they go back to within their range.
  10. So, for example, a nation in surplus, which normally exports more than it imports, would be incentivised to either import more, or devalue their currency relative to the bancor in order to make its exports less attractive to other nations.
  11. In this way, the global balance of trade would be maintained.
  12. For a really great article on this, check this one out from the Guardian.



I mean – I’m not the biggest Keynes fan. But I think that his solution is a bit genius. Especially because it keeps everyone in check; rather than forcing the debtor nations (those with heavy reliance on imports) to be the only ones with the issue of trying to correct their trade deficits while the creditor nations (the net exporters) are allowed to continue flooding the debtor nations’ markets unchecked.

So what happened?

Well, the idea obviously appealed to the debtor nations. But the real objector was the largest creditor nation at the time. Who was…yes, the United States.

The American representative at Bretton Woods, Harry Dexter White:

“We have been perfectly adamant on that point. We have taken the position of absolutely no.”

Instead, because America was the largest creditor nation at the time (and generally speaking, creditors get their way), what the world got was this:


Oh – and also the IMF and the World Bank to help the debtor nations to get out of their trade deficits by, um, lending them more American money…


 Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at Or both.