The IMF should provide loan advances to countries with balance-of-payments deficits. Short-term balance-of-payments difficulties would be overcome by IMF loans, which would facilitate exchange rate stability. This flexibility meant that a Member State did not have to cause depression to bring its national income down to such a low level that its imports would eventually fall within its capabilities. This should avoid the need for countries to resort to conventional medicine, to embark on dramatic unemployment in the face of chronic balance-of-payments deficits. Before the Second World War, European nations – especially Britain – often used it. We can learn a lot about the planned operation of the system by looking at the collapse of the system. The collapse was mainly because the United States would not allow its domestic policy to be compromised in the name of the fixed exchange rate system. Here is a brief report on what happened. For a more detailed description, see Barry Eichengreens Globalizing CapitalBarry Eichengreen, Globalizing Capital: A History of the International Monetary System (Princeton, NJ: Princeton University Press, 1996). and Alfred Eckes A Search for Solvency.Alfred E. Eckes Jr., A Search for Solvency (Austin, TX: University of Texas Press, 1975). Free trade was based on the free convertibility of currencies. Negotiators at the Bretton Woods conference, fresh from what they saw as a disastrous experiment with interest rate volatility in the 1930s, concluded that large currency fluctuations could cripple the free flow of trade.
At the end of the war, the Bretton Woods Conference was the culmination of about two and a half years of planning for post-war reconstruction by the Treasuries of the United States and the United Kingdom. American officials studied with their British colleagues the reconstruction of what had been lacking between the two world wars: an international payments system that would allow nations to act without fear of sudden currency devaluations or sharp exchange rate fluctuations – diseases that had almost paralyzed global capitalism during the Great Depression. … [D]i caximate cause of the world depression was a strukturell fehlerhaft and poorly managed international gold standard. … For many reasons, including the Federal Reserve`s desire to stem the U.S. stock market boom, monetary policy in several major countries became contractualized in the late 1920s, a contraction that was transmitted worldwide by the gold standard. What began to be a lenient deflationary process began to take off when the banking and monetary crises of 1931 triggered an international “battle for gold”. The sterilization of gold inflows by surplus countries [the United States and France], the substitution of gold by foreign exchange reserves and runs to commercial banks has led to an increase in the coverage of silver gold and, consequently, a sharp involuntary decrease in domestic shipments.
Monetary contractions, on the other hand, have been strongly linked to lower prices, output and employment. Effective international cooperation could, in principle, have allowed for the expansion of money on a global scale despite restrictions on the gold standard, but disputes over the reparations and war debts of the First World War and the insularity and inexperience of the Federal Reserve prevented this result.