Into Bretton Woods with Keynes and Out With Nixon and Trump

The architecture was devised by John Maynard Keynes and Harry Dexter White in 1944, embodied in durable institutions (now the International Monetary Fund and the World Bank) by 737 delegates from 44 Allied nations led by the United States, demolished in 1971 by Richard Nixon, whose replacement is in its turn being consigned to the ash heap of history by Donald Trump.

Seventy-five years ago today the leaders of each delegation, gathered in the only partially renovated Mount Washington Hotel in Bretton Woods, New Hampshire, took pens in hand and signed the Bretton Woods Agreement. Although World War II had not yet been won, the leaders of the United States and Great Britain were setting about constructing the architecture of an international financial system that would prevent the instability that had turned the Germans to Hitler for relief from depression and inflation, contributed to the collapse of the American economy, and resulted in a war that in effect bankrupted Great Britain and brought an end to the dominance of the pound sterling.

Keynes, the intellectual leader of the effort, was at times abetted, more often hindered by White, who did not find his dual role as lead U.S. negotiator inconsistent with that of a Russian spy. Together they produced a system of fixed exchange rates acceptable to Keynes, but not entirely to his liking because it was based on a fixed relationship of the dollar to gold, the sort of system Keynes had almost two decades earlier declared “a barbarous relic. Treasury Secretary Henry Morgenthau claimed the new system replaced “the planless, senseless rivalry … the outright economic aggression … that has led to war… [the old system is] dead”.

As it turned out, not dead, only in a deep sleep, to emerge from its coffin when President Richard Nixon lifted the lid in 1971 and out popped what has come to be known as “the Nixon Shock” or, less colloquially, his New Economic Policy, some features of which might have a familiar ring to today’s followers of economic developments. Nixon drove down the value of the dollar by suspending the convertibility of dollars into gold, and levied a 10% tax on all dutiable imports in order to tip the international competitive balance in favor of American-made products and to create American jobs. Alas, the result was the stagflation of the 1970s.

From which successor presidents and various chairmen of the Federal Reserve Board rescued the nation, with the help of more-or-less open markets and policies favoring free trade. Enter a China determined to end decades of “humiliation” and rival America as a great power by creating barriers to imports, stealing American intellectual property, and subsidizing national champions, while American Presidents of both parties contented themselves with occasional growls of displeasure. Finally, Donald Trump, a president prepared to challenge China’s use of malign trade practices to achieve its goal, responded with steep tariffs, ending any lingering possibility of international cooperation on a Bretton-Woods scale for a long, long time, if not forever.

Indeed, rather than attempting to construct a system of stable currencies, Trump is flirting with a new war of the sort Bretton Woods was designed to end – a currency war. The President is convinced that America’s trading partners are manipulating their currencies to drive them down relative to the dollar, making their goods and services cheaper than those made in the USA. So he has added weakening the dollar to his list of reasons for demanding that the Fed lower interest rates. The days when a strong, stable dollar was believed to mirror a strong, stable economy are over: now it’s the lower and the more flexible (manipulable) the better.

Xi knows that if he gives Trump what the American side is demanding – and there is bipartisan agreement that China must agree to verifiable reforms or tariffs remain – he will have to abandon the malign trade practices on which his plan to Make China Great Again, economically and militarily, rests. That might cause him a greater loss than merely of face. The American President is acutely aware that his Chinese counterpart, who calls Trump “his friend”, is in no position to offer more than cosmetic concessions Those might be sufficient to allow Trump to ease the difficulties of the farmers whose votes he needs in 2020, but they do not remove the cause of the current trade war: Trump is settling in for a long war.

That troubles him not. Most important to a President who exalts winners and despises losers, is that America is winning this battle. The US economy continues to grow, share prices to soar, job openings to exceed unemployed workers, consumers to shop and buy. Meanwhile, China’s debt-laden economy is growing at its slowest rate in almost thirty years, empty “ghost cities” dot the landscape, business confidence and hiring plans are at their lowest since at least 2008, and manufacturing companies are fleeing China to avoid U.S. tariffs. And will not return. As the chief executive of a furniture company that is moving part of its production to Vietnam put it, “Once you move, you don’t go back.”

This victory, although not without its costs, is only one reason that America’s move to mercantilism will not soon be reversed, no matter the outcome of next year’s election. Trump loves protectionism, especially but not only tariffs. They are weapons in a war in which the ultimate weapon is denial of access to the huge American market, a weapon no country can match. His antipathy to imports is not limited to specific products or the countries from which they originate. Just last week at the Third Annual Made In America product showcase he featured made-in-America products on the south lawn of the White House (hats, sandals, bikes, Tabasco, boats, recreational vehicles, the THAAD missile defense system) and announced that the Buy American Act requirement that products eligible for purchase by federal agencies contain 50% of made-in-the-USA components would be raised to 75%, and the threshold would increase to 95% for iron and steel products. “The philosophy of my administration is simple. If we can build it, grow it or make it in the United States, we will.” Jean-Baptiste Colbert, the 17th century French mercantilist, couldn’t have said it better.

Protectionism, once unleashed, is an insidious creature, for several reasons.

  • Tariffs create constituencies that resist their repeal, both in the initiator and the retaliating countries.
  • Tariffs quickly lead to supplementary methods to supplement their protectionist force, such as subsidies for those sectors adversely affected by retaliation.
  • Companies that have revamped supply chains have a vested interest in the continuation of US barriers to Chinese imports.
  • Tariffs produce revenues for a treasury desperately short of funds, and unlikely to surrender that cash flow without a fight, especially since congress is about to increase spending, the already-huge trillion-dollar-plus deficit notwithstanding.
  • At a time when the most contentious political issue is income and wealth inequality, tariffs seem to benefit middle class workers at the expense of investment bankers, and therefore will retain the support of the Left.

Democrats have always been beholden to protectionist trade unions that see tariffs as job-creators. And one-time supporters of free trade in the Republican Party are nowhere to be seen or heard for fear of attracting the wrath of a President with a 90% approval rating among Republicans. In short, protectionism now has significant bipartisan support in America. EU beware.

Bretton Woods had a good run. So did the policy of more-or-less free trade. And so will Trump’s protectionism, which, along with retaliatory responses, becomes more firmly embedded in the policies of nations with every passing day.