A stable, global monetary order? Be prepared for change
Currencies are fiat, the ties to gold are gone, and most exchange rates for the major currencies are freely floating
This week marks the 75th anniversary of the Bretton Woods agreement, formulated among 44 allied nations in a New Hampshire hotel. To me, the most remarkable thing about the agreement is not that it collapsed but that it ever existed in the first place — and what that says about such arrangements more generally. By which I mean: every era’s monetary institutions are virtually unimaginable until they are created. Looking forward, don’t assume the status quo will hold forever — rather prepare to be shocked.
Consider the broader history of monetary and financial institutions. The gold standard (and sometimes bi-metallic) regime that marked the Western world from 1815-1914 was without precedent. In medieval times, gold, silver, copper and bills of exchange — from multiple issuers — all circulated as means of payment, and often there was no single dominant form of money. As the gold standard evolved, however, claims to gold became a global means of settling claims and easing foreign trade and investment.
While the system was based on some central bank intervention, most notably from the Bank of England, it was self-regulating to a remarkable degree, and formed the backbone of one of the West’s most successful eras of economic growth. It was not obvious that the West would arrive at such a felicitous arrangement.
Fast forward to the current day. Currencies are fiat, the ties to gold are gone, and most exchange rates for the major currencies are freely floating, with periodic central bank intervention to manipulate exchange rates. For all the criticism it receives, this arrangement has also proved to be a viable global monetary order, and it has been accompanied by an excellent overall record for global growth.
Yet this fiat monetary order might also have seemed, to previous generations of economists, unlikely to succeed. Fiat currencies were associated with the assignat hyperinflations of the French Revolution; the floating exchange rates and competitive devaluations of the 1920s were not a success; and it was hardly obvious that most of the world’s major central banks would pursue inflation targets of below 2%. Until recent times, the record of floating fiat currencies was mostly disastrous.
Another surprising monetary innovation would be the euro. Both Milton Friedman and Paul Krugman warned that the euro was unlikely to succeed and persist. Yet it has proven more durable than many people expected
It is considered bizarre that former US Federal Reserve chair Alan Greenspan advocated a gold standard in 1967, but, in fact, it was a pretty reasonable view at the time, even if it turned out to be incorrect. And it wasn’t just Greenspan who didn’t see where the world was heading: Benn Steil, in his well-known book The Battle of Bretton Woods, wrote: “Keynes thought of freely floating rates as a sort of blind groping … and certainly not as a viable alternative model for underpinning trade relations among nations.” In reality, we are just emerging from arguably the world’s most rapid age of globalisation, from about 1990 to 2007.
The Bretton Woods arrangements also seemed highly unlikely until they were in place. They involved a complicated system of exchange rate pegs, capital controls and a “gold pool” (and other methods) to control gold prices and redemption ratios. What’s more, the whole thing was dependent on America’s role as global hegemon, both politically and economically. The dollar still was tied to gold, and the other major currencies tied to the dollar, but as the system evolved it required that no one was too keen to redeem dollars for gold (the French unwillingness to abide by this stricture was one proximate cause of the collapse of Bretton Woods).
I don’t think a monetary economist from, say, 1890 could have imagined that such an arrangement would prove possible, much less successful. Yet the Bretton Woods arrangements had a wonderful track record, as the 1950s and 1960s generated strong economic growth for both the US and Western Europe.
At the same time, once Bretton Woods ended in the early 1970s, few people thought it was possible to turn back the clock. The system required the US to be a creditor nation, to hold much of the world’s gold stock, and for countries such as France to defer to American wishes on gold convertibility. Once again, the line between an “imaginable” and “unimaginable” monetary arrangement proved to be a thin one.
Another surprising monetary innovation would be the euro. Both Milton Friedman and Paul Krugman warned that the euro was unlikely to succeed and persist. Yet it has proven more durable than many people expected, and there does not seem to be an end in sight. This kind of a common fiat currency, spread across so many nations, is without precedent in world history.
So as you consider the legacy of Bretton Woods this week, remember this core lesson: There will be major changes in monetary and institutional arrangements that no one can even imagine right now. Assume the permanency of the status quo at your peril.
• Cowen is a professor of economics at George Mason University and writes for the blog Marginal Revolution. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.