How did Bretton Woods work, and why did it collapse?

The Bretton Woods system pegged other currencies to the US dollar, and the dollar was pegged to gold at $35 an ounce. It ended because the United States ran persistent deficits that put more dollars into the world than its gold stock could cover. President Nixon closed the gold window in August 1971, and by early 1973 the major currencies were floating. [1] [2]

Delegates at the 1944 Bretton Woods conference created the International Monetary Fund and the institution now known as the World Bank Group. The IMF would monitor exchange rates and lend reserve currencies to countries with balance-of-payments deficits. Its first twenty-nine members signed its Articles of Agreement in December 1945. They agreed to keep their currencies fixed but adjustable, within a 1 percent band, against the dollar. According to [federalreservehistory.org](https://www.federalreservehistory.org/essays/bretton-woods-created), the system became fully functional in 1958, when currencies became convertible. [1]

The IMF explains that a country could change its parity only in cases of "fundamental disequilibrium", and only the member country could propose the change. The IMF could merely approve or reject it. The thinking was that competitive devaluations and trade barriers had worsened the Great Depression, so stable individual rates would stabilize the whole system. The United States, for its part, had to keep the gold price fixed and manage the supply of dollars so that confidence in convertibility held. See [imf.org](https://www.imf.org/en/blogs/articles/2021/08/16/from-the-history-books-the-rethinking-of-the-international-monetary-system). [3] [1]

The Federal Reserve's history describes a built-in flaw. The world's gold stock could not meet demand for reserves, so the United States supplied dollars by running a balance-of-payments deficit while promising to redeem them for gold. By 1961, dollar claims began to exceed the US gold stock. Without more dollars the system was unworkable, and with more dollars it was unstable. The US State Department's history adds that foreign aid, military spending and foreign investment contributed to the dollar surplus, leaving the dollar overvalued. Presidents Kennedy and Johnson tried several support measures, and the department says none worked. Traders increasingly sold dollars, causing periodic runs. See [federalreservehistory.org](https://www.federalreservehistory.org/essays/smithsonian-agreement) and [history.state.gov](https://history.state.gov/milestones/1969-1976/nixon-shock). [2] [4]

Inflation made matters worse. US inflation rose from under 2 percent in early 1965 to 6 percent by the end of 1969, which widened the deficit and sent more dollars abroad. The IMF also notes that deficit countries delayed devaluations for political reasons, while surplus countries had no incentive to revalue, and that growing private capital flows magnified any hint of devaluation. [2] [3]

By summer 1971 speculators were leaving the dollar and central banks were converting dollars into gold. In August, Nixon closed the gold window, ending foreign central banks' right to exchange dollars for Treasury gold. He blamed unfair trade practices and other countries' unwillingness to share Cold War military costs, and he wanted foreign currencies to rise against the dollar. The IMF describes the move as a ploy to force surplus countries to revalue, which in effect brought down the system because the dollar was its linchpin. [2] [3]

The Smithsonian Agreement later that year raised the gold price to $38 an ounce, about an 8.5 percent devaluation, and other currencies were revalued. The net effect was roughly a 10.7 percent average devaluation of the dollar against other key currencies. It did little to restore confidence. Gold reached around $90 an ounce by early 1973. On February 12, 1973, the United States devalued again, by 10 percent, to $42 an ounce. Within a month nearly all major currencies were floating against the dollar. [2]