Bretton Woods Agreement was signed 75 years ago today, and our global financial system is its descendant thrice removed.
Today’s papers lament the passage of the Agreement, but they miss some deeper points, as is their wont.
Bretton Woods was the West’s last attempt to retain a semblance of economic sanity by limiting the state’s ability to meddle in the economy. Since meddling is coded into the modern state’s DNA, pegging paper currency to some universal equivalent was the only way to curb the state’s instincts.
That’s why, when the West was still compos mentis, all major Western economies were on the gold standard. Governments then used their power to govern, rather than governing to increase their power. However, when the situation changed, the state had to slip the tethers of fiscal responsibility imposed by the gold standard.
To be fair, the gold standard has its downsides: for example, it limits the government’s ability to increase the money supply as a means of combating recessions, which inevitably occur whenever supply and demand get out of sync.
Yet the gold standard limits not only the state’s flexibility, but also its ability to increase its own power by using inflation the way Robin Hood used his bow for redistributive robbery.
Hence the attraction of the gold standard, at least to those who value freedom above an ability to ride the economic rollercoaster through hair-raising rises and dips.
The difference between people’s assets denominated in gold or in currency is critical. Gold is a factor of its owner’s independence: it’s beyond the state’s reach, more or less. Its value may dip occasionally, but never all the way to the bottom.
Not so banknotes: we’re welcome to stuff suitcases full of paper, but the government has an almost absolute control over its value because it keeps inflationary levers in its hands.
However, until 1971 some tenuous link between paper money and gold still existed, as America still settled her foreign debts in gold. In fact, once Western countries had abandoned the gold standard, the Bretton Woods Agreement established a version of the same system.
The signatories agreed to peg their post-war exchange rates to the dollar, while the US government undertook to keep the price of gold fixed at $35 an ounce, thus linking all the participating currencies to gold at one remove.
This was supposed to free up world trade by eliminating competition among currencies, and the supposition was sound in principle. However, the Agreement suffered from a congenital defect: it went against the grain of an inherently statist modernity.
Richard Nixon drove that point home in 1971 by killing Bretton Woods stone dead. He drove down the value of the dollar by suspending its convertibility into gold and introduced a 10 per cent levy on imports, along with some short-lived wage and price controls.
Nixon claimed that would create more American jobs. What it created instead was a temporary stagflation – and never-ending government promiscuity in finance. Instead of sitting on the rock-solid foundation of the gold standard, the world began to float on an ocean of debt.
State spending financed by borrowing and the printing press could now proceed unabated. And runaway state spending is the prime cause of inflation.
I like to illustrate this point by comparing Britain’s inflation over the last 50 years of the nineteenth and twentieth centuries. In the former case, it was a meagre 10 per cent; in the latter, a soul-destroying 2,000 per cent.
Such public recklessness has to produce a private equivalent. If money keeps losing value, people turn into either spendthrifts or gamblers.
They spend their cash as quickly as they get it and, if their income doesn’t keep up with their desires, borrow with scant regard for tomorrow. Alternatively, they take chances investing their money before it disappears.
That was the nature of the 2008 crisis: in the preceding 20 years household borrowing in the US had exceeded household income by a factor of three, while the banks had been handing out subprime loans like Smarties.
But at least some sort of discipline persevered in international trade, which had been one of the aims of Bretton Woods. Countries competed more or less fairly, restrictions on trade were few, and duties, if any, tended to be low.
That happy situation survived for as long as the West’s economic supremacy went unchallenged. However, the emergence of the EU protectionist bloc and especially of communist China as a major economic power put paid to the legacy of Bretton Woods.
China’s evil regime scorns civilised behaviour in general and economic behaviour specifically. Hence China undercuts global competition by subsidising her supposedly private enterprise, keeping her own currency artificially low, stealing the West’s intellectual properties and punishing imports with extortionist tariffs.
Now, David Ricardo (d. 1823) showed persuasively that import tariffs aimed at foreign competition end up hitting the country’s own consumers. His advice was to desist from introducing tariffs even in retaliation for such practices elsewhere.
That advice is sound on its own terms, but it fails to take into account the possibility of an evil power being able to compete with a residually civilised West.
It also ignores the mentality of modern nations and some of their leaders. Enter Donald Trump, whose understanding of economics was informed by building casinos for domestic gangsters and luxury apartments for international ones.
He operates on simple principles: you scratch my back, I’ll scratch yours; you kick my backside, I’ll kick yours. Guided by such down-to-earth philosophy, Trump has driven the last nail into the coffin of Bretton Woods, or rather its legacy.
He has introduced import tariffs and is determined to weaken the dollar in an attempt to make American exports more competitive. A currency war is looming, and this is a war with heavy casualties and ultimately no winners.
One inevitable casualty is free – well, freeish – trade, on which the West’s prosperity has been built. China will suffer much immediate pain as a result, but in the long run we all will: sound economic laws have never been repealed.
This isn’t an attack on Donald Trump: he’s trying to untangle the maddening complexities of today’s world as best he can. It would take a philosopher king of Plato’s fancy to respond adequately to every modern challenge as it arises.
Alas, today’s kings aren’t philosophers and today’s philosophers aren’t kings. The two types have gone their separate ways, and men combining the requisite traits to be both have never been thick on the ground.
Bretton Woods Agreement and its aftermath, RIP.