1. Bretton Woods—The Rise and Fall
Chapter 02-
Exorbitant Privilege
Bretton Woods—The Rise and Fall
The US has a lot more banks than many other countries. Most countries have 4 or 5 banks that control most of the industry. So what does this difference mean for the US banking system? Is it better or worse than other countries? Why do we have so many more banks?
This chapter looks at the history of the banking system and the role of financial innovation, particularly in increasing competition. 1

2. Bretton Woods—The Rise and Fall
Makes the U.S. Dollar the International Reserve Currency
Why was Keynes asking for fines for trade surplus countries and aid to trade deficit countries
Employment and inflation 2

3. Bretton Woods—The Rise and Fall
Following WWI
Treaty of Versaille
French seeks punishment of Germany through debt repayment
“The Economic Consequences of the Peace”
Germany’s economy was destroyed
Thus there was no way for a trade surplus
But they were being forced to repay France (And Britain) for the war
Where was this money going to come from?
Inflation 3

4. Bretton Woods—The Rise and Fall
As the British Sterling dies
They impose capital controls
The US forces the removal of these controls as a pre- requisite for loans (1946)
This meant over next year sterling was traded for dollars
Lost $1 billion in reserves in a month!
Reserves were $2.5 billion
Controls return quickly
During the period (1950s-1970s)
Britain, France, Germany and the US all pass capital controls at one point or another 4

5. Bretton Woods—The Rise and Fall
Though Japan’s growth rate by the 1970s was three times of the US
The Yen never was a threat to dollar hegemony
Even with Japan’s closest neighbor, China, from which inputs came, did not use Yen
Like China today, capital controls played key role
They did ultimately remove these restrictions (1980s)
But the effect was a real estate boom as banks who lost corporate bond market customers to international markets
The Bancor
Scheme of a global central bank called “Clearing Union” 5

6. Bretton Woods—The Rise and Fall
Each country would receive a line of credit
Called a Bancor
Governments could use Bancor to purchase imports
Surplus countries would be forced to turn over portion of Bancor (thus surpluses would be “taxed” de facto)
Deficit countries of course could not run a deficit forever (their credit line was not infinite)
The American rep at Bretton Woods was Harry Dexter White
Keynes’ asks for $26 billion in funds, US bargains down to $8.5 6

7. Bretton Woods—The Rise and Fall
But the problem is that other countries still do not have, at this time, resources needed to buy American goods
Including capital goods so that they could rebuild factories
As the Cold War sets in the US fears the collapse of the international financial system (Bretton Woods)
Institute the Marshall Plan in Europe and the Dodge Plan in Japan
Marshall plan took up 10% of the US gov’t budget in first year alone
Provided dollars to finance imported inputs needed
Avoids barter system and preserves dollar’s role 7

8. Bretton Woods—The Rise and Fall
The key factor then for the role of the dollar was lending and investment abroad
Explains why China buys so many treasuries and invests in middle east, Africa, as lender and direct capital investments
By 1960, there were more dollars in the world than there was gold to cover them at The Fed
By 1964, rising price of gold, which is being produced in short supply, puts pressure on dollar
The Gold Pool
Countries agreed to hold onto dollars and reimburse US for half of the gold losses
Asymmetric agreement which favored US 8

9. Bretton Woods—The Rise and Fall
The Triffin Dilemma
If US refused to provide dollars to rest of world, growth stagnates
But if they supply unlimited amounts, then faith in its ability to convert dollars to gold at will declines
Triffin recommends a Bancor note system
Pressure builds to convert dollars to gold
The “Sequential services constraint”
The first countries to convert get gold, but if US runs out, later countries wouldn’t 9

10. Bretton Woods—The Rise and Fall
US tried many tactics
Forced countries receiving US Aid to use that aid to buy goods from US
Forced DoD to buy American goods
Taxed investment income from abroad
Special Drawing Rights (1967)
Bookkeeping claims at the IMF
Not very useful because they were only accepted in transactions with other governments or the IMF
85% of members had to agree every time new issues were made
France was worried about inflation as a result of excess liquidity 10

11. Bretton Woods—The Rise and Fall
By 1967 British BoP crisis hits head
Followed by devaluation of Sterling Pound
Partly caused by rising oil prices and ME countries moving to dolalrs
De Gaulle
Dictator of France at the time
Press conference says he worries about devaluation of dollar
Gold price rises
Gold Pool attempts to push price down by selling gold
$2 billion in two months
US losing gold at a rate of $500 million a day
London closes its gold trades completely 11

12. Bretton Woods—The Rise and Fall
De Gaulle keeps Paris trades open
Nixon is elected in 1968
Takes a bullying tactic or “America First” tactic with Europe
The drain on the treasury accelerated
On August 13th of 1971 Britain asks for conversion of dollars to gold
Nixon suspended convertibility
Includes in the act a tax cut and a 90 day wage and price controls and an import tax
The policies pressure Europe to play along
At the dollar is devalued (or better to say all other currencies are devalued) 12

13. Bretton Woods—The Rise and Fall
Simultaneously Nixon pressures The Fed to raise the money supply!!
Putting inflationary pressure on the dollar
In 1972 another run on the dollar ensues
The fixed exchange rate thus collapsed
There is a moderate devaluation of the dollar
A floating (or managed float) system of exchange rates ensued
Surprisingly the dollar did not see major decline in use
Dollar’s share of international reserves stayed near 80%
Due in large part to the fact oil exporting countries earning higher prices parked their earnings in NY 13

14. Bretton Woods—The Rise and Fall
Inflation during Jimmy Carter’s administration was high
Followed Nixon’s resignation
Carter turns to Paul Volker, then head of The Fed to fix the problem
Volker raises US interest rates to astronomical levels and inflation subsides at the end of Carter’s presidency
After this the decline of the dollar’s proportion as other countries reserves stabilizes 14