Revisiting Bretton Woods
CME Group Chairman Emeritus Leo Melamed speaking at the Macro Financial Modeling Initiative’s second MFM Summer Session for young scholars in Bretton Woods, New Hampshire. The site of the historic 1944 United Nations Monetary and Financial Conference.
Allow me to begin by applauding the Becker Friedman Institute for initiating this Macro Financial Modeling Project and to congratulate its two Project Directors, Lars Peter Hansen, of the U of C and Andrew W. Lo of MIT.
While I congratulate them and agree that identifying the root causes of the 2008 crisis and similar calamities— in a quest to discover a canary for the financial mineshaft— is a noble mission, I feel compelled to tell them that their task is daunting. They are attempting to defy what Georg Wilhelm Hegel sadly told us two hundred years ago: "Experience and History," he stated, "teach us that people and governments never have learned anything from history, or acted on principles deduced from it."
Hegel's admonition stands nearly unblemished.
That said, I feel honored to support this innovative initiative by offering some brief thoughts. I assume that one reason for my invite here is that much of my life is intertwined with Bretton Woods. As everyone knows, it was here in Bretton Woods, at the Mount Washington Hotel, in 1944, that there was an assembly of 730 delegates from 44 Allied Nations in order to re-establish financial order in a war-torn world after the Second World War. No, I was not present. I was just a child at that time and had just arrived to this country.
The Conference lasted three weeks, from July 1 to July 22. The agreement established a system of fixed exchange rates in which world currencies became pegged to the dollar, with the dollar itself convertible into gold. Its two principal architects were John Maynard Keynes, representing the British Treasury, and Harry Dexter White, representing the U.S. Treasury. The Articles of Agreement were hailed as a seminal achievement and ratified on December 27, 1944. It ambitiously prescribed open markets but with fixed exchange rates.
There was but one squeaky wheel. A single voice defying the near-unanimous applause for this achievement. The voice belonged to Milton Friedman. He argued that Bretton Woods was doomed to failure. It tried to achieve incompatible objectives: freedom for countries to pursue an independent internal monetary policy; fixed exchange rates; and relatively free international movement of goods and capital.
Allow me to digress. The world eventually learned that Milton Friedman's opinions were not to be ignored. That truism was adroitly described by Milton's very good friend, Nobel Laureate, George Stigler, on the occasion of 1976 Nobel Prize celebration for Milton Friedman. Professor Stigler introduced Friedman in the following fashion:
Milton, he said, will begin a debate by asking you to grant him three simple assumptions. For instance: That $2 is better than $1; That the law of diminishing returns is valid; And, that individuals do not have complete knowledge of the future.
Simple, undeniable assumptions, right? My fundamental advice," said Professor Stigler, "Do not grant him these assumptions. For if you do, you will find yourself led, by inexorable logic, to conclusions such as these:" That the Federal Reserve System should be abolished; that the Board of Governors of the Federal Reserve should be put on Social security; and that Social Security should be abolished.
During the first decade of Bretton Woods, the system worked fine and it looked as if Friedman was wrong. Trouble was the 44 nations grew up. Some of them on a fast track who became competitive to each other and to the U.S. In practice, maintaining announced parities became a matter of prestige and political controversy. Foreign exchange became a competitive tool. Countries held on to parity as long as they could, in the process letting minor problems grow into major crises and then making large changes. Friedman's prediction was coming true.
Then, beginning in the late 1950s, the curtain opened on the "Information Era." Technology created the transistor---perhaps the greatest invention of the 20th Century. With the transistor, communication was revolutionized and information began to flow globally in minutes rather than in days or weeks. The technological revolution which is still very much alive enabled markets to learn facts before finance ministers could gather to react. It became impossible for a fixed exchange rate system to cope with continual changes in currency values resulting from the daily flows of political and economic information. By the late 1960s, the Bretton Woods fixed exchange rate system had become a joke.