Out of the Woods

States and the Reemergence of Global Finance, Eric Helleiner, 1994.

Pictorial Architecture, Lyubov Popova, 1918.

The last two books I reviewed share a theme: that the unleashing of Polanyian forces in the early twentieth century fundamentally remade the international monetary system. Globalizing Capital argued that these democratic energies had rendered the gold standard politically untenable, while The Spread of the Modern Central Bank and Global Cooperation illustrated how an international network of independent central banks was unable to resuscitate it during the Great Depression. For a decade after, there was not much of an ‘international monetary system’ to speak of, as the Depression spiralled towards the Second World War. When the guns fell silent, however, a monetary system was set up which survived for the better part of two decades: the set of institutions and rules known as Bretton Woods. How did this system control the forces which had doomed the gold standard? And, crucially, why did it too fall apart?

When I reviewed Globalizing Capital, I left off with the Great Depression and the collapse of the interwar gold standard, even though Eichengreen charts a longer history than that. This is because I wanted to save the next chapter in international monetary history for Eric Helleiner’s States and the Reemergence of Global Finance. Helleiner’s aim is to answer the questions I posed above; to explain how Bretton Woods came to tame global finance, and what ultimately caused it to be dismantled in the 1970’s. As the book’s title indicates, Helleiner argues that Bretton Woods — the only international monetary system ever deliberately assembled by states — was also dismantled by them.

But, before we consider the collapse of Bretton Woods, it is worth discussing its beginning (Helleiner actually spends almost half of the book doing exactly this). Bretton Woods — named after the location of the New Hampshire hotel where it was established in July 1944 — was an international monetary system anchored around the United States and two institutions: the ‘World Bank’ and the International Monetary Fund.¹ Exchange rates were set against the dollar, which was in turn convertible to gold at $35 an ounce. Countries dealing with balance-of-payments and exchange rate crises could count on IMF support if they needed. The Bank of International Settlements was sidelined as were the central banks themselves, and bankers generally: all were held responsible for the collapse of international order, the trading system, and the Depression — there is a reason that Keynes represented Britain at the negotiations, not the money-doctors of the thirties, Otto Niemeyer and Montagu Norman.

Bretton Woods promised stable currencies and a liberal trading order under the control of governments and international institutions, not central banks. But, Helleiner stresses, although it established a liberal order in trade, it also created a restrictive order in finance. He quotes Keynes, who declared at the time that “the plan accords to every member government the explicit right to control all capital movements. What used to be a heresy in now endorsed as orthodox”. Capital controls thus became the most central pillar of the Bretton Woods system and the liberal Keynesianism which sprung up amongst it. For postwar liberals informed by the 30’s, Helleiner writes, it was believed that “a liberal financial order would not be compatible, at least in the short term, with a stable system of exchange rates and a more liberal trading order". The capital controls regime did not emerge overnight; it was built up gradually as European countries struggled with political and economic crises in the 40’s and early 50’s. The United States — in favour of a liberal financial order, but preoccupied with the Cold War and thus with stabilising Western Europe — accommodated it. And finally, when the US encountered its own balance-of-payments problems in the early 60s, it too implemented capital controls to manage them.

Here, I believe, Helleiner meets Eichengreen’s Polanyian narrative on shared terms. If we read international monetary history as a conflict between capital mobility and democracy, and the interwar gold standard as an attempt to sidestep this conflict by insulating monetary policy from government, then Bretton Woods represents precisely the opposite: a bid to insulate democracy from capital. Capital controls reduced the need to alter exchange and interest rates, minimising the disruptions to economic activity (even if, one might say, these disruptions can be economically productive). Capital controls were thus an essential part of the postwar Keynesian project which Helleiner and others call “embedded liberalism”. Just as the welfare state provided protection from fluctuation in the labour market, capital controls did the same for fluctuation in the international capital market.

So why did this system fall apart? This is where Helleiner’s emphasis on states matters. Essentially, he argues, capital controls (and the financially restrictive Bretton Woods order they underpinned) lived and died on how they impacted the policy autonomy of states, and the US in particular. After the war this was a positive impact, when fears of destabilising speculative capital flows were strong, and the US was anxious to keep Europe out of communist hands. But all this started to change in the 1960s.

Somewhat ironically, this shift has origins in the US’s aforementioned capital controls program of 1963. These restrictions spurred the nascent ‘Eurodollar’ market in London, the first significant international capital market to emerge since the war.² The Eurodollar market was itself a result of a policy autonomy dilemma for Britain: how to reconcile capital controls with the restoration of London’s previous role as an international financial centre, inside the context of a deteriorating economic position. With capital controls applied in the US, American banks used the Eurodollar market to avoid these restrictions, as the market effectively enabled making international loans without sending capital abroad.³ For its part, the US government supported the Eurodollar market in the 60s because it increased demand for US dollars, and hence made it easier for the US to run deficits (and maintain gold convertibility) amid the Vietnam war.

By the 1970’s, this reemerging international financial market had rendered the unilateral capital control regimes insufficient for controlling capital. The push by many European countries, keen to preserve their policy autonomy, was for cooperative capital controls and taming the Euromarket. However, the United States now operated under different pressures, which meant that for them, a liberalised financial system now stood to expand their policy autonomy. With the US now facing a large current account deficit, not a surplus (and with the gold peg abolished in 1971), it saw speculative international capital as a tool to force reevaluation of foreign — especially German and Japanese — currencies. The US also stood to gain from financial liberalisation since, partly because of the Eurodollar market, private investors would clearly continue to underwrite US deficits. Consequently, the US more-or-less singlehandedly torpedoed the movement for cooperative controls.

This started a chain reaction of financial liberalisation, starting with Britain in 1979 and ending in the early 1990s, by which time the Bretton Woods financial order had been almost completely dismantled. Helleiner gives details for vital turning points: Britain in 1979, Australia and New Zealand in 1985, and Europe up to 1988. On a general level, however, perhaps the most intriguing aspect of this story is why the restrictive financial order dissipated so easily. As we well know today, restrictions in the trading system have been much stickier; and it is curious that although tariffs have reentered the discourse in dramatic style, capital controls have not.

Helleiner’s explanation for this is that the collective action dynamics in trade and finance are opposite. With trade, there is a ‘prisoner’s dilemma’ situation whereby if a country unilaterally liberalises, and another country does not, it ‘loses’ (in a narrow sense). In finance, however, unilateral liberalisation can be useful — you will attract more foreign capital. Thus while trade liberalisation takes round after round of talks, financial liberalisation follows a competitive deregulation cycle. There is also another factor: that although the benefits of trade restrictions are concentrated (in protected industries) and the costs are dispersed (in higher prices), in finance the costs are concentrated (within the financial community) but benefits are dispersed (in macroeconomic stability). The Polanyian forces emanating from capital and commodity markets are not equivalent, and capital controls are substantially more difficult to initiate, and substantially easier to destroy, than trade restrictions. If there is a lesson that can be drawn from the rise and fall of Bretton Woods, this is a good candidate.

In keeping with this theme of inversion, it is true that the strengths and flaws of States and the Reemergence of Global Finance are the mirror image of those of Eichengreen’s Globalizing Capital. Whereas Eichengreen integrates data in his narrative, quantitative evidence is conspicuously absent in Helleiner. But it is also true that Helleiner succeeds where Eichengreen falls short, looking under the hood of international monetary history and at the ‘who, when, and for whom’ of how these monumental decisions were made.

More importantly, however, while Helleiner argues that the balance of power within the political economy of the United States is what built and then (when that internal balance shifted) destroyed the Bretton Woods order, how this is extended to the longer era of US hegemony he leaves open. One could turn to Giovanni Arrighi, whose Long Twentieth Century was published in the same year as Helleiner’s book, although I am not convinced whether Arrighi’s brilliant brushstrokes fit well alongside Helleiner’s comb. Or one could look, as I will soon, to Perry Mehrling’s ventriloquist account of the ‘dollar system’ via Charles P Kindleberger; and to Kindleberger himself. Regardless of which path is taken, however, States and the Reemergence of Global Finance is a landmark that is worth remembering.

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Supplemental: Out of the Woods

1. I write ‘World Bank’ because it was initially known as the IBRD (International Bank for Reconstruction and Development).

2. This was a market for dollar loans issued in London, held against dollar deposits of overseas residents (today, Eurodollars refer to US dollars held in banks anywhere outside the US, but it originally referred to just those held in Europe, where the market began).

3. For a more detailed (but accessible) explanation of how Eurodollars work, I recommend Perry Mehrling’s The New Lombard Street — the book I will be reviewing next!