Conflict & Cooperation(1871 - 1944),Destruction & Reconstruction (1945 - 1958)

The Golden Era

Next >

From the 1870s until World War I, the United Kingdom served as the leading financial and banking center of the world, while gold ruled as the monetary standard of all the major trading countries. Each country pegged its currency to gold at a constant and unchanging rate. The international gold standard system ushered in a period of unprecedented stability and prosperity - at least for the middle and upper classes in the industrial countries.

Gold and Stability
credits

The gold standard provided monetary discipline. Because governments were required to convert domestic currency into gold on request, the amount of currency they could print was limited by the amount of gold in their reserves.
Exchange rates never varied in the classical gold system. This made exchanging money much easier for travelers. American Express even printed the exact amount of foreign currency exchange right on its traveler's cheques.

credits

Industrial Revolution
Technological advances in the nineteenth century produced more goods and created more efficient ways of transporting them across national borders. Governments increasingly recognized the need for easy and convenient currency convertibility. The United Kingdom, economic and financial leader of the world, had based its currency on gold since the early nineteenth century. In the 1870s, Germany and other major trading countries followed its lead and converted to the gold standard.

Meltdown
<--Previous
Next-->

World War I marked the end of an economic era. Faced with an urgent need for more liquidity, the combatant countries took their currencies off the stabilizing gold standard and printed more money. This triggered high inflation, which persisted after the war.

credits
Economic Consequences of the Peace
The postwar settlement, known as the Treaty of Versailles, exacerbated tensions and economic instability rather than fostering growth and cooperation. The European allies, especially France and the United Kingdom, felt that the losers should compensate them for the cost of the war by paying reparations. In 1921, Germany's reparations alone were fixed at 132 billion gold marks almost twice its prewar national income.

Cost of the World War
<--Previous
Next-->

As this contemporary illustration graphically shows, the cost of the "World War" was staggering when compared with the costs of earlier hostilities. Governments were forced to stop redeeming their currencies for gold, since they had to print so much paper money to pay for the war.

credits


Postwar Conundrum
The defeated countries had no gold to pay their reparations. Their economies were exhausted, and the peace terms offered little hope of earning gold through exports.
Without the reparations money, the allies could not repay their war loans from the United States.
The United States refused to cancel the allies' debts, insisting that the loans represented commercial transactions.

credits

What will "the next war" cost?
Impossible Debt
Finally, the German, Austrian, Hungarian, Polish, and Bulgarian monetary systems collapsed under runaway inflation called hyperinflation. The United States loaned money to Germany through the Dawes Plan. This loan, along with private investment, enabled the defeated countries to make scaled-down reparations payments. However, the victors collected only a small fraction of the reparations, and the United States eventually had to cancel the remaining debts of its allies.

Global Depression
<--Previous
Next-->

Normalcy returned with the reestablishment of the gold standard in the mid-1920s, but imbalances plagued the monetary system. The prewar fixed exchange rates no longer reflected the relative economic strengths of the major countries:
The U.K. pound was greatly overvalued.
The U.S. dollar and French franc were undervalued.

credits

The Great Depression Arrives
By the end of the decade, economic and financial troubles had spread around the world. Many factors contributed:
A decline in prices of primary products devastated the economies of such countries as Argentina, Australia, and Chile.
Beginning in 1928, Americans cut back on their investments abroad to capitalize on the booming U.S. stock market. The loss of capital hurt first Germany, which counted on US investments to pay its war reparations, and then the European victors, who relied on Germany’s reparations to repay their own war debts.
The 1929 US stock market crash left the United States in financial chaos and accelerated the withdrawal of capital from abroad.
Trade, production, and employment rates fell throughout the world in a dizzying spiral. The Great Depression had arrived. How would the world respond?

International Response:
Beggar-Thy-Neighbor Policies
Instead of cooperating with one another, countries tried to solve their economic problems unilaterally.To protect domestic industry:
Governments devalued their currencies to make their exports cheaper for foreign buyers and to make imports more expensive for their own citizens.
Governments also raised tariffs to make imports more expensive for their own citizens.
By selling more and buying less abroad, countries should have created jobs at home and improved their balance of payments positions. But one country’s exports are another’s imports, so these policies, adopted by many countries at the same time, only succeeded in drastically decreasing world trade and worsening the depression.

Worldwide Financial Chaos
Austria’s largest bank, the Vienna Kreditanstalt, collapsed in May 1931. Banking panic spread into Germany and Hungary and eventually forced the United Kingdom off the gold standard. Other countries soon followed in abandoning gold.

Failure to Cooperate
A World Monetary Conference was held in London in the summer of 1933, in hopes that a cooperative effort to restore prosperity might succeed where unilateral attempts had failed. The organizers sought agreement on:
Restoring the gold standard
Reducing tariffs, import quotas, and other barriers to trade
General international coordination of economic policies
Unfortunately, the conference failed. Participants could not come to any significant agreement.

Depression Lingers
The results of the world’s failure to cooperate were devastating. Continued unilateral efforts by individual countries only succeeded in deepening and prolonging economic woe.
World unemployment peaked at nearly 30% in 1932 and remained in double digits through the decade.
German and US production dropped to 53% of their 1929 levels.
One nation after another abandoned the gold standard in the 1930s.
Regional trading blocs and bilateral clearing arrangements replaced multilateral trade, making international trade more difficult.
Closed currency blocs replaced the international gold standard, further inhibiting trade.
At its lowest point, total world trade sank to just 35% of its 1929 value.


Keynesian Revolution
credits
To help alleviate the Great Depression, some countries adopted policies based on the theories of economist John Maynard Keynes. Keynes argued that during slow economic times, the government should jump-start the economy by spending money to create jobs and boost demand. The Works Progress Administration (WPA) in the United States was an example of the Keynesian approach. In the end, massive military spending finally succeeded in stimulating the global economy and ending the Great Depression.

Political Consequences
The political consequences of the mistakes made after World War I and during the Depression included the rise of totalitarianism and the outbreak of World War II.

The End of the War is in Sight. . .
<--Previous
Next-->

Road to Cooperation
The desire for economic cooperation stemmed from fear of repeating the post-World War I mistakes that had led to inflation, financial instability, and the Great Depression. While World War II still raged, Allied policy makers debated several plans for international monetary stability:
The U.S. proposal by Harry Dexter White
The U.K. proposal by John Maynard Keynes
Proposals from France and Canada
Keynes called for an International Currency Union, which would function as a "central bank" for the central banks of each country. White, on the other hand, called for a fund to which all member countries would contribute. Both agreed on fixed, but adjustable, exchange rates based on gold.

credits
Bretton Woods
Travel to the United States was difficult and treacherous in the midst of the war, but, incredibly, representatives from 44 countries managed to gather for a conference at Bretton Woods in New Hampshire. Their ambitious goal - to design the framework for postwar international economic cooperation. D-Day had taken place three weeks previously, giving the delegates hope that the war would soon end.

How Could Leaders Ensure a Future of Global Peace and Prosperity?
<--Previous
Destruction and Reconstruction

New Economic World Order
The Bretton Woods meeting was a smashing success. After much delicate negotiation and hard work, the delegates agreed on the fundamental principles of a new monetary system to encourage economic stability and prosperity. Two intergovernmental institutions were created to further these principles:
The International Monetary Fund
The World Bank Soon after, delegates meeting at Dumbarton Oaks in Washington, D.C., set up the United Nations, the political counterpart to the Bretton Woods institutions.
International Monetary Fund and World Bank
credits
Bretton Woods: July 1-22, 1944
The Bretton Woods meeting resulted in the founding of the IMF and the World Bank, twin intergovernmental pillars supporting the structure of the world's economic and financial order. The World Bank finances economic development, while the IMF oversees the international monetary system.


The IMF
The founders felt that a fundamental condition for international prosperity was an orderly monetary system that would encourage trade, create jobs, expand economic activity, and raise living standards throughout the world. The IMF was charged with:
Helping each country set a fixed, but changeable, exchange rate for its currency based on gold
Assisting members that have temporary balance of payments difficulties by providing short- to medium-term credit
Overseeing the international monetary system

United Nations
Dumbarton Oaks: August 27-October 7, 1944
credits

The Dumbarton Oaks meeting resulted in proposals to create the United Nations, an intergovernmental forum for solving international problems and disputes. The proposals were adopted at the subsequent meeting in San Francisco in 1945.
"All of us here have the greatest sense of elation. All in all, quite extraordinary harmony has prevailed. As an experiment in international cooperation, the conference has been an outstanding success."John Maynard Keynes1944

The Post War World
Conflict and Cooperation
Next-->

The Most Destructive War in History
By the end of World War II, much of Europe and Asia, and parts of Africa, lay in ruins. Combat and bombing had flattened cities and towns, destroyed bridges and railroads, and scorched the countryside. The war had also taken a staggering toll in both military and civilian lives. Shortages of food, fuel, and all kinds of consumer products persisted and in many cases worsened after peace was declared. War-ravaged Europe and Japan could not produce enough goods for their own people, much less for export. What was needed to pull Europe and Asia back into the international economy? The answer was money - but what kind? The currencies of war-torn countries? Gold? Dollars?
credits
The Most Expensive War in History
In addition to the toll in human lives and suffering, countries spent more money on World War II than in all previous wars put together. By 1945, exhausted countries faced severe economic problems that frustrated reconstruction efforts:
Inflation
Debt (mostly owed to the United States)
Trade deficits
Balance of payments deficits
Depleted gold and dollar supplies

The Dollar Gap
The devastated countries needed gold or U.S. dollars (the only currency considered to be "as good as gold") to pay for imports and make debt payments. However, both dollars and gold were alarmingly scarce in the war-scarred countries.Many countries retreated from the market. Communist Eastern Europe abandoned it altogether. The world’s multilateral financial and trading system faced a serious threat. Only the United States had emerged from the war with the strength and resources to help. But would it step forward?
credits
Worldwide Gold Shortage
By 1947, the United States had accumulated 70% of the world’s gold reserves. The United Kingdom had gone from being the world’s greatest creditor to the world’s greatest debtor. Countries had sold off most of their gold and dollar reserves, as well as their foreign investments, to pay for the war. What few reserves remained were now quickly running out. Trade deficits meant there was little hope of replenishing them.

Five cigarettes for an egg?A carton of cigarettes for a piano?

Severe inflation plagued the weakened economies. By 1948, wholesale prices were 200% higher in Austria, 1,820% higher in France, and a massive 10,100% higher in Japan than they had been before the war. In 1948, the French government devalued the franc by 80%, making a 5,000 franc note practically worthless. In some countries like Germany, the monetary system collapsed. People resorted to barter, often using cigarettes as money.

Cooperation Tested
<--Previous
Next-->

The economic situation looked grim in 1947. Forty-four countries had agreed to international economic cooperation at Bretton Woods, but the IMF and the World Bank were not yet in a position to provide the needed expertise and financial assistance. Would countries return to the unilateral beggar-thy-neighbor policies of high tariffs and competitive devaluations?

credits
Potential Solution
Many hoped that the United States would provide economic aid to help resolve the crisis. In contrast to the other combatants, the United States ended the war as the world’s greatest creditor, with most of the world’s gold, a substantial balance of payments surplus, and virtually no physical damage to its own land. Would the United States offer additional dollar aid? Could the European countries cooperate with one another and the United States to solve their persistent problems and return to prosperity?

Limited Options for Economic Recovery
Desperate countries could gain the dollars they needed only through:
Exporting more than they imported (balance of trade surplus)
Private investments or loans from the United States
U.S. government aid or loans
However, the devastation caused by the war eliminated any hope of a trade surplus. Chaos and uncertainty in the European economies discouraged private US investments. It seemed that only additional government aid or loans could work.

Cooperation
<--Previous
Next-->

Trade Links Encourage Expansion:
The United States gives dollars to Country A.
Country A uses dollars to increase domestic production and pay for imports.
Country A’s economy expands by selling more domestic products to, and buying more imports from, other countries.
Other economies (including the U.S. economy) expand by selling more domestic products to, and buying more imports from, Country A.
Noncooperation
Without Trade Links, Economies Miss Out on Expansion:
The United States does not provide dollars to Country A.
Country A is unable to increase domestic production and unable to afford imports.
Country A’s economy fails to expand, with few products to export and little foreign exchange to buy imports.
Other economies (including the US economy) fail to expand, unable to sell domestic products to, or buy imports from, Country A.
credits
US Decision
The Case Against
Over $9 billion had been spent already on aid to Europe in the immediate postwar period:
The United States could not afford to give away more money to other countries. There were pressing needs at home.
Existing shortages in the United States would be exacerbated and wholesale prices would rise, causing inflation.
If the United States did nothing, Europe would solve its own economic problems.

The Case For
The United States must act for security, humanitarian, and economic reasons:
If the United States did not help, Soviet-supported Communists could make inroads into vulnerable Western European countries.
Innocent people in Europe were suffering from shortages of basic necessities.
The United States could lose its main export markets if Europe could not find dollars or gold to purchase US products.

"And yet the whole world of the future hangs on a proper judgment...What are sufferings?What is needed?What must be done?"George C. Marshall,US Secretary of StateHarvard University,June 5, 1947

Cooperation for Recovery: The Marshall Plan
<--Previous
Next-->

Dollar Catalyst
In his historic speech at Harvard’s graduation ceremony in June 1947, George Marshall announced the U.S. plan to give additional economic aid to Europe. The offer was made to all of Europe, including the U.S. wartime enemies and the Communist countries of Eastern Europe. However, the recipients would be required to work together to formulate a unified recovery plan.

credits
The European Response
"When the Marshall Plan proposals were announced, I grabbed them with both hands. I felt that it was the first chance we had ever been given since the end of the war to look at [the] European economy as a whole."
Ernest BevinBritish Foreign Secretary
Sixteen European countries responded by cooperating on a general reconstruction plan that was accepted by the United States. In the end, a total of $13.6 billion (equivalent to $88 billion in 1997 money) was appropriated to the plan. The Marshall Plan was a success. By 1950, the participating countries had returned to, or exceeded, their prewar production levels.

The European Recovery Program (ERP - The Marshall Plan) helped Europe to:
credits
Finance its imports and debts without the burden of future repayment
Replace, rebuild and expand both private industry and public infrastructure
Eliminate bottlenecks in production
Restore consumption to a politically acceptable level
Establish and fund the European Payments Union to promote multilateral, rather than bilateral, trade
Eliminate the worldwide dollar shortage

Conditionality
Marshall aid came with "conditionality" - countries wishing to participate had to agree to:
Develop multilateral payment and trade within Europe
Move toward currency convertibility
Move toward eliminating discrimination against U.S. imports
Encourage reductions in public spending
Relax government controls such as rationing
Increase exports to the United States

U.S. Dollars: Fueling the Economy
<--Previous
Next-->

credits
Even after Marshall Plan aid ended, the United States continued to provide economic assistance to other countries. In addition, as the "Cold War" heated up, US military expenditures abroad rose, particularly during the country’s involvement in the Korean War (1950-53). And even more important, US investment abroad grew substantially after World War II.
The outflow of US dollars provided liquidity, which fueled the growing world economy.
IMF Loans
Egypt's 1956 takeover of the Suez Canal provoked an unsuccessful and costly joint U.K.-French military operation. The United Kingdom and France suffered severe financial consequences as a result. They turned to the IMF, which provided them with its largest financial assistance to date.
$262 million to France
$1.2 billion to the United Kingdom
US Government Foreign Aid and Spending
Just as the Marshall Plan aid was ending, US military and nonmilitary aid picked up. The continuous outflow of US dollars helped reduce Europe's balance of payments deficit and the worldwide dollar shortage.


credits

Economic Miracles in the 1950s
<--Previous
The System in Crisis

Europe had recovered its prewar productive capacity by 1950; Japan, by 1952. Their economies grew rapidly over the following decade. As a result, international financial accounts gradually moved toward balance. The dollar shortage had been eliminated.

credits
The System Works
In 1958, the monetary system agreed upon at Bretton Woods was validated when eleven European countries declared their currencies externally convertible. Others were to follow in the next few years.
The dollar-gold exchange standard, based on fixed exchange rates and overseen by the IMF, could finally be realized.

Problems on the Horizon
After 1950, the United States began to register balance of payments deficits. At first, the deficits were welcomed, because the United States enjoyed:
A strong trade balance
Ample gold reserves
A small outflow of private capital
The U.S. government believed that the deficits demonstrated US leadership in providing expanding markets and finance. The US balance of payments deficits provided $7 billion of an $8.5 billion increase in world liquidity during the 1950s. The increase in liquidity enabled the international economy to grow at a record rate.
How long could the United States afford huge deficits without harming its own economy?
And if the United States reduced its deficits, who would provide additional liquidity to allow the world economy to continue growing?