Bretton Woods' Fatal Flaw: Unsustainable Design

The Bretton Woods agreement, signed in 1944, established the US dollar as the world's reserve currency and pegged its value to gold. Under this arrangement, foreign governments and central banks could exchange their dollars for gold at a fixed rate of $35 per ounce. However, by the 1960s, the US had accumulated significant trade deficits, leading to an increase in the supply of dollars abroad, which exceeded the country's gold reserves.

The Bretton Woods system was designed with flaws that made it unsustainable from the start. Keynes proposed a reserve currency, Bancor, managed by an international clearing union, but this idea was rejected. Instead, the agreement created the International Monetary Fund and the World Bank, with each member nation assigned a quota based on its gold reserves.

The dollar-gold peg was vulnerable because it relied on the US maintaining a balance of payments surplus to issue enough dollars. However, as the country's trade deficits grew, the arrangement became increasingly strained. In 1961, the US established the London Gold Pool, which coordinated the sale of gold by participating central banks to maintain the fixed price.

Despite these efforts, the system eventually collapsed in 1971 when President Nixon unilaterally ended the dollar's convertibility obligation. The US had accumulated significant trade deficits and its gold reserves were depleted, making it impossible to meet the demand for dollars abroad.