The End of the Bretton Woods System (1971–1973)
While the U.S. remained insistent on continuing its mission described by the Bretton Woods system, the world was changing. Throughout the 1960s and 1970s, important structural changes were taking place that also contributed to the breakdown of the Bretton Woods system:
The increasing monetary interdependence between countries. Most Western European currencies and the Japanese yen became convertible in 1958 and 1964, respectively. The return to convertibility led to an increase of international financial transactions, which strengthened monetary interdependence.
Due to the aftermath of World War II, a rapid development and integration of international financial markets was introduced. Starting in the mid-1960s, banks formed international syndicates. By 1971, most of the world’s largest banks became shareholders in these syndicates.
These multinational banks moved around large amounts of funds for investment purposes, as well as for speculation and hedging against exchange rate fluctuations. These developments in financial markets made large capital flows possible.
The economies that the U.S. helped rebuild were becoming economic powers themselves. By the mid-1960s, the European Economic Community (EEC) and Japan were on their way to becoming international economic powers. Their total reserves exceeded U.S. reserves, they had higher growth rates, and their per-capita income was approaching that of the U.S.
In fact, the international landscape of economic power in the mid-1960s looked very different than at the time of the Bretton Woods Conference in 1944. In a world with multiple economic powers, the privileged role of the dollar was being questioned. The U.S. was determining the level of international liquidity for all, which caused dissatisfaction among other countries. As the 1970s approached, the U.S., the reserve currency country, didn’t look the part.
Another reason lay behind the dissatisfaction of Europe and Japan with the system. U.S. policies were influencing not only economic conditions; some of these countries resented the military conflicts such as the Vietnam War in which the U.S. was involved.
It seemed that holding the reserve country’s currency, the dollar, by other countries was enabling the U.S. in engaging military conflicts. By the late 1960s, higher inflation rates and large dollar outflows made the dollar overvalued.
At the same time, the German mark and the yen seemed undervalued. Despite these imbalances, countries were reluctant to make the necessary adjustments. The Germans and the Japanese didn’t want to revalue their currencies because it would hurt their export performance.
The U.S. avoided devaluation in order to maintain its international credibility. However, keeping everything the same was getting increasingly difficult because international currency markets were developing and large speculative capital was moving around in search of quick profits.
A political dimension of dissatisfaction with the U.S. as the reserve currency country also came into play. In 1971, détente (easing of strained relations) between the U.S. and the Soviet Union depreciated the role of the U.S. in protecting the Western world from the threat of communism.
During the time of the Bretton Woods Conference in 1944 and throughout the 1950s, the protection the U.S. provided was valuable. However, when security fears lessened, the economic and military leadership of the U.S. became less acceptable.
By 1971, the U.S. had very few nongold reserves and only 22 percent gold coverage of foreign reserves. The dollar became significantly overvalued with respect to gold. Because of current account deficits, anti–free trade sentiments were rising in the U.S. Finally, President Nixon closed the gold window on August 15, 1971, ending the convertibility of the dollar into gold. The dollar was let to float according to its market price.
In December 1971, the Group of Ten met at the Smithsonian in an attempt to build a new international monetary system. The Smithsonian Agreement led to the devaluation of the dollar from $35 to $38 per ounce of gold. However, because U.S. expenditures and current account deficits were continuing, this devaluation did not stop the speculation against the dollar.
In 1972, the devaluation of the dollar reached $44 per ounce of gold. Clearly, whatever remained of the Bretton Woods system couldn’t be rescued. In February 1973, the U.S. and other industrialized countries let their currencies float.