The Rise and Fall of Bretton Woods — Ramifi’s Deep Dive

You are reading Part II in Ramifi’s series on inflation. If you haven’t already, check out Part I: World Reserve Currencies.

As the Second World War drew to a close, the world’s leading economies held a conference in Bretton Woods, New Hampshire. This 1944 conference was the historic milestone that set into motion the next half century’s monetary circumstances.

Tying the US dollar value to gold, economies worldwide shifted to utilizing the US dollar in international commerce. Additionally, foreign currencies could peg their value to the dollar to avoid trade imbalances and reduce economic shocks, all without holding gold reserves of their own.

The dollar was to become gold for the post-war world — a sort of commodity-but-not-commodity that was highly liquid and internationally accepted. It was an excellent solution… until it wasn’t.

The United States completely abandoned the gold standard in the early 1970s, kicking off a period of extreme dollar inflation. All that glitters is not gold, and the US dollar’s brief period of being a gold-backed international reserve currency is a crucial period of monetary history.

The Bretton Woods Conference, July 1944

Gold — A Must

The United States was home to roughly 70% of the world’s gold reserve at the end of World War II. This position gave the US a huge advantage in international negotiations that sought to optimize the increasingly global financial system and avoid any cataclysmic future wars. The logic went something like this: if major currency wars are solved, then wars with guns and tanks will stop as well… we hope.

Due to the prevalence of commodity-backed currencies at the time and the need to instill confidence in what would become the new world reserve currency, the United States agreed to redeem dollars for gold at $35 per one ounce of gold.

After all, the US might have played an essential role in the Second World War, but other nations wouldn’t accept an unbacked dollar and give up their national financial interests. Gold had to be part of the equation.

Doing The Deed

Two new organizations served to move dollars into the global financial system: The International Monetary Fund (IMF) and the World Bank. The IMF filled (and still fills) the role of an international liquidity pool — it holds a mix of reserve currencies and gold and allows nations to borrow against their contributions. The IMF is like a complicated, international version of a savings account, while the World Bank originally extended loans to nations devastated by the Second World War. Today it lends capital to emerging market economies to foster global economic development.

The United States had a lot of the world’s gold.

Holding US dollar reserves rather than gold came with several advantages as well. Treasury assets paid periodic interest, whereas gold paid no interest at all. Additionally, an exporting nation could devalue its currency relative to the dollar to make exports more attractive in international markets. Need to sell more goods? Make it cheaper to do business in your country.

The obverse was true for nations that wanted to strengthen their currency relative to the dollar. Nations could accomplish all of this without having to fuss about national gold reserves. They could freely move their dollar peg as their national economists saw fit and swap dollars for gold if they so desired.

Need Moar Dollars

This monetary flexibility resulted in massive post-war booms in nations that utilized the dollar as their primary reserve currency. So much so that the demand for dollars gave rise to an entirely new asset class — the Eurodollar.

We’ll have an article on Eurodollars soon, but for now, just know that demand for USD was so high that nations began to denominate their financial assets in dollars regardless of not they had the actual dollars to back them. Now that’s popularity.

The United States continued to increase the number of dollars that made its way into the international financial system. You might have already assumed where this is headed — by 1961, the number of outstanding dollars exceeded the United States’ gold reserves. It was only a matter of time until the US drained its entire gold reserves or devalued the $35 per ounce peg.

Redeemable for $35 per ounce of gold, the US dollar was now firmly at the center of the global financial system.

Closure Of The Gold Window

To combat draining gold reserves, the United States devalued the dollar’s exchange rate to gold on two separate occasions. Rather than stemming the tide, this devaluation kicked off rampant speculations and served to increase redemptions of dollars for gold.

In 1971, amid a flood of redemptions of US dollars for gold, President Nixon closed the gold window and disallowed foreign holders of US dollars from converting their holdings into gold.

By 1973, nearly every currency that participated in the Bretton Woods system was free-floating against the dollar — a stark shift from their previous US dollar pegs. This process served to keep most of the world economy firmly denominated in US dollars while also removing the commodity backing the global reserve currency. Gold was out the window, and the world economy was now running on a purely unbacked fiat currency system.

Conclusion

The Bretton Woods system was a crucial period in monetary history. It marked a period of intense economic prosperity and rebuilding after the Second World War. Additionally, it serves as the period of history when the world economy slowly transitioned from a global reserve currency backed by a commodity to a pure fiat currency system in which monetary debasement could occur without immediate tangible consequence.

Following the dissolution of the Bretton Woods system, US dollar inflation skyrocketed, demonstrating the extreme importance of sound money and the role commodities play in monetary systems. That is why Ramifi leverages its role as a synthetic commodity to track dollar inflation accurately. Without something to back the dollar, inflation will continue to accelerate with dire consequences.

Our next article will explore the implications of removing the gold standard from the US dollar and how the global economy subsequently evolved.