Bürgenstock: the anti-Bretton Woods
Reflections on the 80th anniversary of the Bretton Woods conference
July saw the 80th anniversary of the 1944 Bretton Woods conference, which agreed on the post-war institutional framework for the international monetary system. Following is an op-ed I wrote in 2019 on the occasion of the 75th anniversary discussing the lesser known 1969 Bürgenstock conference that laid the intellectual groundwork for dismantling the Bretton Woods system of fixed exchange rates. Exchange rate determination is topical again, with US Presidential candidate Donald Trump proposing to pursue a weak dollar policy. It is useful to put these proposals in the context of previous US and international exchange rate regimes.
When I was editor of Policy, I asked the late Wolfgang Kasper, one of the Bürgenstock conference participants, to write a reflection on the conference, published as The emergence of free exchange rate regimes - a personal account.
Wolfgang also sent me an unpublished autobiographical note on the conference, as well as some 9mm home movie footage he shot in and around the conference venue, featuring many of the leading economists of the time. The previously unpublished autobiographical note and the video are included below with the permission of Wolfgang’s family.
Beware of romanticising the legacies of Bretton Woods
by Stephen Kirchner, AFR, 26 July 2019
The Bretton Woods system of fixed exchange rates and the multilateral trading system established shortly thereafter through the General Agreement on Tariffs and Trade (GATT) were both responses to the beggar-thy-neighbour protectionism and currency wars of the 1930s that contributed to the rise of political extremism and World War II.
The post-war international economy prospered under US leadership and the international rules-based order it helped to establish.
While the aspirations of the Bretton Woods conference were worthy, the institutions it established, most notably the system of fixed exchange rates linked to the US dollar and gold, were not robust. Moreover, they were in fundamental tension with the multilateral trading system.
Milton Friedman recognised as early as the 1950s that the trade and macro-economic imbalances that would build up under a system of fixed exchange rates would ultimately threaten rather than facilitate free trade.
If exchange rates could not adjust to these imbalances, then domestic inflation and economic activity would have to do the adjustment. Fixed exchange rates would become the tail that wagged the dog of the domestic economy. Politicians would resist these adjustments through controls over cross-border trade and capital flows.
The Bretton Woods conference also established the International Monetary Fund to provide assistance to countries facing pressure on their exchange rate from their balance of payments with the rest of the world.
Foreign exchange reserves, together with assistance from the IMF when needed, could in-principle act as a shock absorber in maintaining a stable foreign exchange rate against pressure to revalue. But an increasingly globalised economy inevitably generated economic shocks that overwhelmed the defences offered by foreign exchange reserves and assistance from the IMF.
As Friedman pointed out subsequently, the Bretton Woods system functioned as intended for only eight years, from 1959 to 1967. The late 1960s and early 1970s saw the system break apart and gradually replaced by a system of floating exchange rates.
Two academic conferences in 1969, organised principally by the Austrian-American economist Fritz Machlup, laid the intellectual groundwork for the shift to an international system of floating exchange rates.
While the Bretton Woods conference is still celebrated, the two conferences that contributed to the dismantling of fixed exchange rates are little known today. Yet the system of floating exchange rates they promoted arguably did more to underpin the prosperity of the global economy since the 1970s than the dysfunctional Bretton Woods system.
Australia was late to float, having resisted the change until what former Reserve Bank governor Bob Johnston called ‘the death knock’ in December 1983. The floating exchange rate became a foundation of Australia’s prosperity from the early 1980s.
Some Bretton Woods institutions, most notably the IMF and World Bank, persist. While floating exchange rates rendered the IMF redundant, it has managed to reinvent itself and resist pressure for reform.
Private capital markets have done more to foster economic development and address global poverty than the IMF’s sister institution, the World Bank, but it too has survived.
Bretton Woods revivalists still walk among us. President Trump’s proposed nominee to the board of governors of the Federal Reserve System, Judy Shelton, has advocated a return to a system of fixed exchange rates backed by gold.
Responding to one of Shelton’s Wall Street Journal op-eds in 1994, Friedman wrote "it would be hard to pack more error into so few words".
It is difficult to square Shelton’s Bretton Woods revivalism with President Trump’s desire for easier monetary policy and a weaker exchange rate, although Shelton has shown considerable flexibility on this score since becoming a prospective Fed nominee.
President Trump’s trade war with the rest of the world is ultimately constrained by the system of floating exchange rates. China is only at risk because it maintains a managed exchange rate, but even China could in principle devalue, if not float, to neutralise Trump’s tariffs.
The danger is that Trump then seeks to drag the US dollar into his trade war by intervening in foreign exchange markets or politicising Federal Reserve monetary policy.
Financial markets are already gearing up for the prospect of foreign exchange market intervention. The Federal Reserve has often taken a subordinate role in foreign exchange intervention operations led by the US Treasury.
Friedman was dramatically vindicated by the collapse of Bretton Woods. Always alert to dangerous economic ideas, Friedman also rang the bell on Judy Shelton’s intellectual errors.
Instead of romanticising Bretton Woods, we should instead be recalling the warnings of its greatest critic.
The Bürgenstock conference: an autobiographical reflection
by Wolfgang Kasper
The 1969/70 Annual Report of the [German] Council [of Economic Experts] came out after the new Social-Democrat government of Willy Brandt had taken over. It dealt again, and more urgently, with externally caused inflation and exchange-rate issues. Soon afterwards, [Herbert] Giersch drew on me again to help him write papers, this time for a big international conference series about exchange rate reforms. Milton Friedman (Chicago), Fritz Machlup (Princeton) and a small number of bankers and finance directors of large corporations on both sides of the Atlantic had proposed a working group of academics and practitioners to establish once and for all whether flexible exchange rates were practically feasible or not. In January 1969, Giersch came back from a meeting at Oyster Bay, NY, which had been attended by 38 experts and promised interesting and policy-relevant insights. Now, I was to help him to draft and polish a paper on how currency reform would affect the net profits of enterprises, i.e. sales, prices and cost levels. So, again, my PhD work was put on the back burner.
Then, in May, Giersch fell gravely ill. I sat by his bedside in his home. It became patently clear that he could not write the paper he intended. Giersch had also promised a paper describing how a German business cycle would have worked out under a flexible DM exchange rate. I sat down and wrote something under my own steam, which Giersch accepted rather passively, pale and ill in his bed. The idea had arisen from a conversation between Giersch and Dr Otmar Emminger, the Vice President of the Bundesbank and the man in charge of its international department. Emminger had said: "If anyone can demonstrate to me how things would have worked out under a floating D-mark and without recurrent currency crises, I would be ready to accept that the IMF system should be abandoned." I sat down trying to speculate about an alternative German economic history over the last business cycle, with the D-mark flexible and the price level stable! I got the work done before the deadline for the acceptance of conference papers. Giersch read it. He said that we should publish this under our joint names [1]. From him that was high praise indeed! When he recovered and prepared to go to the conference in Switzerland, he arranged for me to be invited as well.
From June 22-28, 1969, I was one of the 38 participants in the Bürgenstock Conference. What an experience to be mixing with these most famous names! Regine and the girls went to stay in an old farmhouse in the Emmental while I was gone to the mountain top of the Bürgenstock, a luxury hotel high above Lake Lucerne. I did not know what to expect. It turned out to be an intensive feast of ideas and inspiring meetings, me the Benjamin amongst great names from ten different countries. It was obvious that many of the greats knew each other, but I was made to feel most welcome and treated as an equal. As we sat alphabetically, I came to sit next to Prof. Harry Johnson, the giant from Chicago and LSE, who amazed me with his absorption capacity for hard drink - not for the last time. We had adjoining rooms. Harry arranged for the connecting door to be unlocked, so that we could have cocktail parties with the duty-free that he and others had brought. We only ordered the ice cubes and glasses from the hotel. When supplies ran out, some of the wives were delegated to take the telecabin down to the lake and the steamer across to Lucerne to buy new grog, always by the suitcase load.
The MC of the conference was Fritz Machlup, whom I knew from his various academic visits to German universities and who encouraged me to speak out at the conference. The weather was most foul, icy fog most of the time. So, we walked around the quadrangle of corridors for exercise, wearing out the carpets. I struck up a friendship with Robert Roosa, US Democrat Treasury Secretary under Kennedy. He had been a fixed exchange man and had had a famous oral battle with Milton Friedman [2]. By now, he realised that he had lost the argument, and he almost asked me for a bit of tutoring. What amazed me was his great admiration of, and optimism about, the Soviet Union. The two of us took long walks during those rainy days on the Bürgenstock around the hotel's quadrangle of corridors and debated political views about communism. He was clearly taken by the Russian character, but I would not yield in my own views on the Soviet system, as distinct from the Russian character, of which I knew little.
The purpose of the conference was to lock up protagonists of floating exchange rates with practitioners, who had been saying that a free market in currencies was just not technically feasible. To sort this out once and for all had been the idea of Milton Friedman, who did not come to Switzerland for health reasons. So, we slogged it out. One supposed technical barrier after the other was cleared, and many misunderstandings were put to rest. I was responsible for an unplanned controversy, when I spoke about European integration, essentially echoing the arguments that I had discussed with [Herbert] Giersch in one of our long private sessions: fixed rates, when they became disequilibrium prices, hindered the real integration of markets.
The idea of a unitary European currency was at the time being pushed by the Brussels EU bureaucrats, but otherwise not widely noted. My informal, hastily written notes about integration of markets and wrong monetary signals from fixed exchange rates led to Stephen Marris of the OECD (an old friend from encounters in the short-term forecasters group at the OECD) and an Italian economist to fiercely oppose me. They asserted that the bond of fixed rates and moral suasion would force the course of fiscal and monetary policy in the various European countries into one mould, thus making fixed rates, i.e. a common money, possible. We disagreed, and Fritz Machlup asked me to elaborate on my impromptu paper for the published version of the Bürgenstock papers. Our exchanges produced further contributions to the Bürgenstock material, when it was published [3].
As our discussions evolved around the table and more importantly outside the formal sessions, virtually all except a reluctant Japanese oldie and one or two Swiss hardliners came round to the view that flexible exchange rates were technically feasible and probably even desirable. By the end of our meeting, the unexpected happened. Everyone, even the recalcitrants, was prepared to sign letters to the editors of The New York Times and the Neue Zurcher Zeitung telling the world of our conclusions. We decamped as a group down the mountain to Zurich for some superb hospitality and a celebratory meal at the venerable eatery 'Zur Meisn'…
The publication of the Bürgenstock Papers in 1970 made it clear that our efforts were becoming a major influence on the reform discussions concerning the international monetary system. Good economists and prominent policy analysts had by now educated the key players, mainly in Germany and the US. Both governments then acted unilaterally to float their currencies. The cartel of international opinion makers under the IMF was bypassed. The foot-draggers soon followed, allowing a new freer exchange rate regime to emerge spontaneously. It was a pleasure for me personally to see how Otmar Emminger, initially a great sceptic, and others became advocates of flexible exchange rates, using the arguments that we had provided. Soon they seemed to believe that they had invented those arguments themselves! It was a masterstroke and a model how rational economic ideas can influence policies.
Wolfgang’s bibliographic notes: [1] The two papers can be found George N. Halm (ed), Approaches to Greater Flexibility of Exchange Rates: TheBürgenstock Papers, Princeton: Princeton University Press, 1970. [2] Milton Friedman and Robert V. Roosa, The Balance of Payments: Free versus Fixed Exchange Rates, Washington, DC: American Enterprise Institute, 1967. [3] "European Integration and Greater Flexibility of Exchange Rates", and comments, in: Halm, idem, pp. 385-400. A later sequel to my arguments was the only academic paper I ever wrote in French (together with Kiel PhD student Michael Stahl, 'L'integration par /'unification monetaire - une vue pessimiste', in P. Salin (ed.), L'unification monetaire europeenne (Paris: Calmann-Levy, 1974), pp. 133-144. The volume of essays compiled by Pascal Salin was otherwise clearly in favour of a unitary currency. In the introduction Pascal wrote of the 1970s maybe being "la decennie de /'unification monetaire". In the process of publishing the book, events cast new doubt on that, and the publishers reacted with admirable agility. The original title "L'unification monetaire europenne" was given the subtitle "La fin d'une illusion" in the form of an extra wrapper around the book cover. These arguments by Giersch and myself also found their way into the Annual Report of the (German) Council of Economic Advisors (1969): Im Sog des Booms, Jahresgutachten 1969/70 (Stuttgart 'Kllainz: Kohlhammer), pp. 76-93, esp. "Wechselkurs und lnegration", paras 292-297.
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