Bretton Woods Agreement Encourages Free Trade Summary

  • Last updated on November 10, 2022

The delegates of forty-four nations reached an agreement at Bretton Woods as to the parameters of the international postwar economy. The agreement provided the basis for the postwar fixed exchange-rate system and the establishment of the International Monetary Fund and the World Bank.

Summary of Event

In July of 1944, about seven hundred delegates, representing forty-four countries, met at the first United Nations Monetary and Financial Conference, held at the Mount Washington Hotel in Bretton Woods, New Hampshire. The purpose of the conference was to develop an agreement to deal with the organization of the post-World War II international economy, specifically the promotion of exchange rate stability and the restoration of international trade. [kw]Bretton Woods Agreement Encourages Free Trade (July 1-22, 1944) [kw]Agreement Encourages Free Trade, Bretton Woods (July 1-22, 1944) [kw]Free Trade, Bretton Woods Agreement Encourages (July 1-22, 1944) [kw]Trade, Bretton Woods Agreement Encourages Free (July 1-22, 1944) Bretton Woods Agreement (1944) United Nations;economic agreements Monetary and Financial Conference, U.N. (1944) Trade agreements;Bretton Woods Economy, global Globalization Bretton Woods Agreement (1944) United Nations;economic agreements Monetary and Financial Conference, U.N. (1944) Trade agreements;Bretton Woods Economy, global Globalization [g]North America;July 1-22, 1944: Bretton Woods Agreement Encourages Free Trade[01210] [g]United States;July 1-22, 1944: Bretton Woods Agreement Encourages Free Trade[01210] [c]Economics;July 1-22, 1944: Bretton Woods Agreement Encourages Free Trade[01210] [c]Diplomacy and international relations;July 1-22, 1944: Bretton Woods Agreement Encourages Free Trade[01210] Roosevelt, Franklin D. [p]Roosevelt, Franklin D.;United Nations Keynes, John Maynard Morgenthau, Henry, Jr. White, Harry Dexter Hoover, Herbert

In a message read in the conference’s keynote speech, President Franklin D. Roosevelt warned the delegates of the importance and necessity of cooperating in peacetime as they had in war. He expressed his confidence in their ability to work out their differences. He indicated further that the conference marked the beginning of a broad effort to bring about international cooperation with the aim of developing a sound, dynamic, expanding world economy, with rising living standards for all in the postwar period.

The conference ran from July 1 to July 22, 1944. The immediate purpose of the conference was the development of a stabilization fund and a vehicle to finance postwar reconstruction. World War II (1939-1945)[World War 02];reconstruction The agreements made were not binding on any of the nations at the conference. They were instead to be referred to the participants’ various national governments, which could either accept or reject them.

Secretary of the Treasury Henry Morgenthau, Jr., headed the United States delegation and was elected president of the conference. Harry Dexter White acted as his monetary adviser and developed the American proposals. The British team was headed by John Maynard Keynes, an adviser to the British treasury who developed a proposal that was far more visionary and radical than the American proposal.

The Bretton Woods conference produced the basis for the two major post-World War II international financial institutions, the International Monetary Fund International Monetary Fund and the International Bank for Reconstruction and Development, more commonly known as the World Bank World Bank . Both of these institutions were formally established on December 27, 1945, when the representatives of thirty nations met in Washington, D.C., for a signing ceremony. By the end of 1946, their membership had reached thirty-five nations.

The function of the International Monetary Fund was to promote stability in the exchange rates of currencies and to assist nations suffering from short-term balance of payments problems, or imbalances in their imports and exports or in their financial transactions with the rest of the world. The function of the World Bank was to finance postwar reconstruction and economic development in less developed nations.

The basic goals of the International Monetary Fund—the promotion of exchange rate stability and assistance with balance of payments deficits—were aimed at rectifying problems created by common practices that restricted trade during the 1930’s. Many nations during that period used deficits in their balance of payments as a rationale for restricting trade. The manipulation of currency values was a common practice.

The underlying purpose of both institutions was to foster international cooperation in the restoration of international trade and the development of a healthy world economy. The level of cooperation of the Allied nations during World War II was unprecedented, and the spirit of international cooperation prevailing at the end of World War II was different from the economic nationalism and political chaos that prevailed during the 1930’s. The lesson had been learned: Extreme economic nationalism and political chaos in the prewar period were major causal factors in the war.

Every large nation had been responsible for trade barriers in the 1930’s. Attempts to pursue a trade and tariff policy that sought to take as much wealth from neighboring nations as possible were widespread. It was commonly believed that if a country could close off its domestic market with prohibitive tariffs and import quotas while maintaining export markets, it could “export” its unemployment. This proved to be a naïve idea, as other nations retaliated in kind. Nations found that they could reduce imports, but only at the cost of reducing exports.

Trade restrictions Trade restrictions in the forms of high tariffs, import quotas, export subsidies, bilateral trade arrangements, forced barter, competitive currency depreciations, and blocked currencies had all been common at the time. Although these practices were widespread among the major industrial nations, the totalitarian governments went to the greatest lengths to restrict trade. On June 17, 1930, when President Herbert Hoover signed the Smoot-Hawley Tariff Act Smoot-Hawley Tariff Act (1930)[Smoot Hawley Tariff Act] , he instituted the most restrictive tariff act ever signed into law by an American president. Economic historians have concluded that the tariff act, which effectively closed off the United States market to the rest of the world, was a major contributing factor in the global Depression of the 1930’s. The Bretton Woods Agreement was designed to prevent such policies from recurring in the future.

The international economy of the immediate post-World War II period was governed by the Bretton Woods Agreement of 1944. Economic policy;international exchange rates The exchange-rate system envisioned by this agreement, known as the Bretton Woods system, was an exchange-rate regime of stable but adjustable foreign exchange parities. Essentially, it was a compromise between the fixed exchange rates of the nineteenth century gold standard and floating exchange rates. The system was often characterized as an “adjustable peg.” Day-to-day fluctuations in the prices of currencies, measured in terms of other currencies of gold, were to be limited to a band of 1 percent above or below the agreed-upon price, or par value.

Each nation was responsible for limiting the fluctuations of the value of its currency. The narrow band of fluctuations around the par value was similar to that which prevailed under the nineteenth century gold standard, with the important exception that the Bretton Woods system specifically provided for periodic changes in exchange rates. The Bretton Woods system Bretton Woods system Trade agreements;Bretton Woods was a compromise in another important sense. It was an attempt to capture the automatic adjustment process under the gold standard while removing some of the harshness of this process by allowing a discretionary change in exchange rates in the face of a “fundamental disequilibrium” in a nation’s balance of payments.

The Bretton Woods system provided two basic mechanisms of adjustment: inflating (deflating) the domestic economy for nations with surpluses (deficits) in their balance of payments, or altering the par value of a nation’s currency. The latter course of action, changing a currency par value, was only to be used when the nation suffered from a “fundamental disequilibrium” in its balance of payments. Deficits and surpluses continuing over some period of time were supposed to be equally undesirable. In practice, however, more pressure for adjustment was placed on the deficit nations, the result of mercantilistic bias, which looked down upon net importers of goods.

Essentially, adjustment under the Bretton Woods system was a zero-sum game. Any devaluation was matched by a revaluation. The existence of persistent surpluses made it more difficult for deficit nations to adjust. Even though nations’ tolerance for unemployment and inflation vary over time and from nation to nation, at any point in time, it is probably more difficult from the perspective of domestic politics for a deficit nation to deflate its economy than it is for a surplus nation to inflate its economy. Deflating a nation’s economy usually means more unemployment, slower growth, and reduced profits, each of which represents a political disaster for a modern democracy. Consequently, deflation of the domestic economy by nations with deficits in their balance of payments was rarely accomplished.

The alternative mechanism of adjustment was a change in the par value of the currency of a nation facing a “fundamental disequilibrium” in its balance of payments. More pressure to adjust was placed, once again, on the deficit nations. Consequently, this mechanism became currency devaluations for those nations suffering from persistent deficits in their balance of payments. Many nations could not or would not embrace this policy for either domestic or international political reasons. The “adjustable peg” seemed to move only in one direction, if it moved at all, and that direction was downward, with devaluations of currencies.

In practice, the compromise between fixed and adjustable exchange rates did not work. There was a tendency to delay adjustment. When the inevitable adjustment came, it was large and disruptive. A fundamental shortcoming of the Bretton Woods system was the failure to provide for an orderly addition to international liquidity—a central source for borrowing—needed to support growth in world trade.

The United States took on the role of supplying additional liquidity to the world by running balance of payment deficits on a continuous basis. The U.S. dollar rapidly became the world’s major vehicle for payment and reserve currency, or currency used to support the value of the domestic currency. Through these continuous balance of payments deficits, U.S. dollars sent abroad to buy goods and services and for investment purposes did not return. The rest of the world used additional U.S. dollar holdings for monetary reserves and to supplement world liquidity.

Deficits in the United States balance of payments became chronic and persistent, leading to a weakening of the U.S. dollar. Monetary crises followed, and confidence in the dollar waned. The ability of the U.S. Treasury to convert U.S. dollars into gold became questionable as these balance of payments deficits grew, and eventually the Bretton Woods system collapsed.

Significance

The Bretton Woods era encompassed not only the most rapid and widely distributed period of world economic growth in history but also a period of notable economic stability, including price stability. Conventional wisdom among economists at one time seems to have been that the rules and strictures of the Bretton Woods system played little or no role in the impressive world economic growth of the period. Economists are beginning to question this conventional wisdom as they reexamine the Bretton Woods era. The growth of both gross domestic product and international trade slowed significantly after 1973. A growing number of economists attribute this slower growth to the increased volatility of exchange rates that prevailed after the collapse of the Bretton Woods system. The stable, fixed foreign exchange rates of the Bretton Woods system acted to reduce both the risks and the costs of international trade and investment, encouraging more of these activities. Bretton Woods Agreement (1944) United Nations;economic agreements Monetary and Financial Conference, U.N. (1944) Trade agreements;Bretton Woods Economy, global Globalization

Further Reading
  • citation-type="booksimple"

    xlink:type="simple">Best, Jacqueline. The Limits of Transparency: Ambiguity and the History of International Finance. Ithaca, N.Y.: Cornell University Press, 2005. This analysis of international finance revolves around the Bretton Woods Agreements, which are the subject of three of the study’s seven chapters. Bibliographic references and index.
  • citation-type="booksimple"

    xlink:type="simple">Bilson, John F. O. “Macroeconomic Stability and Flexible Exchange Rates.” American Economic Review 75 (May, 1985): 62-67. Bilson reviews various macroeconomic models constructed to explain the instability in international financial markets.
  • citation-type="booksimple"

    xlink:type="simple">Murphy, J. Carter. “Reflections on the Exchange Rate System.” American Economic Review 75 (May, 1985): 68-73. Murphy examines whether an institutional framework can eliminate the exportation of bad effects of monetary and fiscal policy to innocent nations. He concludes that a regime of floating exchange rates will not accomplish the task.
  • citation-type="booksimple"

    xlink:type="simple">Scammell, W. M. International Monetary Policy: Bretton Woods and After. New York: John Wiley & Sons, 1975. Well written and easy to understand. Examines the development of the system, the changes in the environment, and the role the International Monetary Fund played up to 1973. Contains a good discussion of the merits and shortcomings of both the Bretton Woods system and the International Monetary Fund.
  • citation-type="booksimple"

    xlink:type="simple">Solomon, Robert. The International Monetary System, 1945-1981. New York: Harper & Row, 1982. This book is excellent, well written, and easy to understand. Solomon had a long career with the U.S. Federal Reserve System and can offer an insider’s perspective.
  • citation-type="booksimple"

    xlink:type="simple">Williamson, John. “On the System in Bretton Woods.” American Economic Review 75 (May, 1985): 74-79. Williamson examines the rules and strictures of the Bretton Woods system and concludes that fixed exchange rates made a significant contribution to the stability and longevity of the post-World War II economic boom.
  • citation-type="booksimple"

    xlink:type="simple">Yeager, Leland B. International Monetary Relations: Theory, History, and Policy. 2d ed. New York: Harper & Row, 1976. Excellent for readers interested in international finance, containing a wealth of information.

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