From the History Books: The Rethinking of the International Monetary System

IMF Blog, August 16, 2021

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From the History Books: The Rethinking of the International Monetary System

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Bibliographic details

• Authors: Atish Rex Ghosh
• Published: August 16, 2021

The Bretton Woods era

• Key events and dates:
  • Bretton Woods system established in 1944.
  • On August 15, 1971, US President Richard Nixon suspended dollar convertibility by closing the “gold window.”
  • The official price of gold under Bretton Woods was $35 per ounce.
• Institutional design and rules:
  • Currencies were fixed relative to the US dollar, and thus implicitly fixed in terms of gold.
  • IMF member countries could alter their exchange rate parity only in cases of “fundamental disequilibrium”; only the member country could propose a change in parity, and the IMF could approve or not approve the proposed change.
  • The IMF would lend reserves (usually dollars) to enable central banks to maintain parity without “resorting to measures destructive of national or international prosperity.”
• Operational dynamics and tensions:
  • Governments of deficit countries with overvalued currencies often delayed necessary devaluations for fear of political repercussions.
  • Surplus countries had little incentive to revalue, benefiting from trade competitiveness advantages.
  • The rise of private cross-border capital flows meant rumors or expectations of devaluation could precipitate capital flight from deficit countries into surplus countries, aggravating instability.
• 1960s–early 1970s pressures:
  • Experience during the 1960s showed artificial stability of individual exchange rates could delay adjustment and end in traumatic balance-of-payments crises.
  • The United States experienced a balance-of-payments crisis in the early 1970s, driven by lax domestic monetary and fiscal policies to finance the Vietnam War and the “Great Society” programs, alongside reluctance of major surplus countries (notably Germany and Japan) to revalue their currencies.
  • As the United States hemorrhaged gold reserves, Nixon’s closure of the gold window—intended to force revaluations—effectively brought down the system.

New system, new thinking

• Shift in conceptual basis for stability:
  • Post-collapse thinking rejected the presumption that fixing individual currencies against gold or the dollar would ensure stability; fixing created rigidity rather than stability.
  • Attempts to maintain pegs through exchange restrictions or capital controls when exchange rates diverged from domestic policies produced costly and ultimately futile delays in external adjustment.
• Policy emphasis:
  • Stability of the international monetary system was reframed as deriving from domestic policies oriented to domestic stability: orderly growth with low inflation.
  • Domestic stability would yield stable—but not excessively rigid—exchange rates, permitting timely external adjustment and contributing to overall system stability.
• IMF role changes:
  • Countries were no longer required to declare and maintain a fixed parity.
  • The IMF was charged with exercising “firm surveillance” over members’ exchange rate policies to prevent competitive devaluations/depreciations or other currency manipulation.
  • Over time, especially after the 2008 global financial crisis, experience showed domestic stability may still be insufficient for system stability when systemically important countries are involved.
  • Countries now regularly discuss with the IMF the external spillovers from their domestic policies; while not required to alter policies that promote domestic stability, they may be encouraged to consider alternative policies if those better promote stability of the system as well.

What the future may hold

• Historical lesson and enduring principle:
  • The collapse of the system of fixed exchange rates in 1971 underscored that monetary systems must evolve as societies change.
  • The bedrock principle: stability of the international monetary system will depend on international monetary cooperation.
• Emerging considerations and scenario points:
  • Fundamental transformations are accelerating the development, deployment, and adoption of digital money.
  • Possibility posed: a digital transformation of the international monetary system could be underway, changing how international monetary cooperation and stability are achieved.
• Policy implication:
  • Regardless of technological or institutional changes, international monetary cooperation remains essential to ensure the stability of the international monetary system.

Article by Atish Rex Ghosh — August 16, 2021