A 50-year quest for monetary stability

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Global Economy updates

This week marks 50 years since President Richard Nixon announced to the world that Washington would no longer redeem US dollars for gold. The gold peg, fixed at $35 per ounce, was central to the design of the postwar Bretton Woods system of fixed exchange rates. The “Nixon shock” removed that pillar, and the system soon unravelled altogether, ushering in a chaotic period of unstable exchange rates and high inflation.

No one should weep for the gold standard. The “barbarous relic”, as Keynes famously dubbed it, was overdue for retirement. Collective commitment to stability, not an arbitrary price for a metal, made Bretton Woods work for as long as it did. Nor was the Nixon shock unprecedented; the $35 peg itself was established by Franklin Roosevelt after he had devalued the dollar by breaking an earlier gold peg. Nostalgia for gold is misguided and misplaced.

That is not true, however, for the broader aspirations of the Bretton Woods construct. Post-1971 global monetary and financial policy has been a quest to restore the lost stability the system had provided. It took a quarter-century for central banks to decide on and master inflation targeting as the policy strategy to ensure stable domestic prices. Even that eventual success did not guarantee broader financial stability, as asset bubbles and financial crises since the 1980s have shown — and it could yet conceivably be undone by today’s record low rates and high debt.

International stability has been more elusive. While economists and policymakers increased their understanding of floating exchange rates as the post-1971 “non-system” progressed, few have become entirely comfortable with them. They do not deliver the monetary independence they once seemed to promise, nor do they insulate the real economy from financial shocks; they sometimes amplify them. Today’s vastly greater cross-border capital flows have made that only more true.

Governments have pursued various strategies to constrain exchange rate fluctuations. The greatest leap has been made in the EU’s single currency zone. Monetary unification is unrealistic for other economies, and formal pegging systems of separate currencies have repeatedly proved unworkable.

Yet even the biggest economies have found it necessary to keep currency swings contained, from the 1985 Plaza accord to curtail the dollar’s rise, to Washington’s perennial worries about currency manipulation by others or Beijing’s management of the renminbi.

We may be condemned to live with less stability than we would like. Bretton Woods depended on tight controls on cross-border capital flows which neither can nor should return: the globally integrated world economy depends on the ease of fluid financial flows and is, overall, better for having them. But the half-century quest for a replacement for Bretton Woods that fits our times can still go further.

Closer co-ordination of macroeconomic policies would help reduce instability caused by foreign exchange markets anticipating misaligned price and deficit dynamics across countries. And the Bretton Woods feature most relevant today is the least remembered one. Domestic credit regulation helped insulate local economic growth from cross-border financial pressures. Policymakers are rediscovering this in the form of “macroprudential regulation”.

Fifty years on, the lure of gold persists, now in the false promise that cryptoassets can achieve more stability than central bank money. The true lesson of Bretton Woods’ demise is the opposite: gold and its digital equivalents are no match for wise regulation and trust between countries.

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