EC Week 21, topic 16, slide 0 EC120: The World Economy in Historical Perspective Topics Week 21: Trade, International Payments, and the Recovery of the European Economy after Planning for the Post-War, While Avoiding the Mistakes of the Past. 2. The Key Elements. 3. Europe 1945: An Unpromising Beginning. 4. Reality Intrudes on Bretton Woods Planning: The First (Unsuccessful) Attempt to Resume Current Account Convertibility, Britain, Improvision: The Marshall Plan and the EPU. 6. Current Account Convertibility (sort of) Achieved (at least in Europe), Signs of Strain Appeared Almost Immediately Thereafter. 8. Progressive Breakdown in the 1960s, Collapse By Default, A New Regime of Floating Rates.

EC Week 21, topic 16, slide 1 EC120: The World Economy in Historical Perspective 1.Planning for the Post-War, While Avoiding the Mistakes of the Past What to restore: the goal was to return to something like the pre multi-lateral fixed exchange-rate regime that had once been so conducive to trade and prosperity. What to avoid: the deflationary bias, the potentially destabilizing “hot money” flows, the competitive devaluations, and the extreme trade barriers of the inter-war years. London, c Striking dockers, London, July 1923

EC120: The World Economy in Historical Perspective EC Week 21, topic 16, slide 2 1a. Preparations for the Conference at Bretton Woods The first tentative steps: The Atlantic Charter, August Detailed planning began in earnest in 1942 (the programme was not an over-night wonder). Since the time and the circumstances of the end of the war were not known in August 1944, flexibility was unavoidable and emerged as a key characteristic of the Bretton Woods System. ̶ Political origins (place and timing). Churchill and Roosevelt aboard HMS Prince of Wales, August 1941 H.D. White J.M. Keynes

EC Week 21, topic 16, slide 3 EC120: The World Economy in Historical Perspective 2. The Key Elements of Bretton Woods. The three key innovations: Adjustable “par values” would be set, provisionally fixing exchange rates. The agreed acceptance of controls, at least temporarily, particularly on capital flows. The creation of new international institutions each intended to enhance a specific aspect of international economic co- ordination. Bretton Woods Hotel Bretton Woods Conference, August 1944

EC Week 21, topic 16, slide 4 EC120: The World Economy in Historical Perspective 3. Europe 1945: An Unpromising Beginning ●Millions dead, many of whom were skilled; millions more disabled, and millions displaced. Unprecedented widespread physical destruction of factories, warehouses, mines, offices, and (especially) homes. Physical destruction also notable in transport networks: rail, roads, bridges, and waterways. Global trade patterns, disrupted during the 1930s, were completely broken by the war, much more thoroughly than during WWI. Berlin, Spring 1945 Cologne, Spring 1945

EC Week 21, topic 16, slide 5 EC120: The World Economy in Historical Perspective 4.Reality Intrudes: The First (Unsuccessful) Attempt to Resume Current Account Convertibility: Britain, American hopes for a quick return to a fixed-exchange rate, multilateral trading order. Britain, the strongest of the European economies in the immediate post-war period, was the obvious candidate to lead the European return to at least current account convertibility. –The Imperial bonus. British Factory 1947

EC Week 21, topic 16, slide 6 EC120: The World Economy in Historical Perspective 5. The British Crisis Demanded Improvision: The Marshall Plan and the EPU ● Catch-22: Europe’s need for imports before exports could be produced. − Food. − Intermediate goods, especially coal, fertilizer, and cotton. − Capital goods (Germany had always been the big European producer). − Non-food consumer goods (many imported) to encourage work effort. − An inability to borrow (who would lend when currencies were inconvertible, taxation and regulation unpredictable, and exchange rates over-valued?). − Dollar shortages: relief programmes helped, but were insufficient for reconstruction. Lack of convertible foreign exchange, notably gold and dollars, led directly to bilateral settlement – and low levels of trade - in western Europe. General George C. Marshall Berlin Airlift, June May 1949

EC120: The World Economy in Historical Perspective 5a.Bilateral settlement and its discontents: what the Gold Standard had solved due to the many virtues of multilateral trade and what the European Recovery Program (ERP) sought to restore. ● The role of “Marshall Aid”: given that the amount of aid was relatively small, exactly what problems did it solve, bearing in mind the American aim of achieving European reconstruction as cheaply as possible? ● Trade, the key to using European resources for European recovery and unblocking bottlenecks to growth: elements of ERP leverage to pry the bottlenecks open (see Irwin (1995), Figs. 5.1 & 5.2; Kenwood & Lougheed (1999), Table 27; Eichengreen (2007), Figs. 3.1 & 3.2) for evidence regarding the importance of trade in Europe’s recovery): –Above all, the ERP conserved scarce European foreign exchange reserves, securing increased imports for Europe while allowing more foreign exchange to be devoted to intra-European settlements. For the composition of ERP aid, see Milward (1984), Table 17. –Leverage 1: “Conditional aid” (extended through drawing rights), sometimes called “Little Marshall Plans”: foreign exchange creation “out of thin air” (but not always well directed). –Leverage 2: Counterpart funds gave additional support for capital formation. For an indication of the use of counterpart funds, see Milward (1984), Table 20. –Leverage 3: Political pressure to dismantle trade barriers. EC Week 21, topic 16, slide 7

EC Week 21, topic 16, slide 8 EC120: The World Economy in Historical Perspective 5b. More Improvision: Introduction of the European Payments Union (EPU), July 1950 Unsuccessful moves by small-scale schemes without new credits towards multilateral settlement occurred in November 1947 and again in October The EPU (closely modelled on the Bretton Woods scheme, complete with fixed exchange rates and a central IMF-like authority) was bigger, embracing all recipients of Marshall Aid among whom credits were transferable, and included new credits available to the central clearing agent, not least a grant of $350m from ERP funds. The essential feature was that a country settled its trading accounts not with individual countries, but with a central clearing agent: what mattered was the balance with the clearing agent, not the balance with individual countries. Thus big deficits could be set off against big credits (assuming the country in question had an export surplus with at least some members of the payments union).

EC120: The World Economy in Historical Perspective EC Week 21, topic 16, slide 9 6.Current Account Convertibility (sort of) Finally Achieved (At Least in Europe), ● Payment union mechanisms: the structure of incentives. See Eichengreen (1993), Table 4, for the initial schedule of settlements. Debtors: what’s not to like? Creditors: what’s to like? ($350m helped, allowing creditor countries to receive more hard currency in settlements than debtors paid). ● The EPU was “hardened” in 1954 and 1955, before being wound up in December 1958, at which time the major European currencies became convertible for trading purposes (but not for investment). Extensive capital controls remained. ● Discrimination against American imports was relaxed and renewed efforts to reduce trade barriers more widely were made. Frankfurt, c.1959

EC120: The World Economy in Historical Perspective 7.Signs of Strain Appeared Almost Immediately Thereafter. ● The dollar shortage was changing into a dollar glut. (For how and why, see Bordo (1993) Figs. 1.10, 1.11, 1.12, and 1.18). ● An early (but ultimately inadequate) response to growing strains (i.e. when the open market price of gold rose above $35.20/oz.): the London Gold Pool, November 1961, and central bank swap lines, March 1962, both established to support the dollar price of gold. ● Growing capital market sophistication (for example, over-invoicing imports while under-invoicing exports in order to acquire foreign assets) rendered unworkable short-terms fixes for the dollar and the “adjustable peg” for other currencies; markets refused to wait for politicians and policy-makers to correct imbalances. ● A structural problem: how could international reserves other than US dollars be increased fast enough to keep pace with the extraordinary growth in trade? One (limited) answer: Special Drawing Rights (SDRs) issued by the IMF. See Bordo (1993), Fig.1.15 for an indication of relative magnitudes. EC Week 21, topic 16, slide 10

EC120: The World Economy in Historical Perspective 7a. The vexed, persistent question of Bretton Woods: who should adjust and how? ● The inadequacy of limited revaluations by countries with strong balance of payments (notably West Germany), especially as capital controls became less effective as trade restrictions were relaxed after ● The political economy of adjustment. –American refusal to play by ‘the rules of the game’ and curb its growing payments deficit by restrictive monetary and fiscal policies. –British resistance to the policy tightening needed to defend sterling. –The reluctance of the West German government to ‘penalize’ successful exporters. –French resentment at America’s ‘exorbitant privilege’, followed by dollar liquidation from French foreign exchange reserves, June –Tensions over Franco-German currency realignments, August-October 1969 led to a French devaluation of 11.1% in August and a German revaluation of 9.3% in October (after the German federal elections in September). EC Week 21, topic 16, slide 11

EC Week 21, topic 16, slide 12 EC120: The World Economy in Historical Perspective 8. Progressive Breakdown in the 1960s, Collapse European strains: British devaluation, November 1967; French devaluation, August (See Baldwin & Wyplosz (2004), Fig ) Nixon closed the ‘gold window’ at the Fed, August 1971, ending any pretence of the gold convertibility of the dollar. Import ‘surcharges’ (effectively tariff increases) were also introduced. Continued American budget deficits, joined by the growing budget deficits of other governments led to the complete collapse of the Bretton Woods regime in March 1973, with the dollar continuing to fall. The first ‘oil shock’ occurred in October of that year. John Connolly, US Secretary of the Treasury 15 August 1971

EC Week 21, topic 16, slide 13 EC120: The World Economy in Historical Perspective 9. By Default, A New Regime of Floating Rates Emerged in 1973 After floating, the dollar initially fell against most currencies, but not uniformly. Subsequent movements were determined largely by variations in expected inflation not compensated by higher interest rates, with the currencies of more rapidly inflating economies tending to fall. (See Baldwin & Wyplosz (2004), Fig. 10-4). Small, open advanced economies, most of them in Europe, were most at risk of trade disruption in the new order.