Fifty Years of Floating Currencies

Fifty years ago this month, in March 1973, the Bretton Woods arrangement of fixed exchange rates was abandoned, and the world’s major currencies – including the US dollar, pound, yen, and Deutsche Mark – were allowed to float. At the time, the system’s demise was generally considered a policy failure. But the shift from fixed to flexible exchange rates was probably inevitable

The international monetary system that was designed at Bretton Woods, New Hampshire, in 1944, helped lay the economic foundation for the postwar international order. Over the next three decades, known in France as the “glorious 30” (les trente glorieuses), the system delivered rapid economic growth and unprecedented prosperity. And yet the Bretton Woods regime operated as planned only for roughly one year.

Though it was born in 1944, the Bretton Woods system did not become fully functional until 1958, after Western European countries had grown strong enough to make their currencies convertible into dollars. It was the very next year, 1959, that total dollar liabilities to foreigners reached the value of gold reserves held by US monetary authorities. Yale economist Robert Triffin realized the tension inherent in the US dollar’s role as the world’s only de facto reserve currency. Growing international demand for dollars, he predicted, would force the US to run constant balance-of-payments deficits until investors inevitably lost confidence in the greenback, causing the system to break down. This insight later came to be known as “Triffin’s dilemma.”

As it turned out, the increase in dollar liabilities accelerated after 1965, owing to the inflationary US fiscal and monetary expansion of the Vietnam War era. The system became increasingly strained until, in 1971, US President Richard Nixon suspended other governments’ ability to convert their dollar holdings into gold. Two years later, the world’s major currencies became untethered for good. The new floating system demonstrated its worth later in 1973, when currency depreciations helped oil-importing countries like Japan withstand the shock of the Arab oil embargo.

The shift toward exchange-rate flexibility continued after 1973. Initially, most smaller currencies remained pegged to the dollar, but over the following decades, more and more emerging and developing economies moved away from exchange-rate targets and toward increased flexibility.