The Bretton Woods agreement was mostly negotiated by the United States and Britain, and it eventually included forty-four member countries (Ikenberry, 1993). The agreement was reached in principle to allow the world economy to forsake trade blocs and regional currencies in favor of a "liberal multilateral framework" (Ikenberry, 1993, p. 155). The Bretton Woods accord was based on the Anglo-American pact. The rules were designed to create high levels of national commitment to trade expansion and openness in order to ensure economic stability and full employment. Early proponents of hegemony thought that a single and dominant state could create order in world politics and economics. The world order in this perspective entails the provision of public goods and the establishment of regimes. To maintain this order, a continued hegemony is required (Beeson, 2006, p. 2). This implies that effective cooperation between the member states is required within the developed system. The hegemony acts as the stabilizer of the world economy.
Moreover, a liberal global economy requires a hegemon highly committed to protecting the liberal economic principles like nondiscrimination, openness, and free markets (Ipek, 2012). This indicates that there are three key conditions for the development and expansion of Bretton Woods (liberal market system) (Beeson, 2006, p. 5). They include a hegemony, common interests between participating states, and the liberal minds. A hegemon is “a necessary but not sufficient condition” for the establishment and maintenance of a liberal global economy. It just helps the system to hold together and stabilize. However, with time, the stabilization role of the hegemony becomes limited and thus making the system unstable and leading to its fall. This essay aims at investigating if the rise and fall of the Bretton Woods was related to the rise and fall of America as a hegemon in this system.
The Rise of Bretton Woods
The formation of the Bretton Woods was based on the ‘White plan’ that guided the negotiations (Ikenberry, 1993). The plan aimed at forming an International Monetary Fund (IMF) with foreign exchange and gold contributions from member states (Bordo & Eichengreen, 2007). The participating countries had to borrow limited amounts on a conditional basis in order to finance their BOP deficits (Meltzer, 1991). The British government was compelled to accept this White plan together with the tight liquidity constraints. However, the British government demanded a number of concessions from the US which were granted in various ways. First, the hegemon (US) provided ‘scarce currency clause’ which enabled the rationing of any scarcely supplied currency. The rationing was to be done through the IMF (Bordo, 2017). Second, a transition period was established to allow the exchange restrictions and discriminatory trade. After the transition period, member countries had to implement the currency convertibility which targeted transactions on current accounts (Meltzer, 1991). Negotiators from both British and US agreed on the restrictions placed on short-term movement of capital as a necessary condition for the control of the domestic monetary system (Bordo, 2017, p. 4). In Bretton Wood agreement, the exchange rate of the US was pegged to the gold as opposed to other member states whose par values were pegged to the currency of each other (Bordo & Eichengreen, 2007).
Being the strongest state in the world after World War II, the US pursued a global-integrated economic order to protect its social welfare and domestic preferences (Meltzer, 1991, p. 55). The country was minimally impacted by the war and thus its administration focused on nationalism and vast economic mobilization in order to engage with the rest of the world. The export manufacturers from the US faced minimal competition from other European economies which were devastated by war (Ikenberry, 1993). The US was the major creditor state across the world and thus had to sustain its import markets. This led to homogeny cooperation that favored the establishment of the fixed-but-adjustable rate of exchange regime (Bretton Woods) (Meltzer, 1991, p. 56). Therefore, the establishment of the Bretton Woods was fostered by the domestic interests of America including orientation to international sectors and demand for greater social welfare. The domestic influence of the hegemon regarding sustainable and open capital and trade flows enhanced the rise of Britton Woods System. In fact, both the British and American policymakers agreed on the prioritization of currency convertibility and stability during the formation of Bretton Woods (Ikenberry, 1993). This stabilization aimed at enabling the governments to adopt expansionary and multilateral policies to offset trade and capital imbalances. The targeted international cooperation was to enable effective management and tolerance of the short-term imbalances in exchange rates (Ikenberry, 1993, p. 298).
The post-1945 world capitalist economy was developed due to the hegemony or dominance of the US (Uzan, 2007). Both the US and the Britain had a substantial interest in restoring a prosperous and stable global economy. America was the hegemon of the Bretton Woods and thus had the ability to facilitate leadership and stability of the alliance (Beeson, 2006, p. 6). According to Uzan (2007), America was the only dominant power with the ability to act unilaterally in stabilizing the Japanese and European economies after World War II. Besides, the country has the capacity to manage a global financial system. This is because it possessed the technological superiority, political control over key resources, and stronger competitive advantage than other members (Meltzer, 1991). The US had high status and prestige in the global political system making its roles to be legitimized and accepted. The US intervention in the two destructive wars made it to find a way of restructuring the international economic and political relations in line with its particular interests and liberal ideals (Beeson, 2006, p. 6). This led to the formation of the Bretton Woods an international monetary system. However, the formation of the Bretton Woods also depended on Britain’s consensus since its economic position did not allow Britain to have the hegemonic leadership (Bordo, 2017).
In Bretton Woods, America utilized its influence and resources to form and manage a global economy based on monetary stability, free capital movement, and free trade (Beeson, 2006, p. 1). To achieve the international order, the US encouraged other powerful nations to adhere to the principles of the liberal market (Ikenberry, 1993). According to the hegemony theory, the hegemon offers collective or public goods like international security, open economy, and stable global currency (Ipek, 2012). The size of the US enables it to perform this role because the country's size ensured that the costs associated with such provisions are lower than economic gains accrued (Braithwaite & Drahos, 2001). The influence of the US emerged from its ability to control capital in terms of providing and denying credit and borrowing at a cheap rate (Meltzer, 1991). The US focused on preventing free riding, exploitation, and cheating of other nations. Since it has the dominant power, the US enforced rules and principles of the liberal economy and encourages the other countries to share the system’s costs. However, the overwhelming power of the US did not enable it to simply formulate rules regarding the global monetary system. In addition, the formulated rules formulated by the US to guide Bretton Wood agreement were inappropriate to the after-war global conditions (Bordo, 2017).
During 1950’s, the US dollar rose to prominence due to the stabilizer role it played in the global economy (Ikenberry, 1993). Besides, the deep and open capital markets and the importance of the US in the international trade strengthened its currency compared to other players (Bordo, 2017). The dollar became a private global money and was used in the 1960s as value store, the medium of exchange, and unit of account in exports and import invoices (Meltzer, 1991, p. 56). The continuous private acceptance of the dollar across the world as the main intervention currency made it be used as financial reserve across the world (Bordo, 2017, p. 5). The Bretton Woods became the standard for gold dollar by 1960 because the balance of payment deficits of the US provided rest of the world with dollar reserves to facilitate international trade (Humpage, 2015). A strong dollar made the US a dominant stabilizer of the Bretton Woods. For instance, when British recorded massive deficit in its balance of payment in both dollars and gold, the US offered it with a loan of $3.75 billion (1946 Anglo American loan) in order to restore the convertibility of its current account (Bordo, 2017, p. 10).
The Fall of Bretton Woods
According to Bordo (2017, p. 21), the breakdown of Bretton Woods was caused by the increased inflation in the US which was the center country of the system. The inflation began in 1965 when the administration of Willian McChesney Martin, the chairman of the Federal Reserve adopted the inflationary policy. According to Leeper and Walker (2011), the new policy adopted by the Fed integrated the increasing fiscal deficits through the use of fiscal dominance strategy. The expenditures on the Vietnam War increased the fiscal deficits of the US. This fiscal pressure made the Fed adopt the accommodative monetary policy where the interests rates would be stabilized during the funding of the operations by the Treasury (Meltzer, 1991). Humpage (2015) argued that these operations constrained the Federal Reserve from tightening the country's monetary policy to offset the pressures from the inflation. The gold reserves of the US were insufficient to meet the outstanding dollar liabilities (Bordo & Eichengreen, 2007, p. 54). The Fed administration feared to curb the inflation because adopting tight monetary policies would increase the rate of unemployment (Bordo, 2017, p. 22). In order to finance the expanding fiscal needs, the US started inflating its exports. The designed policies to curb the inflation were not appropriate to the principal currency of the Bretton Wood system (Beeson, 2006). Therefore, the rising inflation in the US spread to other parts of the world because of the expanding deficits in the balance of payments. Since the US was viewed as a supply of the financial intermediation services across the world, most individuals hold the dollar balances because of its valuable service flow (Bordo, 2017). The inflation was enough to stimulate speculative attack on the monetary gold stock of the world in 1968 (Bordo, 2017, p. 25). This led to Gold Pool breakdown. The breakdown implied that the US was to maintain the price stability across the system. However, the US implemented the inflationary monetary policy that led to ultimate fall of the system. The US violated the Bretton Woods' rule of adopting fiscal and monetary policies which are consistent with the agreed upon (official) peg during a crisis (Leeper & Walker, 2011).
Secondly, Bretton Wood broke down due to the unwillingness of the surplus states to adjust and integrate dollar balances and also revalue their currencies (Bordo, 2017, p. 25). During the early 1970s, the Bretton Woods was threatened by the increased economic conflict between the key industrial states and the economic decline of the US (Rathnayake, 2012 ). For instance, the real exchange rates were changed by the increasing differences in productivity between Japan and Germany on one hand and the US on the other. This growing gap between these big economies indicated a decline in the power of the US in the Bretton Wood System. The system lost its effectiveness due to the declining US power relative to other European states and Japan. As a result, there was no central source of power (hegemony) leading to a decentralized system (Bordo, 2017). The hegemon theory argues that with increasing liberalization, more dynamic, competitive, and efficient economies emerge and undercut’s the economic surplus and international position of the hegemony (Ipek, 2012). In this case, Japan and the British present these efficient and dynamic economies which reduced the power of America in overseeing the functioning of the Bretton Woods. Regimes with well-dispersed powers (lack hegemony) experience difficulties in providing global collective goods like financial assistance during a crisis.
Third, there existed two design flaws in the Bretton Woods System that led to its collapse (Bordo, 2017). First, the gold exchange system placed the US under convertibility crisis. In fact, this threat made it difficult for the hegemon to adjust the pursued inflationary policies. Second, the process of changing the formulated adjustable peg entailed was costly thus making it to evolve into ‘a reluctant fixed exchange rate system with lack of effective adjustment’ (Bordo, 2017, p. 26). This made it difficult for the US to stabilize and manage the Bretton Woods. The international competitiveness of the US decreased leading to financial crisis (Great Inflation) and the collapse of Bretton Woods.
Conclusion
The above discussion has shown that the rise of a hegemon can lead to a liberalized and open market economy. However, the decline of the Hegemon’s powers will lead to the closure or collapse of the developed system. After World War II, the US dominated the world economies and had the hegemony to organize and manage an international financial system. Due to the strength of its dollar and its monopoly over the export markets, the US formulated the Bretton Woods agreement with Britain to liberalize the market and create fixed-but adjustable exchange rates. There are two main factors related to American hegemony that led to the fall of Bretton Wood. First, the liberalized markets led to the emergence of strong economies in Europe and Japan and thus declining the power of the US. Second, the increasing balance of payment deficit increased the rate of inflation in the US which later spread to other parts of the world.
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