50 years of nixing Bretton Woods, and the world is yet to recover

August 15, 1971, is a historic day for India and the United States. As August 15 marks India’s Independence, then Prime Minister Indira Gandhi gave the customary speech from the Red Fort in Delhi. She spoke about removing poverty (garibi hatao), rising inflation, corruption, and troubles in Pakistan. She hinted that the Indian economy will tilt leftwards, and this did happen.

In the United States, then President Richard Nixon made a similar echoing speech. Apart from talking about bringing peace, he announced a New Economic Policy (NEP — how frequently polity uses this phrase!). The NEP was on three targets: inflation, unemployment and international speculation. Inflation and unemployment rates had risen in US mainly due to policy misadventures. This article will focus on international speculation. However, some history is required.

A Global Currency

In 1944, several policymakers from different countries assembled in Bretton Woods (in the US). The agenda was to discuss restoring and reconstructing economies after World War II. One of the components of reconstruction was exchange rates. It was decided that all currencies would be pegged to the US Dollar (USD), and it would be pegged to gold.

For Bretton Woods to succeed it was important that the US has enough gold to cover the global circulation of the USD. However, due to multiple factors like aid, war spending, etc., there were more dollars in circulation than gold. The earlier US Presidents tried to manage the situation but ended up aggravating it. The US fiscal and current account deficits only rose leading to inconsistency between the roles the USD was to play as both a domestic and global monetary anchor. There was devaluation pressure on the currency.

Nixing Bretton Woods

What did Nixon do to address these growing inconsistencies? He first shifted the blame from poor policy to an outsider which was the international currency speculators. He stated that the international monetary system (IMS) has been in a crisis for the last seven years and blamed speculators for the same.

He added that speculators had the USD as their next target which was not acceptable as a currency derives strength from the economy and the “American economy is by far the strongest in the world”. Accordingly, he directed the Secretary of the Treasury “to suspend temporarily the convertibility of the American dollar”.

With these few words, Nixon nixed the Bretton Woods agreement which had served the world economy for 27 years. The Nixon shock created multiple problems for the world economy, a shock from which the world is yet to recover.

For a long time, economies were on a fixed exchange rate system where the currency was either pegged to gold/silver (before WWII) or the USD (after WWII). As both these options were not available anymore, there was a scramble to find the next exchange rate system.

Nixon had hoped that the US “will press for the necessary reforms to set up an urgently needed new international monetary system”. But this did not happen as the US, along with other economies, grappled with twin oil shocks which led to high inflation and balance of payments problems for several economies. As a result multiple options emerged from fixed peg to full flexible exchange rate system. Several Latin America and Asian economies grappled through currency crises. In particular, Europe had to struggle through many a systems before adopting the Euro. The United Kingdom, which opted out of the Euro, had a Nixon moment in 1992, when it blamed George Soros for the Pound Sterling’s impending devaluation.

Far-reaching Changes

India had a historical association with Bretton Woods. Despite being a British colony, the Indian contingent participated and contributed in the Bretton Woods discussions, and was a founder signatory to the system. The RBI’s Annual Report (1971-72) noted that the demise of Bretton Woods implied changes of a far-reaching nature in the international monetary system.

The Indian Rupee was pegged to the USD till December 1971, and then switched to the Pound Sterling, subject to the accepted margin of 2.25 percent for fluctuations in either direction. The period of 1970s was full of misadventure for India’s currency managers as documented in RBI’s history.

Not surprisingly, the 1991 reforms started with devaluing and liberalising the exchange rate system. India currently follows a managed float system where the rupee trades flexibly across all currency markets and the RBI intervenes only in case of excessive volatility.

Enter Cryptocurrency

Fast forward 50 years and how do we assess the IMS? While the US economy is struggling to remain at the top with China at its heels, the USD continues to remain the dominant currency for world trade and financial markets. However, its dominance could be challenged by cryptocurrencies.

In 2008, Bitcoin heralded the cryptocurrency revolution where the direction has moved from privately-issued currency to central bank digital currency (CBDC). We are seeing many interesting developments in this space. The Central Bank of Seychelles has issued a CBDC and El Salvador has made Bitcoin legal tender. The Chinese and Europeans see the CBDC as a way to counter the USD hegemony. The European Central Bank (ECB) is still working towards a digital Euro. After playing the waiting game the US has entered the CBDC space recently. How will all this technological revolution play out? We do not have answers yet, but given the pace of change, we will not have to wait for another 50 years to find out.

Today, how would the two leaders reflect on their speeches made 50 years ago? Indira Gandhi would see that the Indian economy has changed significantly since the 1991 reforms which turned around some of her policies. Yet the economy continues to face similar problems to that of 1972, such as inflation and unemployment. The economy also suffers from elements of socialism she set in process. She would be surprised to see how Bangladesh, which is also celebrating its 50 years of independence, is doing better than the Indian economy on multiple fronts. Richard Nixon would see that his decision might have saved the USD then but set in motion a process which could undermine the USD going ahead.

The study of history usually leads to a mixed legacy and these two cases are no different.

Amol Agrawal is faculty at Ahmedabad University.

Views are personal and do not represent the stand of this publication.