International Monetary Fund and World Bank

Francis J. Gavin

If the success of institutions were judged by the breadth and passion of their critics, then both the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (World Bank) would count among the most effective multilateral organizations in the world. Beginning in the late 1990s it became an annual ritual for tens of thousands of anti-globalization protesters to descend upon Washington, D.C., in late September to disrupt their annual meetings. But the left has had no monopoly on criticism of the IMF and World Bank. Republican U.S. congressmen and free-market economists have long derided both entities as misguided and even corrupt. Furthermore, these protests were nothing new: both the left and the right in the United States vehemently objected to the Bretton Woods agreements that created the IMF and World Bank near the end of World War II.

Do the arguments made against the Bretton Woods institutions, both now and in the past, have any merit? And why do these multilateral institutions, created for the noble goals of preventing international monetary turmoil and alleviating global poverty, incite such heated responses, both in the United States and abroad? Finally, are the IMF and World Bank simply tools of American foreign policy, as is often claimed? At first glance these criticisms are puzzling, especially since protesters have vastly overestimated the power and effect these institutions have had on the world economy. The second half of the twentieth century witnessed tremendous changes in all parts of the domestic and global economy, including in those areas that are the responsibility of the two Bretton Woods institutions: international monetary relations and economic development. But a strong case could be made that other forces—the Cold War, macroeconomic reform, technology, the massive increase in capital and trade flows—were far more crucial to unleashing and sustaining these changes than either the IMF or the World Bank.

In fact, in order to understand the influence and development of these organizations during their first few decades, it is more useful to talk about a "Bretton Woods system" rather than dissecting the specific institutional histories of the IMF and World Bank. The agencies themselves were both anemic and ineffective during their early years. For example, the World Bank was established in order to aid postwar European reconstruction but was quickly supplanted when the United States established the European Recovery Plan and the Marshall Plan. Only later did it embrace the mission of funding development, infrastructure, and anti-poverty programs in the underdeveloped countries of the world. The IMF was similarly pushed to the side during its early years, as bilateral negotiations, currency blocs (like those for sterling and the franc), or Marshall Plan institutions such as the European Payments Union drove postwar international monetary relations.

Still, while the IMF and World Bank were moribund for some time, and are not particularly influential in the early twenty-first century, the Bretton Woods agreements did set down certain "rules of the game" that, if not always enforced by the IMF and World Bank, certainly have animated much of the spirit of international economic activity since World War II. Furthermore, in spite of their weaknesses, it is important to remember that at the time of their inception, the idea of creating such multilateral economic institutions was truly revolutionary. The logic behind these organizations and their mission emerged from a powerful if sometimes flawed causal and historical logic. After the economic collapse of the 1930s and destructive war of the 1940s, the conventional wisdom held that unfettered capitalism was unstable, prone to crisis, and unfair in its international distribution of wealth. Just as the U.S. federal government intervened in the domestic economy through the New Deal to eliminate the extremes of market capitalism while maintaining the benefits, so too were the newly formed global organizations formed to regulate, but not stifle, the global economy.

Depression and war had ushered in a profound shift in the relationship between governments, national economies, and the global economic order by the time representatives of forty-four nations met at Bretton Woods, New Hampshire, in July 1944. Before World War I, international monetary relations were not considered the province of national governments. Rarely did any entity intervene in foreign exchange markets, and when one did, it was nongovernmental banks such as the House of Morgan or the still private Bank of England. There were several attempts at monetary cooperation and collaboration among international private bankers during the late nineteenth century, but it was sporadic. And while the idea of providing aid to rebuild the devastated, war-torn economies had been considered after World War I, the notion of a permanent international bank to guide global efforts to increase living standards and eliminate global poverty was truly remarkable.

One criticism is, however, quite justified. Both the World Bank and especially the IMF have often been tools for U.S. foreign policy and foreign economic goals. Part of this has to do with the nature of constituent power within these organizations. Unlike the United Nations, where each state has an equal vote, representation within the Bretton Woods institutions is established by the size of the financial contribution. Since the United States is by far the largest contributor, it has the principal voice in determining the policies and procedures of both institutions. Furthermore, the United States is able to pressure many of the other large contributors, like Japan, Germany, Saudi Arabia, and Kuwait, into following their policy preferences.

In fact, it is fair to say that America has dominated both of these institutions since their founding. To give just a few examples: in the 1940s, it was the United States bypassing these institutions through the Marshall Plan and regional aid schemes. In the 1950s and 1960s, the United States used the IMF to bail out sterling, the currency of its close ally Great Britain, and the World Bank to promote its modernization schemes. During the 1990s the relationship between the IMF and the Clinton administration's Treasury Department was downright incestuous, as both institutions forged the now controversial "Washington consensus" in its aid and economic reform packages. Rarely has either Bretton Woods institution pursued policies at odds with U.S. foreign policy goals.

THE IMF BRETTON WOODS MONETARY SYSTEM

The Bretton Woods conference of 1944 produced the most ambitious and far-reaching international economic agreement between sovereign states in history. By far the most important aspect of these arrangements were the articles that created the International Monetary Fund and established the rules for global monetary relations. American and British financial officials, led by John Maynard Keynes and Harry Dexter White, hoped to establish a system that would maintain stable, fixed exchange rates, allow national currencies to be converted into an asset over which they had no issuing control (gold), and to provide an effective mechanism to adjust exchange rates in the hopefully rare event that a "fundamental" balance-of-payments disequilibrium emerged. In the event of nonfundamental deficits that normally arose in international transactions, the deficit country would pay with a reserve asset (gold or a key currency convertible into gold), or seek short-term financing from the International Monetary Fund, which would supply the currency needed. The IMF was also assigned the task of overseeing and enforcing these arrangements.

This IMF-guided system was much different from any previous international monetary system. It was not like a traditional gold standard, where the domestic money supply, and hence the domestic price level, was directly determined by the national gold stock. Under the gold standard, a balance-of-payments deficit would be paid for through the export of gold, resulting in a decrease in the domestic money base and a deflation of prices. The decreased purchasing power would lower that country's imports, and the increased international demand for that country's lower-priced goods would increase exports, naturally correcting the balance-of-payments deficit. Conversely, an influx of gold, by increasing the domestic monetary base and domestic prices, had the opposite effect of boosting imports and discouraging exports, thereby eliminating a payments surplus. According to standard market theory, any balance-of-payments disequilibrium would be adjusted more or less automatically, eliminating the need for government interference. But the cost of making payments balance could be very high, and included deflation that caused widespread unemployment in deficit countries. In reality this system worked much better when capital flows from London, and to a lesser extent Paris, kept the system functioning smoothly.

The founders of the IMF explicitly rejected the gold standard as a model for future international monetary relations. White and especially Keynes believed that the interwar experience had demonstrated that a balance-of-payments adjustment process that relied on deflating the economy of a deficit country was draconian in an age when national governments promised full employment and a wide array of social spending. Decreasing the monetary base in a deficit country would lead to a fall in national income, unleashing unemployment and necessitating large cuts in government spending. To avoid such a politically unacceptable system, the Bretton Woods IMF regime allowed nations to import and export gold without penalty (that is, without having to change their domestic monetary base). If and when balance-of-payments deficits arose between countries, they would be corrected through short-term IMF financing and small, IMF-approved changes in the exchange rate. This points to an interesting fact about the Bretton Woods conference and agreement. Although Bretton Woods was hailed as the hallmark of international cooperation, in reality it provided national economic and political authorities an unprecedented amount of immunity from the international pressures of the global market. To a large degree, this was the policy preference of both the United States and Great Britain. Macroeconomic decisions were the sole province of national governments, which were quick to sacrifice measures that would bring about balance-of-payments equilibrium in order to achieve important domestic goals.

Because U.S. economic foreign policymakers worried that the existing gold stock was too small to sustain the growing demand for international liquidity, the Bretton Woods IMF regime was set up to be a two-tiered system in which certain key currencies—those convertible into gold, such as the dollar and (it was hoped) sterling—could be used in lieu of gold to settle international transactions. It was hoped that this would conserve the use of gold and dramatically increase the amount of liquidity available to finance international transactions. This meant that much of the world's reserve requirements would be supplied through the balance-of-payments deficits of the key currency economies. Why did the Bretton Woods planners allow such a thing? Keynes recognized that Great Britain would face postwar deficits, and he wanted a system that did not penalize sterling. Ironically the British economist also feared American surpluses and wanted to guarantee that the United States fulfilled international liquidity needs.

But it was unclear how large these deficits had to be to fulfill international reserve needs. If the key currency economies had no deficit, or too small a deficit, then the world would have to rely on gold alone to finance trade. Without key currency deficits, liquidity would dry up and international transactions disappear. But if the key currency country ran balance-of-payments deficits that were too large, the resulting inflation would test the value of the key currency and set off a large-scale conversion of the currency into gold. This would remove valuable liquidity from the system and set off a fierce competition for gold, with deflationary effects on the international economy. Capital controls, trade restrictions, and currency blocs might ensue. This made the meaning of British, and to a greater extent, American balance-of-payments deficits somewhat ambiguous. The system was designed to make deficits necessary, but it was never clear how large or how small a deficit was needed to supply liquidity without undermining confidence in the value of the dollar.

What were the larger motives of the founders of the IMF plan? U.S. and British foreign and economic policy goals were often at cross-purposes by 1944. It has often been noted how remarkable it was that Keynes and White, despite the vastly different economic priorities of the countries they represented, were able to come up with such an extraordinary compromise. Indeed, Keynes's original proposal envisioned a "currency union" in which countries would have had to pay a penalty on their surplus payment balances. Additionally debtor nations would have unrestricted and virtually unlimited access to the resources of the clearing fund without having to seek international approval or make domestic adjustments to correct payments disequilibria. Keynes's original plan had an enormous inflationary bias, and would have allowed Great Britain to tap the immense resources of the United States without having to go through the arduous and embarrassing process of asking for direct aid.

The IMF Bretton Woods system has often been portrayed as an attempt to move away from the vicious economic competition of the late nineteenth and early twentieth centuries. American policymakers were motivated, it has been suggested, "by a humanitarian desire to prevent the kind of financial stresses and economic dislocations that might lead to future wars." The noted policy analyst Judy Shelton summed up the conventional wisdom when she argued in 1994 that "Keynes and White were convinced that international economic cooperation would provide a new foundation of hope for a world all too prone to violence. 'If we can continue,' Keynes observed, 'this nightmare will be over. The brotherhood of man will have become more than a phrase.'"

Keynes's own writings call this interpretation into doubt. Not only would his blueprint protect Great Britain's planned full-employment policies from balance of payments pressures, it would also present a convenient and politically painless way to get money out of the United States in the guise of international banking and monetary reform:

It would also be a mistake to invite of our own motion, direct financial assistance after the war from the United States to ourselves. Whether as a gift or a loan without interest or a gratuitous redistribution of gold reserves. The U.S. will consider that we have had our whack in the shape of lend lease and a generous settlement of consideration…. We in particular, in a distressed & ruined continent, will not bear the guise of the most suitable claimant for a dole … On the contrary. If we are to attract the interest and enthusiasm of the Americans, we must come with an ambitious plan of an international complexion, suitable to serve the interests of others sides ourselves. … It is not with our problems of ways and means that idealistic and internationally minded Americans will be particularly concerned.

While the Americans rejected the currency union plan as too radical, the British came up with a substitute in the scarce-currency clause for the IMF, which permitted extensive capital controls and trade discrimination against major surplus countries. Roy F. Harrod, a U.S. Treasury official and Keynes protégé, even suggested that the scarce currency not be discussed in public, for fear that the U.S. Congress might figure out its true implications. Keynes agreed, stating, "the monetary fund, in particular, has the great advantage that to the average Congressman it is extremely boring." But the heated debates in Congress over the IMF demonstrated that some Americans had a better understanding of the scarce-currency clause than Keynes assumed.

The controversial scarce-currency clause was eventually included as Article 7 in the IMF Bretton Woods agreement, but the Truman administration interpreted its provisions very narrowly. This angered many British policymakers, who in later years blamed many of Britain's economic woes on the Americans' narrow interpretation of the clause. During deliberations over whether or not to devalue sterling in 1949, the UK president of the Board of Trade bitterly lamented the American position:

In particular, United States policy in the Fund has been directed … to making the "scarce currency" clause a dead letter. We thought originally that this clause might give some real protection against a dollar shortage; indeed, Lord Keynes's conviction that this was so was one of the main factors which led His Majesty's Government and Parliament to accept the Loan Agreement. Once the clause comes into operation, it gives wide freedom for discriminatory exchange and trade controls against the scarce currency; and then there is real pressure on the country concerned to play its full part in putting the scarcity right, e.g., by drastic action such as we want the United States to take to stimulate imports.

In the end, the British had little to complain about. By the late 1940s the Truman administration's foreign policy goal of promoting European reconstruction and eventual integration led the United States to permit extensive dollar discrimination while furnishing billions of dollars of aid through the Marshall Plan. Furthermore, to the surprise of many, the United States ran consistently large balance-of-payments deficits throughout the postwar period. The problem was not, as Keynes and White had feared, too little liquidity. The opposite was the case. By the late 1950s and early 1960s, there was a growing sense that the flood of postwar dollars had become too large, and that measures had to be taken to choke off the persistent American balance-of-payments deficit.

A ROUGH START FOR BRETTON WOODS AND THE IMF

The Bretton Woods blueprint for exchange-rate stability, hard convertibility, and international cooperation through the International Monetary Fund proved untenable from the start. In 1947, buoyed by an enormous stabilization loan given by the United States after the cessation of lendlease, Great Britain attempted to make sterling convertible into gold and dollars, as stipulated by the Bretton Woods agreement. This first real test of the agreement proved a dismal failure. There was an immediate run on the pound, and within months Britain used the entire proceeds of the loan. Current account convertibility of sterling was suspended, and no other major currency would attempt anything approaching hard convertibility until the end of 1958. The failed attempt to make sterling fully convertible was a major reason the United States decided to circumvent both the IMF and World Bank to provide direct aid to Great Britain and western Europe through the Marshall Plan. The sterling crisis also persuaded the Truman and Eisenhower administrations to accept widespread trade discrimination and monetary controls aimed at the dollar and dollar goods, in clear violation of the terms of the IMF's rules and regulations. Some of the monetary restrictions were lifted in 1958, but much of the trade discrimination against American goods continued for decades.

The pretense of IMF-monitored exchange-rate stability was abandoned in 1949, when Great Britain undertook a massive devaluation of sterling in order to make its exports more competitive and to write down wartime debts. Great Britain did not seek the approval of the IMF or any of its major non-Commonwealth trading partners. It did secretly consult with a small, high-level group of Truman administration officials led by Secretary of State Dean Acheson. The 1949 devaluation outraged officials from the IMF and the international community and threatened to undo the tentative movement toward European economic integration and the dismantling of worldwide trade and currency controls. The lesson learned by other nations was that there was no punishment for a unilateral devaluation if national interests warranted it. If one of the countries that helped design the IMF and the Bretton Woods system flouted its rules, how could other nations be expected to tow the line? The IMF was powerless to stop any transgression against its charter.

Perhaps the most shocking fact was that the International Monetary Fund, which was supposed to be both the source of liquidity for temporary payments imbalances and the enforcer of Keynes and White's international monetary rules, was almost entirely excluded from Great Britain's decision (which was made in close consultation with the Truman administration). In actuality, the IMF was emasculated in the 1940s and 1950s, with little authority or voice in international economics. Desperately needed liquidity was supplied to the world by direct American aid, through programs like the Marshall Plan, Point Four, and the Military Assistance Program. In fact, signatories of the Marshall Plan were strictly forbidden from using the IMF to correct payments imbalances. The Marshall Plan actually created a separate monetary system for western Europe, the European Payments Union, which had its own rules that flouted both the spirit and the letter of IMF regulations. The EPU allowed only extremely limited intra-European convertibility and permitted discrimination against dollar transactions. It was only much later that the IMF became a player in world monetary relations, a period that began when the United States used the IMF as a vehicle to make an enormous loan for Great Britain after the Suez crisis in 1956–1957.

"Disequilibrium" characterized the postwar IMF monetary system throughout the so-called Bretton Woods period. During the early postwar period, there were large payments imbalances between the devastated economies of western Europe and the United States. Large European deficits were to be expected, but they were made worse by the fact that currency par values were often established in an arbitrary manner. Although the IMF was supposed to approve initial par values and any subsequent changes, in actuality each country could pretty much establish whatever rate it wished. If exchange rates had "floated" on foreign exchange markets after the war, they might have found a sustainable rate that would have closed the payments gap with the United States more quickly and efficiently. But after rates were set, changes came in dramatic and disruptive devaluations, the direction of which was always known in advance. Extensive trade and capital controls that discriminated against dollar goods were established instead. In order to fill the large payments gap, the United States provided enormous amounts of aid (in fact, initially Marshall Plan disbursements by the United States were determined by the payments deficit of individual European countries). The adjustment process during the postwar period was not automatic but had to be managed by governmental policy and controls. This made the Bretton Woods period different from the gold standard and the free exchange-rate period in one important respect: because the adjustment process could only be accomplished by government intervention and policy, the system was highly politicized.

THE FLAWS OF THE IMF BRETTON WOODS SYSTEM

Why did the Nixon administration finally pull the plug on the IMF Bretton Woods system on 15 August 1971, after two decades of monetary chaos and instability? In fact the decision was to a large degree inevitable. In its final form the Bretton Woods Monetary Agreement that created the IMF was unworkable because it lacked a mechanism to adjust persistent payments imbalances between countries. Exchange-rate stability could only be maintained by providing ever-increasing amounts of "liquidity," a process that created enormous political difficulties and ultimately undermined confidence in the IMF system.

Why were the fixed exchange rates unstable? The IMF plan, unlike a pure gold standard, affirmed the primacy of domestic economic goals, which included the maintenance of full-employment economies over strict balance-of-payments concerns. But exchange-rate stability can only be sustained when there is comparable price stability between countries, a near impossibility. If prices change markedly because of inflation or deflation in a given domestic economy, then currency exchange rates must shift accordingly or else their initial par rates will quickly be rendered obsolete. When exchange rates are not changed to reflect price shifts, balance-of-payments deficits and surpluses quickly emerge. Such a situation would be especially problematic if the initial par values were already out of line, which was often the case under the IMF Bretton Woods system, because nations were given wide discretion to establish their own rates.

The ensuing balance-of-payments disequilibria were a constant source of monetary instability in the IMF Bretton Woods system. For example, if Great Britain's domestic economic goals produced a yearly inflation rate of 6 percent, and the United States pursued policies that resulted in 4 percent inflation, then the exchange rate would have to be adjusted if balance-of-payments disequilibrium was to be avoided. But this obviously contradicted the IMF's goal of exchange-rate stability, and without market-determined rates there was no easy mechanism to adjust the exchange rate without creating havoc. Deflating the domestic economy to bring the balance-of-payments into balance was not politically realistic or desirable after World War II. Furthermore, the IMF system actually rewarded speculators, who knew the direction of any revaluation and could simply put pressure on a vulnerable currency until a nation exhausted its reserves or its will defending the old exchange rate. Speculators made a fortune forcing the devaluation of sterling in 1949 and 1967. The only option to avoid damaging devaluations was capital and trade controls. Every major country, including the United States, had to install capital controls in one form or another during the early years of the IMF Bretton Woods system in order to maintain their exchange rate, despite the fact they were forbidden (except in extreme cases) by the IMF.

A second flaw, less well recognized but equally serious, was the method of providing "liquidity" in the IMF Bretton Woods system. Liquidity is simply another word used to describe reserve assets that are transferred from debtor to surplus countries to cover their payments gap. In order to offset a negative payments balance and maintain a fixed exchange rate, governments had to supply some universally accepted asset over which they had no issuing control to cover. Until 1914 this asset was, at least in theory, gold. Because the IMF Bretton Woods planners believed that there was not enough gold to supply world liquidity (reserve) needs, key currencies, such as the dollar and sterling, should be used to supplement or replace gold to settle international transactions.

The failure to make sterling fully convertible in 1947 meant that the dollar alone would serve the reserve asset, or "liquidity," function. As a result the dollar was demanded by foreign nations both as a reserve asset and to finance much of the world's trade. These factors, in conjunction with the economic recovery of Europe, helped produce a sizable American balance-of-payments deficit. But it was not like the payments deficit of any other nation. Some of these excess dollars were actually desired by the rest of the world, not to purchase American goods and services but for reserve and international settlement purposes. In other words, the dollar's unique role in world trade and reserve creation meant that a certain level of American balance-of-payments deficit was desirable and in fact necessary for the international economy. But how much of a payments deficit was needed to supply global liquidity was difficult, if not impossible, to determine. Initially most foreign central banks preferred to hold dollars because they earned interest and had lower transaction costs than gold. But as American dollar liabilities—created by the yearly payments deficits—increased, confidence in the gold convertibility of the dollar fell. After convertibility was established by the major economies of western Europe at the end of 1958, central banks began to buy increasing amounts of gold from the United States with their excess dollars.

This brought up a larger question: how stable and cooperative could the IMF Bretton Woods system be if it only worked when the world's largest economy, the United States, ran yearly balance-of-payments deficits? Much has been made of the advantages and disadvantages this system conferred on the American economy. When foreign central banks held dollars for reserve and transaction purposes, it enabled American consumers to receive foreign goods and services without having to give anything other than a promise to pay in return. It was like automatic credit, or, if the reserves built up indefinitely, like getting things for almost nothing. This arrangement, which is the benefit of seigniorage, could be maintained as long as the dollar was "as good as gold," when holding dollars in the form of short-term interest-bearing securities was probably preferable to buying gold, which earned no interest income and had high transaction costs. The danger came when overseas holders of dollars worried that the dollar was not as good as gold or for noneconomic reasons preferred holding gold to dollars. This sentiment emerged in the late 1950s and 1960s.

Under the IMF Bretton Woods system, overseas central bankers could turn in their excess dollars for gold at any time. But at some point the ratio of dollar liabilities to American gold would increase to a level that might cause a loss of foreign confidence in the dollar and a run to the U.S. Treasury gold window. American policymakers saw this as a threat to the economic well-being and foreign policy of the United States. The loss of American gold was also seen as a threat to the world economy, because it was believed that a worldwide preference for gold over dollars would decrease the amount of liquidity needed to finance and balance ever-expanding world trade. A mass conversion to gold would force the United States to suspend convertibility, which would wipe out the dollar's value as a reserve and transaction currency. It was feared that competition between central banks for scarce gold could subject the international economy to paralyzing deflation. Another fear was that the resulting collapse of liquidity would freeze world trade and investment, restoring the disastrous conditions that paralyzed the world during the 1930s and created depression and world war.

The IMF Bretton Woods monetary system did have certain disadvantages for the United States. The fact that overseas central bankers held dollars in their reserves meant that the United States could be pressured for political reasons by the countries within the IMF Bretton Woods system. While the United States accrued benefits from the system, its pledge to convert dollars into gold made it vulnerable in ways other countries were not, especially as the ratio of gold to dollars decreased over time. To some extent Great Britain ran a similar gold-exchange standard before 1914 with a very low gold to sterling ratio, but international monetary relations were far less politicized before World War I. If France held a large supply of dollars as reserves and wanted to express dissatisfaction with some aspect of American foreign or economic policy, it could convert those dollars into gold. Converting dollars into gold gave surplus countries an important source of political leverage. It was this scenario that caused President John F. Kennedy to exclaim that "the two things which scared him most were nuclear weapons and the payments deficit."

The IMF Bretton Woods system trapped reserve countries in another way. If a nonreserve country ran a persistent balance-of-payments deficit, it had the option of devaluing its currency to improve the terms of trade of its exports. The dollar was priced in terms of gold, so if it was devalued, other currencies could simply shift the value of their currencies so that no real devaluation could take place. The only true devaluation option that the United States had was to suspend the convertibility of the dollar into gold. The rest of the world would be left with a choice. Overseas central bankers could support the exchange rate of the dollar by using their own reserves to maintain their exchange rates with the dollar. Or they could "float" their currencies in all the foreign-exchange markets to determine their true value. Suspending dollar-gold convertibility was an option few American policymakers wanted to consider during the 1950s and 1960s. For their part, most European surplus countries dreaded either option.

Why was there such a fear—both in the United States and abroad—of abandoning the IMF Bretton Woods fixed exchange rates and moving to a market-determined, free-floating exchange-rate regime? It is hard to underestimate the powerful influence of the received wisdom concerning the history of monetary relations between the wars. In the postwar period it was a widely held belief that the economic collapse of the 1930s was caused by a failure of international monetary cooperation. In the minds of most postwar economists and policymakers, capital flight, which had its roots in free-market speculation, had ruined the gold exchange standard, which destroyed international liquidity and froze international trade and financial transactions. The collapse of the rules of the game unleashed a vicious competition whereby countries pursued beggar-thy-neighbor policies of competitive devaluations and trade restrictions. To most, the culprit behind the international economic collapse was a free market out of control, fueled by pernicious speculators who had no concern for the larger implications of their greed-driven actions. This economic collapse unleashed autarky and eventually war. A market-driven international monetary system was no longer compatible with stability and international cooperation. Any situation that remotely looked like a repeat of the 1930s was to be avoided at all costs. IMF planners and Western policymakers determined that in the postwar world the market had to be tamed and national interest replaced with international cooperation that would be fostered by enlightened rules and institutions. Strangely, few seemed to understand how chaotic and inefficient the IMF Bretton Woods system eventually became. Massive American aid and constant intervention tended to obscure the system's failings. The intellectual framework that produced the IMF Bretton Woods blueprint, though deeply flawed, had a profound impact on the postwar planners in most Western countries, including the United States, and thrived well into the 1970s.

More than anything else, policymakers in America and western Europe were afraid of the unknown. While the system was inefficient and prone to crisis, monetary relations, no matter how strained, were far better than during the interwar period. Furthermore, Western monetary relations were interwoven into a complex fabric that included key political and military relationships, including U.S. troop commitments to West Germany and Japan. No one knew what would happen to this fabric if the IMF Bretton Woods system collapsed, and few were anxious to find out.

What eventually destroyed the original IMF Bretton Woods system was that it did not have an effective, consistent process to adjust payments imbalances between countries. In order to preserve or restore a balance in international payments, payments imbalances between a country and the rest of the world must be brought into equilibrium through an adjustment process. The adjustment process can take many different forms, depending upon the rules of the international monetary system in question. There are two monetary systems where the adjustment mechanism is automatic, at least in theory: a gold standard and a system of free exchange rates. The nineteenth-century gold standard eliminated payments deficits and surpluses automatically through changes in a country's aggregate demand brought about by importing or exporting gold. The present system of free exchange rates eliminates prospective payments imbalances through market-driven shifts in exchange rates. In both systems, payments imbalances are brought into equilibrium through processes that are largely automatic and independent of any governmental interference. The adjustment process in gold standard and free exchange rate regimes tends to be less politicized.

But this is not how payments imbalances were adjusted in the IMF Bretton Woods system. Instead, domestic economies were protected from demand fluctuations produced by gold or other reserve movements, and the system of fixed exchange rates prevented the market from determining the equilibrium price for a nation's currency. Since there were inevitably great differences among national monetary policies, some method was needed to adjust for the changes in the relative value of currencies produced by differential rates of inflation and savings. But exchange-rate variations were difficult because they unsettled foreign exchange markets, and it was impossible to get countries to agree to shifts because they feared the adverse effects on their terms of trade. Countries were equally reluctant to sacrifice full employment and social policy goals for balance-of-payments purposes. This left no effective means to close balance-of-payments gaps automatically. As the economist Robert Stern stated in 1973, "Since the functioning of the pegged rate system may appear to avoid rather than expedite adjustment, it might be more fitting to characterize this system … as the 'international disequilibrium system.'"

Consider the lengths to which the Kennedy and Johnson administrations went to settle America's balance-of-payments deficits in the early 1960s. After the Eisenhower administration went into a near panic over the loss of gold in the days immediately before and after the 1960 presidential election (Eisenhower even proposed using the more abundant uranium in place of gold to settle America's payments deficit), the new Democratic administration made solving the problem one of its key foreign policy goals. A whole series of complicated formal and informal arrangements ensued—some through the IMF, others bilaterally, and still others with the so-called Group of Ten, or industrialized nations. But none of these American policies dealt with the crucial issue of creating a more effective adjustment mechanism.

The liquidity issue was much discussed both within and outside of the IMF during the late 1950s, 1960s, and 1970s. Liquidity, which was merely a euphemism for reserves, was the vehicle for financing balance-of-payments deficits in the Bretton Woods system. The greater and more persistent the imbalances, the more reserves, or liquidity, are needed to make the system work. In a system of fixed exchange rates that does not have an automatic adjustment mechanism, differential inflation and savings rates will quickly produce large imbalances between countries. Government leaders, unwilling to adjust exchange rates or alter domestic priorities for balance-of-payments purposes, clamored for more liquidity to finance balance-of-payments deficits. But it was rarely pointed out that this liquidity would be unnecessary if there was an efficient, effective, and automatic process for adjusting imbalances.

During the late 1950s and 1960s, when both policymakers and academics recognized that the international monetary system was flawed, hardly a proposal for reform was produced that did not emphasize the need for more liquidity. Suggestions ranged from increasing the country subscriptions to the IMF to inventing a whole new form of liquidity. The most dramatic American proposal came during the summer of 1965, when the Johnson administration's secretary of the treasury, Henry Fowler, called for a "new Bretton Woods conference" to create new liquidity. When the major western European nations eased capital controls and allowed for convertibility of their currencies into dollars, trade and capital flows increased dramatically. This made liquidity a more important issue: larger trade and capital flows increased the payments imbalances that inevitably arose in a fixed exchange-rate regime. More reserve assets were needed by national foreign exchange authorities to defend their exchange rate in the face of increasingly large and sophisticated currency markets. If controls were to be avoided (and they were not), countries would have to cooperate to manage disequilibrium. This would require agreements and institutional arrangements, such as the IMF, the General Agreement to Borrow, the swap arrangements, the Group of Ten, and the gold pool. But in the end, all of these reforms and ad hoc measures were merely Band-Aids to cover the deep structural flaws within the IMF Bretton Woods monetary system.

THE IMF AFTER THE COLLAPSE OF BRETTON WOODS

Despite the strenuous efforts of U.S. foreign policymakers, the IMF Bretton Woods system suffered a slow, painful death in the 1960s and early 1970s. Institutionally the IMF was at the center of many of the attempts to keep the system on life support. The organization's deposits, and ability to loan, were increased substantially in the 1960s. The IMF was also at the center of a series of proposals to reform and recast international monetary relations. The most interesting was the American proposal to supplant the dollar's reserve and liquidity role with an instrument called "Special Drawing Rights," or SDRs. The idea for the SDRs emerged from a 1963 G-10 study on the need for additional liquidity and was formally proposed by the United States in the summer of 1965. The French were vehemently against the SDR, or any instrument that increased the IMF's power, since they believed the organization was a vehicle for American hegemony. Tough and at times acrimonious negotiations finally produced an agreement that was signed in Rio de Janeiro in September 1967. The SDRs were hailed as a major accomplishment, a needed supplement to the IMF Bretton Woods system, but in fact they were never widely used.

Ironically the greatest beneficiary of the monetary disorder of the 1960s and 1970s might have been the IMF. Irrelevant during the late 1940s and 1950s, the organization became the focal point of efforts to fix a broken international monetary system. Increased capital and trade flows brought more balance of payments volatility, and the IMF was called upon repeatedly to bail countries out of foreign exchange crises. The British requested billions to stave off monetary crises in 1961, 1964, and 1966. None of this aid helped, as sterling was finally devalued in 1967, although unlike the 1949 devaluation, the IMF played a key role. Even the French were forced to ask the IMF for help to defend their currency after their currency collapsed in the wake of the May 1968 Paris street protests. The IMF also served as a convenient vehicle for U.S. foreign policy goals when direct aid was not politically feasible, especially in the case of the bailout of sterling.

The IMF's power and influence as an organization increased even more after the collapse of the global monetary rules it was assigned to oversee. Nixon ended dollar-gold convertibility at Camp David on 15 August 1971 without consulting the IMF. But every American attempt to restructure the system during the ensuing sixteen months did so with the IMF as the centerpiece organization. Any attempt to maintain the Bretton Woods fixed exchange rate system collapsed, however, after February 1973, when the United States and the world abandoned the short-lived Smithsonian agreement. The world returned to market-determined free exchange rates, the very system the IMF was established to prevent.

Economic malaise, in the form of international recession and a fourfold increase in oil prices, combined with exchange-rate volatility to spread balance-of-payments chaos worldwide. After Camp David the IMF's role, and even its customers, changed dramatically. After abandoning fixed exchange rates the large industrialized countries like Japan and the countries of western Europe were less concerned about balance-of-payments difficulties. Market-determined changes in cross exchange rates replaced the ineffective adjustment mechanism of the old IMF Bretton Woods system. Nor did these large countries need the liquidity provided by the IMF, unless they wanted to defend their exchange rates against the overwhelming forces of the market. But the countries of the developing world could not as easily ignore dramatic changes in their exchange rates, and the oil price surge left many unable to close their balance-of-payments gaps without outside help.

Thus in the 1970s the IMF acquired a new client—the developing world. The fund also had new subscribers—the states of the Middle East that had grown rich with profits from their oil. Countries like Kuwait and Saudi Arabia had vast amounts of money, some of which went to increased subscriptions to international organizations like the IMF, and most of which was "recycled" through American banks and invested in the underdeveloped world. This massive recycling was both a response to and the reason for the Third World debt crisis of the late 1970s and 1980s. The IMF increasingly found itself providing balance-of-payments financing to poorer countries hit hard by the energy price spikes of the 1970s and the debt crisis of the 1980s.

One of the most controversial aspects of the IMF's post–Bretton Woods lending program has been its requirement that funded countries undergo what is called "structural adjustment." Since IMF funding is meant to fill a balance-of-payments deficit, stabilize the foreign exchange rate, and avoid devaluation, the institution demands fundamental macroeconomic and institutional reforms to remove the causes of the payments imbalance. Stabilizing a currency and halting massive capital flows usually require policies that deflate the domestic economy, such as raising interest rates and slashing the size of the state's budget. Many critics contend that these measures hurt the weakest members of the affected society. The first programs cut are usually in much-needed social welfare, health care, and educational programs that help the poor. Higher interest rates deflate the economy and lead to increased unemployment. Furthermore, the poor do not have the option of transferring their assets and capital abroad, as the wealthy often do during currency crises in the underdeveloped world.

The harshness of the IMF's structural adjustment program—and U.S. policymakers' role in promoting these controversial plans—came into greater focus in the late twentieth century. Largely at the behest of the Clinton administration's Treasury Department, the massive IMF bailout of Mexico in 1995 required an economic reform plan that led to large layoffs and sharp downward pressure on workers' wages. Similar complaints have been voiced in East Asia, where Indonesia's efforts to calm a currency crisis through "structural readjustment" led to political turmoil, domestic unrest, and economic collapse. The IMF's reputation has been further damaged by the widespread misuse of its funds in Russia. Things got so bad that the IMF was publicly criticized by Joseph Stiglitz, the chief economist of its sister organization, the World Bank. Worse, the IMF was seen as a handmaiden for America's foreign policy goal of privatizing, reforming, and opening overseas markets. The sharp criticism forced the IMF to reassess all of its lending procedures and requirements, including its structural adjustment programs.

THE WORLD BANK AND ITS OFFSHOOTS

The World Bank, though far less influential than the IMF, has certainly been no less controversial since its opening in 1946. The bank has actually gone through fundamental changes since accepting its original agenda to promote the postwar recovery of Europe and Japan—its first loan was for $250 million to France in 1947. As it has added to its mandate, it spawned several new organizations to the original International Bank of Reconstruction and Development (IBRD).

In 1956 the bank established the International Finance Corporation (IFC) to provide subsidized loans and guarantees to poor, underdeveloped countries. The IFC provides long-term financing at near-market rates. The IFC provides $4 to $5 billion in new loans annually. The International Development Association (IDA) is perhaps the most controversial additional arm of the World Bank. The IDA was created in 1960 to provide money to countries too poor to borrow from the World Bank's primary institution, the International Bank of Reconstruction and Development. IDA loans carry no interest rate, are very long term (thirty-five to fifty years), a small yearly fee (.75 percent), and a ten-year grace period. The United States has been the largest contributor to the IDA, providing more than $20 billion between 1960 and 2000. The International Center for Settlement of Investment Disputes (ICSID) was established in 1966 to promote increased private investment to the underdeveloped world. Similarly, the Multilateral Investment Guarantee Agency (MIGA) was created in 1988 to reduce the risk faced by private global investors in poor countries. In addition to providing advice, MIGA insures and guarantees up to 90 percent of a project's investment.

The bank gets its money from country contributions and its investments in financial markets. The membership has increased from the original 44 nations that met at Bretton Woods to 183 in 2001. The United States is by far the largest contributor, providing over $50 billion since 1944. Although its total share has decreased, the United States still provides more than 17 percent of total funds. Several bodies govern the bank, including a board of governors (with a member from each country), a twenty-five-member executive directorate (with the five largest donors—the United States, Japan, Germany, France, and Great Britain holding permanent seats), and a president, who is by tradition an American.

EXECUTIVE PERSONALITY AND THE WORLD BANK

Far more than the IMF, the World Bank's direction and policies have been established by the personality of the executive director. The director's authority came largely as the result of a power struggle in the bank's early years between the first president, Eugene Meyer, a seventy-year-old investment banker selected by the Truman administration, and the bank's management and executive board. This dispute over power sharing led to Meyer's resignation after only six months. The high-profile "wise man" John J. McCloy was brought in to succeed him and to place the tottering bank on a better footing. McCloy's first act was to get the bank's executive board to relinquish its activist position and allow the president to dictate the organization's policies and directions. Though McCloy only stayed two and a half years, he began the tradition of powerful American World Bank presidents who drove the multilateral organization's agenda.

The World Bank's original mission was to provide reconstruction loans to war-torn Europe and Japan. These loans were intended for basic infrastructure projects such as roads, bridges, electrical plants, and the like. But the bank's lending policies were very conservative at first, and the recipients both demanded more funds and resisted the conditions attached to financing. The European Recovery Program, or Marshall Plan, soon eclipsed the World Bank. This U.S.-financed program provided far more money and attached fewer strings. During its first four years the World Bank provided only $500 million to western Europe, a figure dwarfed by the Marshall Plan and even by private American investment.

The World Bank's conservative lending policies continued under the long-term leadership of Eugene Black (1949–1962). While Black, a former president of Chase Manhattan Bank, enjoyed a solid reputation in the financial world, he was wary of moving too quickly away from the bank's original mandate. But by the late 1950s and 1960s the World Bank decided to escape its international irrelevance by reinventing itself. Western Europe and Japan were well on their way to a robust economic recovery that the World Bank had little to do with. The key event was the creation of the International Development Association in 1960. The IDA was established to make subsidized loans to poor countries that were credit risks and could not afford private commercial loans.

In order to borrow from the IDA a country must meet four criteria. It must be very poor (less than $800 per capita GNP in 2001). It must have sufficient political and economic stability to warrant financing over the long term. The country must have extremely difficult balance-of-payments problems, with little opportunity to earn the needed foreign exchange. Finally, its national policies must reflect a real commitment to development. These goals and policies reflected a new passion within the U.S. academic and foreign policy community for using foreign aid to promote "modernization" in the so-called Third World.

The IDA did not start out well. In fact a whole series of regional institutions were developed in order to fill the perceived void created by the World Bank's stingy loan practices. In 1958 the European Development Bank was created, largely for the benefit of francophone Africa. The European Investment Bank was established to finance infrastructure projects within the European Economic Community. In 1958 the Inter-American Development Bank was set up in Washington, D.C., to spur growth in Latin America. The African Development Bank was created in 1964, and the very successful Asian Development Bank began operations in 1966. If imitation is the sincerest form of flattery, then the World Bank was successful indeed. But the proliferation of regional banks also signaled the failure of the Bretton Woods institution to fully embrace the enormous global development challenges that arose in the 1960s.

The World Bank began its real transformation under the controversial leadership of Robert S. McNamara (1968–1981). McNamara took over the bank after his resignation (or firing—he was never sure which) as President Lyndon B. Johnson's secretary of defense in 1968. McNamara became the father of a much-contested lending concept called "sustainable development." He dramatically increased the bank's lending portfolio, and by the time he left in 1981, lending had increased more than tenfold, from almost $900 million to $12 billion. McNamara succeeded in finally making the World Bank relevant to the global economy, particularly in the underdeveloped world. But he also left a legacy of continuing controversy that has fueled passionate anti–World Bank rhetoric from both the extreme left and right.

By the time McNamara had decided to leave the bank, there had been a sharp shift in orthodoxy within both the economics profession and policymaking community toward development aid. The election of Margaret Thatcher in England and Ronald Reagan in the United States signaled a move away from Keynesian demand management toward a more laissez-faire philosophy. This was bound to affect the bank. In fact, just as the last years of Jimmy Carter's presidency witnessed a defense buildup and a spate of economic deregulation that foreshadowed the Reagan years, so too did the final period of the McNamara presidency bring a sea shift in World Bank policies. By the end of the 1970s there was a growing dissatisfaction with the results and perceived lack of accountability in World Bank lending. This led the bank to institute its own "structural adjustment" policies in the hope of encouraging macroeconomic reform among countries receiving funding.

McNamara's successor, A. W. Claussen (1981–1986), faced mounting challenges: hostility from the new U.S. administration, a poorly performing portfolio, and increasing fears of a full-blown debt crisis in the developing world. Over time, Claussen replaced McNamara's more progressive staff members with neoclassical economists like Anne Krueger. Claussen maintained a far more low-key style that served the bank well during this period of transition. Claussen's successors Barber Conable (1986–1991) and Lewis Preston (1991–1995) did not fare as well. The World Bank was forced to suspend its lending to its largest (and in many ways most successful) client, the People's Republic of China, after the June 1989 Tiananmen Square massacre. This set a precedent of sorts for the bank, as it had scrupulously tried to stay out of "borrower politics." The Preston presidency faced growing questions about the bank's effectiveness, detailed below, which continued to plague Preston's successor, James Wolfensohn, who took over after Preston's untimely death in 1995.

WORLD BANK CRITICS ON THE RIGHT AND LEFT

The World Bank and its lending practices have come under increasing scrutiny. The critique from the right contends that the World Bank has shifted from being a "lender of last resort" to an international welfare organization. In doing so the World Bank has become, according to critics, bloated, incompetent, and even corrupt. Worse, the bank's lending policies often reward macro-economic inefficiency in the underdeveloped world, allowing inefficient kleptocracies to avoid the types of fundamental reforms that would in the long run end poverty in their countries. These critics like to compare the fantastic growth in East Asia to the deplorable economic conditions of Africa. In 1950 the regions were alike—South Korea had a lower per capita GDP than Nigeria. But by pursuing macroeconomic reforms, high savings, investing in education and basic social services, and opening their economies to the global trading order, the "Pacific Tigers" have been able to lift themselves out of poverty and into wealth with very little help from the World Bank. Many countries in Africa, however, have relied primarily on multilateral assistance from organizations like the World Bank while avoiding fundamental macroeconomic reforms, with deplorable but predictable results.

Conservatives point out that the World Bank has lent more than $350 billion over a half-century, mostly to the underdeveloped world, with little to show for it. One study argued that of the sixty-six countries that received funding from the bank from 1975 to 2000, well over half were no better off than before, and twenty were actually worse off. The study pointed out that Niger received $637 million between 1965 and 1995, yet its per capita GNP had fallen, in real terms, more than 50 percent during that time. In the same period Singapore, which received one-seventh as much World Bank aid, had seen its per capita GNP increase by more than 6 percent a year.

The left has been no less harsh in its criticisms of the World Bank. They claim that World Bank loans privilege large infrastructure projects like building dams and electric plants over projects that would benefit the poor, such as education and basic health care. Worse, these projects often have wreaked havoc on the local environment. Forests, rivers, and fisheries have been devastated by World Bank–financed projects. Some projects even have led to the forced resettlement of indigenous communities. One estimate holds that more than two and a half million people have been displaced by projects made possible through World Bank loans.

Environmentalist and anti-globalization groups point to specific failed projects. The Sardar Sarovar dam on the Narmada River in India was expected to displace almost a quarter of a million people into squalid resettlement sites. The Polonoroeste Frontier Development scheme has led to large-scale deforestation in the Brazilian rain forest. In Thailand, the Pak Mun dam has destroyed the fisheries of the Mun River, impoverishing thousands who had made their living fishing and forever altering the diet of the region.

In response to these accusations, the World Bank has attempted reforms, appointing its own inspection panel in 1993. But critics point out that the bank needs to be more responsive to outside forces and criticisms. The World Bank has never rejected a single project since 1944. The bank staff is very highly paid—the average compensation of a World Bank employee in 1994 was $134,000. The bank can't even properly manage the construction of its own headquarters: the 1993–1994 project came in almost $100 million over budget. Perhaps most damning, the bank's lax lending standards have led to a rapidly deteriorating loan portfolio.

CONCLUSION

The future of both Bretton Woods institutions remains uncertain. Both the IMF and World Bank escaped the efforts of the Republican U.S. Congress in the mid-1990s to sharply curtail and even eliminate both organizations. These agencies have been less successful in answering the charges from the left, as the IMF retains its demand for "structural adjustments" and the World Bank still favors funding for large, project-driven funding. While both the IMF and the World Bank have instituted some reforms, they have been unable to appease the concerns of outraged environmentalists, labor unionists, and nationalists and advocates of indigenous peoples in the developing world.

Still, as this essay has suggested, these two organizations are really the misguided target for the legitimate concerns people of all ideological stripes have had about the rapid pace of globalization in the past half century. It is likely this globalization would have occurred whether or not there had been a Bretton Woods conference, and it is all but certain it will continue in the future regardless of the policies pursued by the IMF and World Bank. While it is true that they have often been too driven by U.S. foreign policy concerns, in the end the influence of both institutions has been widely overstated. And despite their mistakes during the past half century, they have rarely been given credit for many of the little things they do well. For example, both institutions perform economic surveillance over most of the world's economy, a valuable task that no other international or private organization could perform with such skill. Both agencies also serve as a store of expert knowledge and wisdom for countries throughout the world that lack trained specialists. While neither the IMF nor the World Bank has met the lofty goals of their founders or wielded the nefarious influence charged by their critics, they have and should continue to play a small but important role in promoting prosperity and economic stability worldwide.

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See also Balance of Power; Economic Policy and Theory; Foreign Aid; International Organization; Post–Cold War Policy .

CAPITAL MOBILITY

It is not widely recognized that the worldwide explosion of capital flows came only after the IMF–Bretton Woods system of fixed exchange rates and dollar-gold convertibility collapsed in the early 1970s. By the late 1970s, many developed countries began to abandon the array of capital controls that had been necessary to maintain strict par values. Exchange-rate flexibility combined with deregulation of the financial markets, improved technology, and the development of innovative financial hedge instruments to protect against exchange-rate risks to encourage a massive increase in cross-border capital movements. Even more significantly, the direction of these flows changed, as more capital began to move to the developing economies around the world, particularly in East Asia and Latin America.

Has this revolution in capital mobility been a good thing for the world? Previously poor East Asian economies have become economic dynamos in record time, most of the former Soviet empire has joined the world trading system, and Europe has begun a once-unthinkable experiment of a single currency. Never in history has there been such breathtaking change in international monetary relations in so short a period of time.

There is no doubting the benefits that the international financial revolution has brought to the world. But there have also been troubling crises that deserve attention: the volatility of the dollar's exchange rate in the 1980s, the developing-country debt crisis that burdened Latin America and threatened the solvency of major Western banks, and the bumpy road to the European Monetary Union. But most monetary and financial crises are not simply the product of unfair speculation or herd behavior. There is almost always a real-world culprit, whether it is loose monetary policies, fiscal largesse, or insufficient supervision of domestic financial institutions. Fortunately, as the link between these macroeconomic and regulatory problems and monetary chaos are better understood, there should be far fewer destabilizing crises in the future.