The IMF and Bretton Woods: History, Role, and Reform

Origins of the Bretton Woods System

At the Bretton Woods Conference in 1944, which created the World Bank and the International Monetary Fund, the Western capitalist nations sought to avoid a repetition of the events that had led to the Great Depression and the Second World War. Their goal was to establish a stable international economic order that was not bound by the rigidity of the pre-1914 gold standard system. The interwar period of 1919–39 was one of economic and political chaos, featuring deflationary devaluations, closed trading blocs, massive unemployment, and the failure of the revived gold standard in 1925–31. These conditions were key factors in the rise of the Nazi regime in Germany in 1933 and the fascist takeover of Japan that began in 1931.

President Woodrow Wilson had been an early advocate of free trade and had warned against the nationalism and autarky in economic policies that became the norm in the 1920s and 1930s. Secretary of State Cordell Hull (1933–44) had also stood in this Wilsonian tradition and was one of the early architects of the General Agreement on Tariffs and Trade, although the U.S. Congress refused to join the International Trade Organization in 1950, which would have had broader and more comprehensive powers in this area, similar to the later World Trade Organization. Similarly, the founders of the World Bank and the International Monetary Fund were acutely aware of the many failures of the post–World War I settlement, symbolized by the Versailles Treaty and the failure of the United States to join the League of Nations (Boughton, 2004, pp. 4–5).

In 1944–45, the architects of the new international economic system had the recent catastrophes of the Great Depression and the Second World War in mind as they designed institutions they sincerely hoped would prevent such events in the future. They were also aware that under the classical gold standard the money supply had been "inadequate to finance the growth of world output and trade," while floating exchange rates had led to wild fluctuations in currency values and rampant speculation that proved destabilizing (Bordo, p. 29). Consequently, the Bretton Woods system as originally envisaged instituted a regime of exchange rates fixed by international agreement, carefully coordinated to ensure full employment and the avoidance of future deflationary spirals, with controls over speculative, short-term capital movements (Bordo, p. 300).

In 1944, the United States was the world's largest creditor nation while Great Britain was bankrupt and heavily in debt to the U.S. and the Commonwealth. These factors proved crucial in determining the form that the Bretton Woods institutions finally took. Representing Britain, John Maynard Keynes — the most widely respected economist of the day and hardly an advocate of free markets and laissez-faire — recommended the creation of a world central bank, or International Clearing Union (ICU), with its own currency of account called bancor. All member countries would have their exchange rates fixed to this new international monetary standard and would be able to obtain credits from the ICU based on a quota system.

Design of the IMF: Keynes vs. White

Harry Dexter White, the assistant Treasury Secretary of the United States, envisioned the dollar as the main reserve currency of the world, alongside a stabilization fund consisting of gold and the currencies of each member state. White pressured Britain to abandon the idea of an ICU and bancor in return for a direct loan of $3.75 billion (Bordo, p. 32). As the U.S. insisted, the IMF would be based on the dollar and "would lack most of the powers of a central bank," which Congress would not have supported in any case (Boughton, 2004, p. 8). The U.S. dollar, fixed to a gold standard, therefore became the basis of the international trade and monetary system. All IMF member states were allowed to fix their own exchange rates to the dollar within a margin of 1% of par value, although they could increase or reduce their rates by up to 10% without IMF permission. Initially, the resources allocated to the IMF totaled $8.8 billion. In practice, only the U.S. ever fixed its exchange rate to gold; all other member states tied their currencies to the dollar (Bordo, p. 37).

In practice, the Bretton Woods system did not begin to function fully even in the Western capitalist nations until the end of 1958. The main reason was that "the transition period from war to peace was much longer and more painful than was anticipated," and the incipient Cold War — combined with the Soviet Union's refusal to join the World Bank and IMF — meant that political, strategic, and security concerns were at least as vital to the U.S. and its NATO allies as restoring normalcy to the international economic system (Bordo, p. 37). Stalin never joined the IMF and World Bank; the Soviets pressured Poland to withdraw in 1950 and Czechoslovakia in 1954. Mainland China was not represented at the IMF after the Communist revolution there in 1949, and Fidel Castro withdrew Cuba from it in 1959. In this sense, the IMF became "largely a capitalist club that helped to stabilize market-oriented economies," particularly after West Germany and Japan were allowed to join in 1952 (Boughton, 2004, p. 8).

Of the original 40 members, only three were African nations — Egypt, Ethiopia, and South Africa — since almost all the others were still colonies. Ghana and Sudan joined only in 1957 upon independence, and by 1990 all 55 African countries were IMF members, though they held only 9% of the total voting power and three seats on the executive board (Boughton, 2004, p. 9).

The IMF's Limited Role in the Early Postwar Era

In 1945–58, only the dollar was a fully convertible currency. Most countries were short of gold and hard currency reserves, while their economies had been devastated by the war and international trade had collapsed. The U.S. government was well aware of these catastrophic economic conditions and feared that Communist movements would exploit the chaos and misery of the postwar world. It made little use of the IMF and World Bank in addressing what it regarded as the supreme foreign policy challenge, relying instead on bilateral and multilateral aid packages consisting of direct government-to-government grants and loans. Private capital movements figured very little in the formulation of these early Cold War policies.

During this period, the IMF had virtually no role in restoring postwar stability and lacked power and prestige. As the U.S. and its allies undertook to rebuild Western Europe after 1945, "the Bretton Woods institutions were largely bypassed" (Kahler, 1990, p. 94). In 1949, for example, Great Britain devalued the pound by 30%, followed by a wave of similar devaluations in other countries, without consulting the IMF except in the most perfunctory way. Even had it been consulted, the IMF staff had not "formed an opinion as to how large a devaluation would be appropriate" (Polak, 2005, p. 29). Canada also floated its currency against the dollar in 1950–61, also ignoring IMF policy (Bordo, p. 45). In the 1956 Suez Crisis, the U.S. was able to force Britain to withdraw from the canal zone by applying pressure to the pound, but "the IMF was not necessary for sending the desired signals in that instance" (Kahler, p. 98).

In 1967, the Labour government of Britain did notify the IMF about its plans to devalue the pound, and the IMF staff recommended a devaluation of 15%, close to the 14.3% finally enacted in November 1967. In addition, the IMF was able to "contain the number of secondary devaluations and thus avoid a chain reaction such as the one that had occurred in 1949." General de Gaulle did not consult the IMF about the devaluation of the franc in 1968, however (Polak, pp. 32–33).

In the 1940s and 1950s, the dollar served as the main international reserve currency, pegged to gold at $35 per ounce. In most Western nations, capital controls also continued into the mid-1960s. Essentially, this was a dollar-gold standard in modified form, with the U.S. playing the global hegemonic role that Britain and the pound had played up to the First World War (Bordo, p. 49). So it remained until the crises of the 1960s and early 1970s finally led to the end of the international gold standard and a new era of floating exchange rates. As late as August 1971, when President Richard Nixon and his Treasury Secretary John Connolly unilaterally took the U.S. off the gold standard, they gave the IMF a mere thirty-minute notice and later replaced the managing director when he publicly complained about American economic policies (Kahler, p. 98). Since neither the U.S. nor any other Western nation had given any serious indication of abandoning the gold-dollar standard prior to this time, "the world was thus ill prepared for the 1971 crisis of the dollar." Nor had the IMF given much consideration to the vastly expanded role that private capital markets would assume in the 1970s and 1980s, since those were "much less developed than they are now" (Polak, p. 37). These tremendous movements of capital across borders became a major factor in the inability of the IMF to reach firm conclusions about what the correct values of exchange rates should be.