Bretton Woods 1971-2021: The birth of the new age of modern markets.

• Author: Mulford, David C.

Closing the U.S. gold window and scrapping fixed exchange rates happened in August 1971. It was bound to happen eventually--and it did, later than it should have. The writing was on the wall at least three years before the event.

Wage and price controls were also introduced at the same emergency monetary meeting at Camp David and this was a significant mistake by President Nixon and the Federal Reserve. These actions did not contain inflation as hoped nor did they help generate growth.

To understand why closing the gold window and scrapping Bretton Wood's fixed exchange rate regime were not mistakes, and wage and price controls were a mistake, one has only to look at the history of the times before and after each of these policy events.

Abandoning the Bretton Woods fixed exchange rate system and terminating the U.S. dollar's link to gold proved to be an historic regime change that influenced world economic developments and the evolution of global markets for the rest of the century. Essentially, over these years the world moved from a system of pervasive capital controls to the free movement of capital which today is taken for granted in world markets. Wage and price controls, on the other hand, was simply a damaging policy mistake that was overcome by new policies in a few years.

By the mid-1960s, the United States was suffering from a sharply rising balance-of-payments problem. This was due to the economic recovery of Europe and Japan after the destruction of World War II, and accelerated by the costly U.S. military buildup in Vietnam and President Johnson's simultaneous commitment of resources to his Great Society programs. U.S. companies were also investing heavily overseas in these years and American tourists were flooding to Europe to spend their new savings.

The fixed exchange rate system as advertised was not for real. Instead, it was a fixed system which from time to time, without warning, was adjusted by individual players deciding suddenly under duress to devalue their currencies, such as the United Kingdom devaluing sterling by 14 percent in November 1967. These mini-crises themselves defined the reality of the fixed exchange rate system, making the Bretton Woods system appear more like a large-scale stop-and-start exercise, with no predictive order or consensus.

What was significant at the time was the combination of these forces. The outflow of U.S. dollars taken as a whole was creating and fueling the popularly known Euro bond and Euro currency markets in London from 1963 onwards. Although relatively small at the time, these were by and large unregulated, cross-border markets that provided an important source of financing to companies and governments. They were supra-national in nature, spread across and over national, stillclosed, and regulated European markets, which continued to follow the regulatory habits of the post-war period. U.S. policy actions helped fuel this growing market initially, first by imposing the U.S. interest equalization tax in 1963, effectively closing the U.S. market to foreign borrowers for the next ten years. A...