Crisis and Leviathan: IMF Edition

Why do we still have the International Monetary Fund? It began life in 1944 with one rather specific purpose, to make sure that currencies traded at fixed rates of exchange. Since at least 1973, few currency issuers (brave exceptions include China and Panama) have shown the slightest interest in fixed exchange rates. Shouldn’t the IMF have folded a long time ago?

What happened was mission creep. For about thirty years, from 1944 to 1973, the IMF did in fact supervise a world generally on fixed exchange rates. These were the “thirty glorious years” in France; the time of the “economic miracle” in Germany, Japan, and Italy; and the era of “postwar prosperity” in the United States. Yet all the while, and despite the incredible and comprehensive post-World War II boom, the IMF was preparing for a another day, when it might be indifferent to fixed exchange rates and concentrate on other things, such as being the world’s central bank.

Strange—cultivating benign neglect toward the financial architecture of one of the greatest economic expansions in all of history (the postwar boom) in the interest of some alternative future, wherein the IMF would have a more sovereign role, with real consequences necessarily a secondary matter. Then again, public-choice economics has taught us for years that bureaucracies devote themselves to one task above all others, namely mission creep.

After 1973, the year that the major countries renounced exchange-rate fixity, the IMF found that it was ready to thrive in the new world. Countries devalued heedlessly, soon enough they realized (given stagflation) that this was a mistake, and then came to the IMF for loans. It was an upgrade in status. From 1944 to 1973, the IMF had to be content, at least with respect to its major members, with monitoring countries that were generally playing by the rules and getting rich doing it; 1944-73, the IMF was an ever-less-significant adjunct to the world economy. 1973-2008, as the number and importance of countries becoming desperados before the IMF leapt most nicely, the institution became a power broker nearly on par with the top national hegemons.

Shortly before the 2008 crisis, people at the IMF actually were beginning to fret that their institution was becoming obsolete. The mass joint devaluations of currencies around the world of recent years—the thing that gave us the housing and commodities bubble—had created so much global cash that the IMF’s own stash was getting irrelevant. But then came the meltdown. Everyone had to write down losses and endure a flight to the dollar (and, for a time, the euro). Countries ran like the wind back to the IMF for loans. Business picked up like never before, and heretofore secret talk of the IMF’s operating as a world central bank popped out into the open. Instability and recession reigned in the world economy, but the IMF was bolstered.

There is little reason not to believe that if left to its own devices, the international cognoscenti will, over the next decade or two, effect the de-nationalization of central banking in favor of a global institution. The only one plausible enough, and preparing for this day all along, is the IMF. Friends on the American right should be cautious when they make calls to “End the Fed.” Shrewd operators may well take advantage of this sentiment and pull a double-cross by outsourcing monetary policy to this ambitious multinational creature.

Benn Steil’s remarkable book, The Battle of Bretton Woods, is an account of how the IMF first came to be, back in the sleepy New Hampshire summer of 1944. As every student of international economics knows, the United States held a conference in 1944 at the Bretton Woods ski resort there in the White Mountains. Forty some countries attended, and the agreement that emerged stipulated that after World War II concluded, the gold standard would resume operations in a particular fashion. Each currency would trade at a fixed rate of exchange to the dollar, and the dollar would be redeemable in gold at the prevailing price of $35 per ounce.

It is also widely known that this arrangement was the brainchild of the United States, particularly of Department of Treasury official Harry Dexter White. What we did not know until now, and that thanks to Benn Steil’s book, is how ferocious the opposition to the American plan was at Bretton Woods, especially when it came from the major British attendee, none other than John Maynard Keynes.

Sifting through the archives, and reading familiar sources from a new perspective, Steil reveals that Keynes’s opposition to what was transpiring at Bretton Woods was as fulsome as Keynes had ever mustered over his long and blustery career over any issue. “Keynes has been storming and raging” at the American plan, Steil quotes a contemporary, a man who witnessed Keynes going on with outbursts pregnant with ethnic slurs, on the order of: “This is intolerable. It is yet another Talmud. [Harry White was Jewish.] We had better simply break off negotiations.”

What was the big deal? The American plan at Bretton Woods, after all, did little more than formalize the status quo a decade in the making. The United States had been guaranteeing the dollar at $35 per ounce of gold to foreign monetary authorities since 1934. The massive flow of gold to the United States that then came, as war clouds gathered world-wide, left few countries equipped to guarantee their own currencies in gold. A convention arose whereby foreign countries conducted monetary policy such that their currencies’ exchange rates with the dollar held, making those currencies, as the terminology developed, “as good as gold.”

Bretton Woods made this convention official, with one notable addendum. A new institution would be established to help countries that got in trouble as they made sincere efforts to keep their currencies at par with the dollar. This was the IMF, conceived and lobbied into existence by White. Keynes’s assessment of White’s proposal for the IMF: it was “a tremendous labor to read and digest,” and “unworkable in practice….[O]ne sees how inadequate it is to solve the real problem.”

The real problem—what was that? For White in 1944, the real problem was relatively minor. The basic structure of the international currency system had already been set up by events. A new version of the old gold standard, with the dollar alone convertible to gold, and other currencies to the dollar, had arisen naturally, de facto, from the ruins of the Great Depression and the war. All White wanted to do was to identify and bolster this status quo.

The IMF was part of this agenda. It was to be, exclusively, a credit facility that enabled countries to borrow dollars to purchase (and thus bid up) their own currencies on the open market, in case their exchange rates fell by 1% against the dollar. The IMF would serve as a buttress for the international monetary status quo of fixed exchange rates and dollar convertibility to gold.

It can be argued that on these criteria, the IMF was unnecessary even in the immediate wake of World War II. Theoretically, all a currency producer, even in a place devastated by the war, had to do to maintain the value of its issue after 1945 was conduct legitimate monetary and tax policies. Demand for the currency, even against the dollar, would stay robust in these circumstances, as West Germany amply demonstrated after 1949.

Perhaps, then, in creating the IMF, White was solving a problem that did not exist. Perhaps he felt that since not all countries could be expected to be paragons of financial management (as West Germany and indeed Japan turned out to be), there had to be a bureaucratic support system for fixed exchange rates.

At any rate, the matter cannot be gainsaid that the express point of the IMF was to assist the nations of the world in maintaining a healthy approximation of the gold standard. The major attributes of the classical gold standard were fixed exchange rates among currencies and the convertibility of currencies to gold. With the Bretton Woods IMF system, these things took primacy of place.

For Keynes, the real problem was one of international liquidity—at least this was Keynes’s official view. Keynes had an alternative to the White plan (they were authored independently) wherein a sort of new international central bank determined how much each country could trade in given circumstances. In the Keynes alternative, which got nowhere at Bretton Woods, each country would be given a nice quota of new currency (called “bancor”). Countries could run trade deficits until the bancor ran out, and then they would have to devalue their currencies to better their terms of trade and erase the deficits. Countries that ran trade surpluses would have to either start running deficits or see their growing bancor balances taxed.

Students of economic history have long known about the competing plans of White and Keynes from the early 1940s. It is on reading The Battle of Bretton Woods that essential matters of context and fact arise to put them in perspective. For while White’s plan quite obviously was an attempt to ratify the best of existing conditions, a rather practical affair, Keynes’s plan appears as a wild parlay to reorganize the international economy without the benefit of precedent, custom, and existing institutions. What was Keynes doing?

It turns out—and this is the dirty secret of Steil’s book—that Keynes’s heart really was not in his own plan. It functioned as a diversion. Keynes’s true intentions lay elsewhere. What Steil nails down with page after page of evidence is that Keynes’s chief priority at Bretton Woods was to maintain the imperial trading preference of the British Empire. For decades, Britain had been enforcing sweetheart deals with its imperial trading partners, with Canada, Australia, India (where Keynes had begun his career), and all the rest, keeping non-imperial capital out of these places and forcing them to furnish the home economy with cheap raw materials and to buy British products.

In a world where the British colonies would be IMF members, all this would have to go by the boards. You cannot sell cheap (to Britain) and by dear (from Britain) and have your currency do anything but devalue against a major third-party reference point such as the dollar. Imperial preference would have to be retired if the White plan became the norm.

As Steil writes, totally appropriately, “Keynes was deeply troubled by the seeming impossibility of reconciling Britain’s need for what he called a ‘Schachtian device’ to manage its postwar trade and American demands for nondiscrimination.” “Schachtian device” refers to the German economic practices of the 1920s and particularly the Nazi years of the 1930s, when finance minister Hjalmar Schacht strove to concoct a colonial system whereby goods and raw materials from non-German territories under German influence would supply the home country on the cheap. If we take but one thing away from The Battle of Bretton Woods, it should be the clear knowledge that as World War II was reaching its conclusion, Keynes devoted his ample energies and talents to salvaging the British colonial system, even to the point where he was comfortable with inviting favorable comparisons with extortionist German practices of the early Hitler years.

This, of course, is not the Keynes that has come down to us in history, not the economist-philosopher demigod lionized by the establishment and generations of liberal scholarship. But there is too much evidence in The Battle of Bretton Woods to hold otherwise, too much incredible special pleading and machinating on Keynes’s part, through to his abrupt death in 1946, in the service of enabling the preferences of the British Empire.

All this leaves hanging the Keynes plan, the thing that was supposed to be competing with the White plan at the Bretton Woods conference for worldwide approval. Steil does not come out and say it, but his narrative makes it plain enough that Keynes’s plan was a red herring. It became a stratagem on Keynes’s part to derail the White plan and the IMF, lacking intrinsic significance. The one thing imperial preference could not abide was fixed exchange rates to the dollar. The colonial, soon to be Commonwealth, territorial currencies would tumble down remorselessly against the dollar as every special arrangement favoring the British decreased their purchasing power. If, in such circumstances, the IMF came in to get these currencies back to par with the dollar, the first thing that would have to go would be all the preferences.

The Keynes plan set up a highly intellectualized and untried alternative to the White plan, and in that it had the marks of a good diversion. In being cerebral, it could befuddle. From the perspective of imperial preference, it mattered little whether the Keynes plan were adopted—it permitted if not encouraged currency devaluations, after all—but it mattered greatly if the White plan came to pass. If the Keynes plan could have merely stalled the White plan, it would have done its work. No accord on fixed exchange rates by war’s end would have permitted Britain to conduct economic policy any way it liked.

It is telling that in Steil’s narrative, again and again in his negotiations with the Americans over the course of four years, from 1942 to 1946, Keynes encouraged Britain to threaten to leave or otherwise suspend its cooperation. Keynes fought demonstrably little for his own plan, he fought a good deal against the White plan, and the great proportion of his rhetoric and recorded strategy lay in the service of Britain’s imperial preference.

As it turned out, White and his American colleagues had nerves of steel. They rammed home their plan, and Keynes and his fellow advocates of empire were left out in the cold. Power has its privileges, if only you use it, and in this case the Americans did just that. Having fought to win the war, they were not going to be indifferent to the peace—a statement which, incidentally, does not hold true with respect to American China policy at the time.

The postwar world appears, but only superficially, to have validated Keynes’s concerns. As Tony Judt laid out in his fascinating book Postwar of a few years ago, the late 1940s were economically largely worse in Britain than the Depression-addled 1930s. In the 1950s and 1960s, Britain grew at a small fraction of the rates logged in West Germany, Japan, France, and Italy. And it lost its empire. All totted up to the White victory at the Battle of Bretton Woods.

The United Kingdom could very easily have maintained its growth rates (and perhaps a grateful portion of its empire) if it had been able to attract capital in this period. But like no other country in the postwar era, Britain was bent on socialization, on taking state control of major industry after major industry and ramping up the dole. It would be convenient to associate the sorry performance of Britain in the generation before Thatcher as the wages of the Bretton Woods agreement. But given that there were devastated World War II belligerents that soon placed among the richest economies in the world is sufficient to indicate that Bretton Woods was no death knell. You could be a by-the-book participant to the fixed exchange-rate order, as Japan and West Germany most certainly were, and become the second- and third-largest economies in the world, just behind the United States itself, by 1965.

The Battle of Bretton Woods is an essential volume in any understanding of John Maynard Keynes, who though now seven decades gone is as influential a mind as we may yet see in the twenty-first century. For in a most curious—and dubious—development, Harry Dexter White’s IMF, going strong as it is in our own floating-currency day, is making a fair bid to transform itself into the bancor-granting institution that Keynes laid out in his red-herring plan for Bretton Woods.

With the advent of “special drawing rights,” calls for “international cooperation” in the macro-financial community, and the manifest crisis of national central banking and currency management—not to mention the relentless ambitiousness of international bureaucrats—the road is getting clear toward some international depository of trade receipts and accounts that would also have the tools of monetary creation at its disposal. One of the most fearsome elements of strategy is the warping of the adversary’s own weapons against it, in the context of patience and a long-run vision. If the IMF becomes the creature that Keynes put forth in the 1940s, and that surely not in seriousness, mission creep will have scored one of its greatest successes yet.