August 15, 2021 marks the 50th anniversary of the day President Richard Nixon “closed the gold window,” ending the postwar Bretton Woods international monetary system. It is an appropriate moment to reconsider the internal inconsistencies of the Bretton Woods system. As its contemporary critics understood, Bretton Woods was doomed to fail if it could not be fundamentally reformed. One of its chief contemporary critics was the French economist, Jacques Rueff.
Rueff (1896 –1978) was the most important French classical liberal economist of his generation. As a young economist, he worked under Raymond Poincaré on the successful devaluation of the franc in 1926. He then worked on financial issues for the French embassy in London, where he observed first-hand Britain’s failed attempt to resume the gold standard after a wartime inflation, without devaluation against gold to match the wartime erosion of the pound’s purchasing power relative to gold (or enough deflation to raise the pound’s purchasing power back to that of gold’s). Rueff came to attribute the Great Depression to the failure to re-establish the classical gold standard after the war. Instead, an improvised and ever-changing “gold-exchange standard” allowed imbalances to build up until the financial system crashed. It was not the classical gold standard, but a gold-exchange standard mismanaged by central banks, that failed in the interwar period.
Rueff helped to organize the Walter Lippmann Symposium, an international gathering of classical liberals in Paris in 1938 to discuss Lippmann’s 1937 book The Good Society. The meeting has been seen as a precursor to the Mont Pelerin Society. He would later attend the first meeting of the Mont Pelerin Society. In 1939 he became Deputy Governor of the Bank of France, but was dismissed during the German occupation on account of his Jewish ancestry.
After the Second World War, Rueff was a leading free-trade advocate while holding a variety of official positions in the French government, in the European Coal and Steel Commission, and on the European Court. When French President Charles DeGaulle returned to power in 1958, he appointed Rueff to chair a commission on fiscal and monetary reforms for France. The resulting “Rueff Plan” made the French franc freely convertible into dollars, ending exchange controls, after a sizable devaluation. The plan also included tariff reductions, the removal of business subsidies, and a halving of the budget deficit. In his obituary, the New York Times wrote that Rueff “was perhaps best known for his austerity reform program of 1958, which stabilized the French economy” at the outset of de Gaulle’s Fifth Republic, adding: “With adoption of the Rueff Plan, the French economy began a period of vigorous industrial and trade expansion and Mr. Rueff continued in prominence through the 1960s as a sharp critic of United States monetary policies and payments deficits.”
The Internal Contradictions of Bretton Woods
Rueff and the American economist Robert Triffin were the two most prominent analysts to identify the inbuilt problems of the postwar international monetary system established at Bretton Woods. Under the system, the currencies of other nations were to maintain fixed exchange rates with the U.S. dollar (they were redeemable for U.S. dollars, but not directly for gold). The U.S. dollar was the “key currency,” the only one directly redeemable for gold and against which a large gold reserve was held. The right to redeem, however, was limited to foreign central banks. U.S. firms and citizens continued to be legally barred from holding monetary gold. To get gold by redeeming U.S. dollars, a foreign central bank had to be willing to risk the disapproval of the U.S. authorities, at a time when the U.S. was providing Marshall Aid and defense against the Soviet Bloc.
Rueff saw in the Bretton Woods system, with the U.S. dollar the key currency, the same weaknesses exhibited by the gold-exchange system during the interwar period with the British pound and the U.S. dollar then sharing key currency status. Under the classical gold standard, every central bank (or banking system, if like the U.S. and Canada it had no central bank) held its own gold reserves. Under Bretton Woods, by contrast, non-U.S. central banks held only assets denominated in the gold-redeemable U.S. dollar (most importantly, U.S. Treasury bonds) as their reserves for maintaining a fixed exchange rate with the dollar.
This arrangement gave the United States what France’s Minister of Finance called an “exorbitant privilege.” The U.S. could acquire goods and services from the rest of the world merely by expanding the supply of dollars, with the bill coming due only in the indefinite future. The temptation proved irresistible. The Bretton Woods set-up was not incentive-compatible: It enabled the U.S. government to profitably issue the world’s reserve currency, with immediate benefit but little immediate cost to pursuing a monetary policy too expansionary to maintain its peg in the long run. Foreign central banks held dollar assets as reserves and therefore would gladly accept them—up to a point. (The foreign central banks did not hold Federal Reserve Notes or dollar checking account balances; they swapped those for interest-earning safe dollar assets.) The flow of dollars overseas meant that foreign monetary systems gained reserves and also could nominally expand, while (in contrast to the classical gold standard under which the U.S. would lose gold to settle its balance of payments) the U.S. did not need to contract. Thus the gold-exchange system, in Rueff’s words, “substantially impaired the sensitivity and efficacy of the gold-standard mechanism” at self-regulation.
Notice the qualifier in the previous paragraph: up to a point. The immediate postwar period was characterized by complaints of a “dollar shortage” in Europe as central banks tried to build up the dollar reserves that they need to peg their national currencies to the U.S. dollar. Over time, with the U.S. government happily printing dollars to export to Europe in exchange for goods and services, talk turned to the problem of a “dollar glut.” European central banks accumulated more dollar-denominated IOUs than they wanted. As Rueff later noted, the U.S. could even go somewhat beyond the willing-accumulation point to the extent that it could successfully use political or diplomatic leverage to discourage foreign central banks from redeeming its currency. But such diplomatic talk could not be effective forever as ongoing monetary expansion caused ever-growing reserves of dollars to pile up in European central banks.
Unlike Triffin, who favored patching over the problems of the Bretton Woods system with expanded IMF credit facilities, Rueff recommended eliminating its core contradictions by replacing the Bretton Woods gold-exchange standard with a full-fledged international gold standard of the classical pre-WWI sort. Each nation was to hold its own gold reserves. In this recommendation Rueff was nearly alone, joined by only one contemporary European economist, Michael Heilperin of the Graduate Institute of International Studies in Geneva. In the United States, the economic journalist Henry Hazlitt criticized Bretton Woods along lines similar to Rueff’s. International policymakers, of course, did not embrace Rueff’s analysis or recommendations.
The Unraveling of the Bretton Woods System
Gold drained from the U.S. Treasury throughout the 1960s as European central banks understandably redeemed some of their accumulating dollar inventories. Shrinking U.S. gold reserves in turn amplified redemptions: European central banks must have understood the growing danger of a devaluation of the U.S. dollar against gold as U.S. gold reserves ran out. A central bank left holding dollar assets when devaluation came would have redeemed too little too late.
The International Monetary Fund tried to paper over the problem by issuing “Special Drawing Rights” (SDRs) for use as international settlement media in lieu of gold. But the SDRs proved futile at stopping the drain of gold from the U.S. Treasury. When U.S. gold reserves fell critically low in August 1971, rather than tighten U.S. monetary policy, Nixon “shut the gold window,” severing the international monetary system’s last link to gold. An unbacked settlement system was tried in the Smithsonian Agreement of 1971, but it lasted less than 18 months before the world entered the modern era of outright floating fiat currencies.
Rueff’s 1971 book The Monetary Sin of the West (first published in French as Le Péché Monêtaìre de l’Occident) provides a scrapbook of the ever-worsening situation under the Bretton Woods system during its last decade. Rueff saw the imbalances building up in the 1960s as similar to those that built up prior to 1929, and feared a crisis of Great-Depression scale. The crisis that unfolded in 1971 was not a debt-deflation crisis, however. It turned out to be a debt-repudiation and inflation crisis.
In passing, Rueff perceptively argued that chronic crises are to be expected when a central bank is placed in charge of a gold standard. The market mechanisms of a decentralized gold standard coordinate money supplies with demands better than any central monetary planner can or will: “I do not believe, as a matter of fact, that the monetary authorities, however courageous and well informed they may be, can deliberately bring about those contractions in the money supply that the mere mechanism of the gold standard would have generated automatically.” In practice, the authorities delayed contraction, prolonging the boom until the necessary correction is a large painful shock, whereas a decentralized gold standard operates daily, slowly, and gradually to maintain equilibrium via the price-specie flow mechanism.
In a February 1970 article from Le Monde, included in The Monetary Sin of the West, Rueff warned that “if residual requests for conversion of dollars into foreign exchange or gold … were more than the United States could satisfy,” the American monetary authorities would have to close the gold window. As an accompanying footnote, inserted into the 1972 American edition, poignantly reads, “That happened on 15 August 1971.”
Rueff’s consistent prognosis that the Bretton Woods system could not survive in its then-current form, because other national governments would eventually be unwilling to continue accumulating piles of dollar claims, proved correct. On the other hand, Rueff consistently warned that another Great Depression loomed if the system was not promptly fixed in the manner he suggested. He wrote many times about a “catastrophe” in the works. After the fact, we know that these warnings were unduly alarmist. He failed to consider the exit strategy that Milton Friedman (16 years Rueff’s junior) proposed during the 1960s, even before the U.S. gold reserves began to run out, namely a move to floating exchange rates combined with a monetary rule for constraining inflation once the gold-redemption constraint was removed. No deflation was necessary.
Of course, Friedman only got the first half of his program. The de jure end of Bretton Woods ratified the de facto end (since the mid-1960s) of the Fed making monetary policy as though constrained by gold redeemability. No other constraint replaced it. Annual money growth (M2) hit double digits. The inflation rate, already rising, followed: it moved into double digits in 1974, 1979, and 1980. As it turned out, then, the Bretton Woods gold-exchange system ended in monetary expansion and the Great Inflation, not in monetary contraction and a Great Depression. One might say that the inflation merely postponed the recession to 1980-82. While it is true that 1980-82 was a relatively severe recession, it was nothing like the Great Depression.
Reprinted from the Cato Institute