this would require determining a replacement of the British currency for the purposes of settling international transactions. Due to the sizeable gold reserves held by the United States, the attendees were keenly aware that the dollar was the only currency that could potentially replace the role of the now weakened British pound. The participants agreed to a new currency arrangement, known as a fixed exchange rate regime, with the U.S. dollar playing a central role. Under this new arrangement, which economists commonly refer to as the Bretton Woods system, the U.S. dollar would be linked to gold at a pre-determined fixed rate of $35 per ounce. In turn, all other currencies were then pegged to the dollar, as it was viewed as being as “good as gold.” This immediate convertibility from U.S. dollars into a fixed amount of gold brought much-needed economic relief and helped to restore confidence in the global financial markets.
Quick Fact
In addition to establishing the U.S. dollar as the global reserve currency, this historic conference also initiated a number of new government institutions, including:
• The World Bank
• The International Monetary Fund (IMF)
• The World Trade Organization (originally called the General Agreement on Trades and Tariffs, or GATT)
As the nation entrusted with the issuance the global reserve currency, the United States emerged as the lone economic victor in the post–World War II era. In fact, one senior official at the Bank of England described the deal reached at Bretton Woods as “the greatest blow to Britain next to the war.” Why? The Bretton Woods system provided immense power to the emerging American economic empire as global currency demand shifted from the British pound to the U.S. dollar.
Bretton Woods Conference
John Maynard Keynes (right) represented the UK at the conference, and Harry Dexter White represented the United States.
Bretton Woods — The Changing of the Guard
At the end of the 19th century, the city of London was the capital of a global superpower. Through its aggressive and systematic colonization efforts, the British Empire had been able to dominate and control more geography than any previous empire before it. At the height of its rule, it was accurately stated that “the sun never set” on the British Empire. Put simply, Great Britain was the largest economic empire the world had ever seen. Its financial and military prowess made the empire’s official currency, the British Pound Sterling, the most sought-after currency on earth. But like most empires before it, military overextension and economic arrogance left Great Britain ripe for replacement by a leaner and more nimble competitor. By the end of World War II, Britain’s excesses had nearly sealed its fate. Along with the rest of the European community, the British Empire was left economically devastated. The economic challenger that would rise to the occasion to fill the economic vacuum was none other than the United States of America.
At this point, an appropriate question to be asking is: “Why would Britain and all of these other nations be willing to allow the value of their currencies to be dependent upon the value of U.S. dollar?”
The answer is quite simple: they didn’t really have a choice. These war-weary nations were broke. And there was literally no other currency, outside of the dollar, that was able to fill the growing demands of the global economic system. The fact that nations could convert their dollars into gold at a fixed rate of $35 per ounce helped alleviate concerns about the dollar’s new global role. After all, the Bretton Woods system did provide nations with an escape hatch in the event they had buyer’s remorse. If a particular nation no longer felt comfortable with the dollar, they could easily convert their dollar holdings into gold and sit on the economic sidelines. While this flexibility helped restore a much-needed stability in the global financial system, it also accomplished one other very important thing: the Bretton Woods agreement instantly created a strong global demand for U.S. dollars as the preferred medium of exchange for settling international transactions.
And along with this growing demand for U.S. dollars came the need for . . . a larger supply of dollars.
Now that I have explained how the U.S. dollar was crowned as the global reserve currency in 1944, let us turn to the benefits of such an arrangement.
The Golden “Permission Slip”
To fully appreciate the economic benefits that the United States derives from its enviable role as the holder of the world’s reserve currency requires an understanding of why a global demand for dollars is beneficial.
To illustrate, imagine that right now I have listed a beautiful beachfront home for sale at a price of $2 million. Now also imagine that we could instantly decrease the total money supply within the U.S. economy to a mere $1 million dollars. What would happen to the value of my home for sale? It would drop dramatically! Why? Is my home suddenly become less valuable? No. Instead, the decline in my home’s value was directly caused by the sudden decrease in the overall money supply within the economy. It would be impossible for me to ask for $2 million for my home because, in our imaginary economy, there is now only $1 million in existence.
And as we have already explained, printing more dollars leads to an increase of asset prices. In essence, more dollars leads to higher prices within the economy. So, if an increase in the overall money supply causes asset prices to rise, then what effect does an increasing global demand for dollars have on an economy? In essence, it gives the U.S. government a “permission slip” to print more dollars. After all, we can’t let our global friends down, can we? If they “need” dollars, then let’s print some more dollars for them.
Is it a coincidence that printing dollars is the U.S. government’s preferred method of dealing with our nation’s economic problems today? The U.S. government only has four basic ways to solve its economic problems:
1. Increase income by raising taxes on the citizens
2. Cut government spending by reducing public benefits
3. Borrow money through the issuance of government bonds
4. Print money
It should be obvious that raising taxes and reducing spending can be political suicide. Borrowing money is a politically convenient option, but the government can only borrow so much. So that leaves the government with the final option of printing money. Printing money is a unique, albeit temporary, solution that requires no immediate economic sacrifice and no spending cuts. Therefore, it is the perfect solution for a country run by morally weak leaders who desperately want to avoid making any sacrifices. But as we explained in a previous section, a monetary policy that relies upon the continued printing of money places the nation at great risk of huge inflation.
Q: So how has the United States been able to avoid suffering from massive inflation despite their continued reliance upon reckless money-printing campaigns?
A: Through the “permission slip” to print excessive amounts of dollars it was given as a result of the Bretton Woods system.
The only reason that the United States can print so much money without experiencing huge inflation is because the Bretton Woods system created a global demand for dollars. Understanding this “permission slip” concept, and how the United States has abused it will be very important as we continue.
Have you ever asked yourself why the U.S. dollar is called a Federal Reserve note? Once again, the answer is simple. The U.S. Dollar is issued and loaned to the United States government by the Federal Reserve Bank. Because our dollars are loaned to our government by the Federal Reserve, which is a private central banking cartel that I will explain in much more detail later in this book, the dollars must be paid back. And not only must the dollars be paid back to the Federal Reserve; they must be paid back with interest!
And who sets the interest rate targets