Lecture notes: The postwar order

This is the story of …

Bretton Woods system after WW2
IMF ― International Monetary Fund
post Bretton Woods ― new roles for the IMF
World Bank, Marshall Plan, OECD

Analytical issues:

why the system was created
why it broke down

Lessons of the inter-war period

avoid the “mistakes of the inter-war period”

common problems after many wars:

soldiers return ― need work
return economic system from military production
often post-war depression and economic difficulties
quite similar to the post-pandemic economy …

In the 1920’s:

hyperinflation throughout Europe
my great grandmother begging in northern Sweden …

In the 1930’s:

Wall St crash leading to the Great Depression
inter-national trade and finance system broke down
everyone only thinking of themselves — no one was thinking of the system as a whole

Reparations from Germany

a political logic, not an economic
Keynes: punish Germany was a bad idea in 1918
would depress the world economy
1945 — not repeat the mistake

The Kindleberger thesis

“Charles Kindleberger”

There are lots of different explanations for the Great Depression:

US monetary policy
misuse of the gold standard
deflationary policies
and so on …

Kindleberger: international factors were crucial

the British inability to organize the international economic system
the US unwillingness to do so
“the US was offered the world, but they declined”

US tradition of isolationism

the Monroe doctrine and all that
stayed out of world politics during the 19th century
never jointed the League of Nations

Three pressing goals:

maintaining an open market for trade
provide lending to countries which needed it
discount existing loans

Symmetry:

“If the world economy behaved symmetrically, there could be no world depression. A decline in the price of wheat might produce losses for farmers; it would, however, lead to gains in real purchasing power for consumers. … Gold losses for one country would be deflationary, but gains for the recipient country would yield offsetting expansion.”

“Beggar thy neighbor” policies

competitive devaluations of the currency

make exports cheaper and imports more expensive
sell more and buy less

Mercantilism ― enrich the country at the expense of the neighbors

problem if everyone does it — everyone loses
widely regarded as an economic cause of WW2

the imperial trading systems

particularly annoying to the Americans
open up the British empire for themselves

in order to assure peace

establish an international financial order where such competitive retaliation is impossible

The international financial system is unstable unless someone stabilizes it

Hegemonic stability theory

why did these efforts fail?

this is a “collective goods” problem
in everyone’s interest for something to exist — but in no-one’s interest to create it

e.g. stairway in a block of flats — or cleaning the dishes in a student dorm …

the problem is that whoever takes on the costs of cleaning the stairs gets the same amount of benefit as everyone else
so everyone hopes someone else will do it and they won’t have to

Solution:

someone takes the time to organize a system in which the cleaning costs are shared out, and we all benefit
needs someone to organize this, call a meeting, negotiate and persuade everyone it’s a good idea

Same is true for international finance:

everyone benefits from a rules-based trade system and stable currency regime — but it is in each state’s interest to cheat
mercantilist policies
to protect your markets while getting the benefit of other states open markets

“Regime”

a system of rules which organize the actions and expectations of states — an “institution,” but not necessarily formal

financial regimes
trade regimes
military regimes
aviation regimes
postal regimes

How can regimes be created?

a leader-state to take the initiative and organize a system

Nineteenth-century ― England played this role

England had taken the lead in organizing the gold standard
twentieth-century ― only the US play this role

“Hegemon”

In the 1930’s the US failed to take on the leader role

After World War II: the US obviously the dominant power

Economically:

the war had not been fought on its territory ― nothing was destroyed
it had been selling stuff to the combatants
large percentage of all the gold
large percentage of the world’s manufacturing capacity — something like 40%

Militarily:

troops on every continent
had won the war ― well, the Soviets did actually, but the Americans helped out

Politically:

the US as the most capable and trusted
in a way which is hard to believe today …

cf. Turkish membership in Nato

participation in the Korean War

“Exploitation” of the hegemon

it is difficult to be a hegemon
you incur the costs of organizing the regime
others can free-ride
cf. someone cleans the staircase ― they save money
you are taken advantage of by the countries you sponsor

Examples

militarily ― Europe, Japan
trade ― allowing some countries to have more
lenient rules
finance ― to run surpluses

Perhaps a hegemon is not needed …

perhaps there are other ways of solving collective goods problems …
the rules have become “embedded” in the social activity

There is a “lag” before the rules break down

cf. driving on the left or on the right ― either one is fine and once we have become used to it, there is no incentive to change
but difficult to create new rules ― difficult to react to new situations ― what if the rules no longer apply?

Repeated interaction over time

we come to develop patterns of cooperative interactions
provided that the “shadow of the future” is long enough ― that we don’t know when our last interaction will take place
cf. life in the trenches of World War I, according to Axelrod

Implications for an international financial regime

decentralized governance could be possible
but it would make changes slow ― sometimes quicker actions are required
not just the accumulated wisdom of the ages ― but someone reacting to something

John Maynard Keynes

Institutions are required

By 1941 when the US enters the war

already preparing plans for a new United Nations

also true for international financial cooperation:

one week after Pearl Harbor Harry White is commissioned to look into ways of organizing international economic and monetary co-operation
thinking about the future, and learning from the past

Post-war consensus

US optimism:

we’re winning the war, saving the world
high ideals about new world of unity and peace

Domestic consensus

built around the welfare state and the planned economy required by the war

Planned economy:

belief in technology could solve problems
war planning could be spectacularly effective ― the war economy was credited with ending the Great Depression
the closest to a totally planned economy in the US
Ford and GM could convert their entire design, test and manufacture lines to producing airplanes in 90 days!

Long-term implications of “state planning”

Important background to later spectacular US “private” industries (cf. Kuttner)

true for Boeing
Silicon Valley

Conclusion:

the government can do good things
industrial planning works

The welfare state

the war had also required new levels of social co-operation and equality

mobilization of all men
women in the work force and even in the armed forces
strict food rationing — British people being better nourished than at any time before or since!

Greater unity:

very different from the divisive economic struggles of the 1930s

In Britain:

political coalition between all parties throughout the war
Beveridge Report — NHS etc

In the USA:

Roosevelt very popular
Keynesian policies of full employment, even among some parts of the conservative business sector
the welfare packages of the New Deal

Lesson from the Great Depression

We can control the economy and make it work for us in better ways

The new reformist attitude clashes with:

nineteenth-century ― laissez-faire liberalism
Marxism
both of which insist on iron laws which govern the economy and which we are powerless to influence

Organizing an international financial system

but what will it look like?

Keynes vs. Hayek rap duel

The lyrics are here

The Bretton Woods system

Bretton Woods, New Hampshire — Mount Washington hotel or their own web site

meeting in July, 1944
delegates from 44 countries
but only the Americans and the UK delegations mattered

Aims:

keep currencies stable
help with recovery and reconstruction

The US: rich exporting countries shouldn’t limit their exports to balance world trade

it was poorer countries that had to import more

but Keynes:

all sides should moderate in order to balance trade
rich countries had to do their bit — limits exports become less competitive

eg. Germany – Greece during the euro crisis …

we are all in it together
we have to cooperate if we are to prosper

Britain:

Britain wants to protect its empire
wants an agreement on commodity prices, which is what colonies export
wants to allow imperial preferences

Keynes wants:

members to have the right to draw on fund and bank whenever necessary
can see this as a sort of international contribution-based welfare system
not a world government, just a big pile of money ― provided largely by the US ― that members can dip into

Ideally

Britain will be able to protect its colonial trade and pursue full employment, while getting the US to pay for it….

The US position

US wants more trade:

as a result of the war US shipping has grown massively
is feeling generally more internationally minded
wants a big trade expansion

Needs stable, convertible currencies and free trade

prepared to pay for co-op – to be the hegemon
but― doesn’t want to pay too much

Wants control over the system

wants a smaller fund, drawing only with permission
the dollar should be the reserve currency

In the negotiations:

the US holds all the cards …

The post-war economic order would require:

increased trade ― as the only way to ensure growth and international
co-operation
reject mercantilism – not try to enrich themselves at the expense of others

Trade requires:

currency stability: to allow orderly trading
exchangeability of currencies
open markets: to encourage the international division of labor and therefore
efficiency

In addition:

provide international liquidity ― to prevent the BoP crises of the 20’s and 30’s
smarter, more flexible, form of stabilization than the rigid gold standard of before

Outcome:

no commodity price agreement – US refuses
no clearing union or currency – dollar tied to gold is reserve currency

No free trade deal either

Britain refuses, and the ITO proposed to handle trade negotiations is blocked by US Congress

However, the IMF and the World Bank

both of which are much as the US wanted

but problems …

currencies are not made convertible for 15 years
the IMF left with little to do without convertible currencies
monetary system can’t function — the US was the only real creditor

Balance of payment deficits

Balance of Payments (BoP)

summarizes a country’s economic transactions with the rest of the world over a specific period, usually a year
It includes the trade balance (exports minus imports), capital flows, and financial transfers

Balance of Payments deficit

more money flowing out of the country than flowing in
when the combined value of imports, capital outflows, and financial transfers exceeds the combined value of exports, capital inflows, and financial transfers, a BoP deficit occurs

Think of it as …

n be like an international liquidity problem
but without a global government to solve it by creating more money

what is the problem?

a problem since the country might default on loans
and reduce trade with the rest of the world
might deal with the problem in ways that hurt other countries — competitive exchange rates, customs and tariffs

BoP, some statistics:

- Turkey, United States, China

Ways to deal with it

3 monetary strategies to solve a deficit problem — and one non-monetary

1. tighten fiscal and monetary policy

raise taxes
cut spending — austerity will mean less govt borrowing from abroad
raise interest rates
less cash around should — less spending on imports, while hopefully exports remain same

2. devalue currency

imports will now cost more, and so sell less, while exports will be
relatively cheaper, and sell more
raises the price of all imports ― reduces people’s power to purchase imported goods
― and foreign companies lose market share

3. borrow money to cover temporary BoP gap

4. non-monetary strategies – like promoting exports, or protectionist measures

tariffs and other barriers to imports – as US had done in 1930
this raises the price of imports
targeted exactly at specific industries

Assessment

1) is the most immediately painful to the population of now-democratic countries,
it is hard to borrow enough for 3)
2) and especially 4) are often preferred
both of which hit foreign trade directly and had decimated international trade in the 30’s

The idea was to compel countries to try

1) first
2) only if necessary, and
4) as little as possible

They wanted an international financial system to organize these responses

and a fund to enable 3)

All currencies are “pegged”

their price is fixed in relation to dollars
allowed to vary 1% up and down

Central banks responsible for restoring the price

they have to hold dollars
sell or buy to restore the price of their own currency

The dollar

itself tied to gold …

one once of gold costs 35 dollars
the Federal Reserve promises to buy or sell gold to restore this peg
the Fed must have a reserve of gold ― and it does ― 60 percent of world reserves in Fort Knox

Thus

all currencies directly tied to the dollar and indirectly to gold
more flexible than the gold standard ― not so dependent on gold production

The dollar as reserve currency

no limitations on is expenditure …
its currency is accepted everywhere ― Americans can get whatever they want ― they only need to print the money
the Americans can print their own gold
all other countries have to work hard to earn it ― have to sell things to the Americans in order to get paid in dollars

Benefits to the U.S.

Seigniorage

The ability to essentially “print money” that is globally accepted allows the U.S. to borrow at lower interest rates. This translates into lower government borrowing costs and reduced pressures on taxation and public spending.

Trade Advantages

Most international transactions are conducted in U.S. dollars, reducing exchange rate risk for American companies and giving them a competitive advantage in global trade.

Geopolitical Power

The dollar’s prominence provides the U.S. with significant leverage on the global stage, including the ability to implement effective economic sanctions.

Liquidity and Investment

High demand for the dollar makes U.S. financial markets attractive, liquid, and relatively stable, drawing investment from around the world.

Lower Transaction Costs

When a country’s currency is the world’s reserve currency, it doesn’t have to worry about exchange rate fluctuations within the global financial system, which can lower transaction costs for businesses and consumers.

Downsides and Constraints

Trade deficit

To supply the world with enough dollars, the U.S. must run a trade deficit. This can contribute to domestic issues like job loss in certain sectors and greater income inequality
Trade deficit — “When a country imports more goods and services than it exports, it is buying more from other countries than it is selling to them”

Currency Value

High demand for the dollar keeps its value strong, which can hurt U.S. exporters by making American goods more expensive for foreign buyers.

Fiscal Irresponsibility

Easy borrowing can lead to fiscal profligacy, as the government might be less incentivized to manage debts and deficits responsibly.

Global Shocks

Being the world’s reserve currency means that economic or financial instability in the U.S. can have outsized impacts on the global economy.

Monetary Policy Limitations

The Federal Reserve has to consider the global repercussions of its monetary policy decisions, which might not always align perfectly with domestic economic needs.

1950s and 60s — dollar scarcity

a problem

everyone is running very high trade deficits with the U.S.
they are buying much more from them than they are selling
post-war era: America has everything and Europe has nothing

as a result

dollars are scarce
everyone wants to get hold of them ― “dollar hunger”

convertibility restrictions

governments felt that they should be used for useful purposes only
develop the country ― buy patents etc (cf. Japan)
not squandered on luxuries

Americans

should run BoP deficits in order to provide liquidity to the rest of the world
pump dollars into the world economy ― good for restarting commerce

American generosity

allowing the Allies to trade on very favorable terms ― take advantage of the American position
short-term advantage for the Europeans ― long-term advantage for the Americans — enlightened set-up — cf. the price of hegemony

After convertibility

when Europe eventually returns to currency convertibility in 1958

Japan only in 1964
members borrow from the IMF to help them solve BoP problems, and the World Bank makes loans
doesn’t take very long before it breaks down
the system doesn’t actually operate that long

The Bretton Woods system breaks down

Strange assumption from 1944:

that the world always would stay the way it was

in particular

US superiority in trade
little inflation
US have most of the gold

when this no longer is the case, the regime is under strain

Dollar glut

European reconstruction
Germany and Japan in particular

the Europeans are selling more to the Americans

reduced BoP problems
instead of too few dollars, there are too many

US inflation

as a result of LBJ reforms
the Vietnam War

the dollars is overvalued in relation to gold

The Nixon shock

unilaterally removes the peg to the gold
others can no longer convert dollars into gold
without consulting with allies ― or with the State Department

1973

all currencies come to float freely
find their own price in relationship to each other ― supply and demand

domestic considerations: Vietnam war or the Great Society

printed too much money — undermines the confidence in the dollar

international obligations: the US is not doing this

deflation for the world — no means of payments

but in fact a lot of countries still hold on to gold

continue to defend their currencies with dollars
especially for the losers in the war — they were not a part of the Bretton Woods conference
difficult for them to abandon gold

implications

dollar and gold were never perfect substitutes
collapses because of a dollar crisis — but the dollar remains important — there was actually confidence in the dollar
sterling also played a role

the gold pool

the system required the cooperation of central banks
London gold market in the 1950s
1961 dollar crisis — betting against the dollar

the US

market in gold allowed to vary
but the US Fed hopes that there won’t be a demand for gold

1960s

Japan, Germany and France want a different system
they were not originally involved in the creation of the system

The New IMF

the institution could have closed up shop

no need to maintain parity values between currencies
no pegs to monitor

new tasks

consult with countries that experience financial crises ― above all developing countries
help out with emergency loans to bail them out

“conditionality”

will provide loans but only on certain conditions
various austerity measures

deal with BoP problems

cut social spending
reduce inflation
open up markets to foreign competition
reduce corruption and increase accountability

Voting rights

voting: US gets over 17.5 of all votes
23 Sub-Saharan African States grouped in the same constituency get 1.16%

located in Washington DC

but the head is a European

Kristalina Georgieva, 2019-present

World Bank

IBRD

“International Bank for Reconstruction and Development”

set up to

reconstruct Europe
no mention of 3rd world development, despite their pleas…..
but the Marshall Plan is always more important for this purpose

Organizational setup

voting rights
headquarters
managing director

Later developments of the World Bank …

“the reduction of poverty”

Current president: Ajay Banga

interviewed about current state of the world economy

The Marshall Plan

George C. Marshall, US Secretary of State

“The Marshall Plan”

ERP, the European Recovery Program

speech at Harvard June 5, 1947, offering US support
started in 1948 — ended in 1951, but the US continued to make payments
transfer 13 billion $ — equivalent to 114 billion $ today

Ear destruction

great destruction of infrastructure
takes a long time to revive — rationing etc in England in the early 50s
unemployment
the Communist parties are doing well

question of Germany

the US started by keeping Germany agricultural
but realized European prosperity depends on it
also include in military alliances

Aims

rebuild war-torn Europe
prevent a repetition of the depression that followed WW1
remove trade barriers
modernize European industry — US business practices
deregulation
economic growth — prosperity
prevent the spread of Communism

Soviet Union and the Eastern Bloc

Stalin originally seemed interested, but backed out

Poland, Czechoslovakia and Hungary really wanted to join
forced East European countries to do the same
Finland too!
instructions to European communist parties to sabotage the deal

Implementation

Passes US Congress

Truman gets public support for it

US, Canada, but also Sweden were not damaged by the war — in a great position to sell stuff to the rest

great demand for products — everything is needed — but no money
use the Marshall money to buy things from the US

Germany

companies could borrow funds
repaid and lent out again

technical assistance

Taylorism, and other business practices, as a way to increase Euroepan productivity

Outcomes

Not the cause of economic expansion

but important in certain areas, at a certain times
growth in Germany picked up independently
technical support important — US business practices

Political commitment to Europe

we are not going to leave you alone
this time we are not going home

European integration

strongly pushed by the EU
but it eventually didn’t happen this way

Laissez-faire critique

an obvious form of state intervention
a kind of Keynesianism for the world

Legacy

“equal to the Marshall Plan”

OECD

“OECD”

the institutional legacy of the Marshall Plan