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A retrospective on the bretton woods system: Lessons for international monetary reform
Journal
of International
Economics
36 (1994)
187-199.
North-Holland
Book reviews Michael D. Bordo and Barry Eichengreen, eds., A Retrospective Bretton Woods System: Lessons for International Monetary (University of Chicago Press, Chicago, IL, 1993) pp. xiii+675
on the Reform
The Mt. Washington Hotel, in Bretton Woods, New Hampshire, was the site of the 1944 conference that established the rules and institutions of the international monetary system that came into being after the Second World War. That system lasted for 25 years, until 15 August 1971, when the United States severed the link between gold and the dollar, and it was interred officially five years later, when the Interim Committee of the International Monetary Fund (IMF) agreed on the terms of the Second Amendment to the Articles of Agreement of the IMF, legalizing the shift to floating exchange rates. Twenty years after the closing of the gold window, the National Bureau of Economic Research held another conference at the Mt. Washington Hotel to revisit the Bretton Woods system. This book is the result. The book begins with an overview of the Bretton Woods system, by Michael Bordo, and two other papers on the origins of the system. Albert0 Giovannini examines the roles of rules and discretion in the Bretton Woods system and in earlier monetary systems. John Ikenberry examines the political origins of the system. These papers are followed by six more on the functioning and ultimate collapse of the system. Maurice Obstfeld offers a persuasive interpretation of the balance-ofpayments adjustment process. He argues that the risk of exchange-rate changes inherent in the Bretton Woods system prevented private capital markets from financing imbalances freely, making the system heavily dependent on the availability of official reserves, but also exposed the system to speculative pressures too big to be contained by available reserves. Hans Genberg and Alexander Swoboda examine the provision of liquidity under the Bretton Woods system. Treating the system as a pure dollar standard and using a long-run monetary model, they rely on a simple stockadjustment process to explain how U.S. monetary policy determined global reserves and the evolution of the money supply outside the United States. Alan Stockman studies the transmission of real and monetary shocks. The first part of his paper develops an equilibrium model amended by a stylized form of price stickiness to explain the behavior of real variables, including 0022-1996/94/$07.00 0 1994-Elsevier SSDI 0022-1996(93)01301-T
Science
B.V. All rights
reserved
188
Book
reviews
the real exchange rate; the second part presents empirical work on the transmission of inflation. Kathryn Dominguez uses game-theoretic models to show why rules against beggar-thy-neighbor policies cannot be sustained in the absence of penalties or rewards, and she argues that the institutions of the postwar system, the IMF and the GATT, were not equipped to mete them out. The chief contributiuon of those institutions, she concludes, was to help markets and governments monitor national policies. Sebastian Edwards and Julio Santaella revisit the exchange-rate and adjustment problems of the developing countries. They use a variety of economic and political indexes to explain why certain countries devalued unilaterally, whereas others did so in conjunction with IMF programs, and why some devaluations were more successful than others. Finally, Peter Garber models the demise of the Bretton Woods system as a speculative attack, but not the attack predicted by the celebrated TrifIin paradox - a rush by official institutions to sell dollars for gold. As domestic credit expanded in the United States, he says, market participants came to believe that the dollar was overvalued in terms of other currencies, and they started to sell dollars, exhausting the willingness of foreign central banks to buy and hold additional dollars. The book includes two papers on more recent matters: Richard Marston tries carefully to measure the effects of capital controls and exchange-rate risk on interest-rate differentials under the Bretton Woods system and under the subsequent float. Susan Collins and Francesco Giavazzi use survey data on European households’ views about future inflation and unemployment and about their own well-being to trace changes in attitudes towards inflation and the contribution of those changes to the viability of the European Monetary System (EMS). (Oddly, none of the papers in this book uses the target-zone model to interpret exchange-rate behavior under the Bretton Woods system, although it was a target-zone regime in the same sense that the EMS is a target-zone regime. I should like to believe that this omission reflects the editors’ judgment concerning the limitations of the target-zone model rather than the authors’ unwillingness to do the hard work of compiling daily exchange-rate data.) Finally, there are two panel discussions, one on the Bretton Woods system itself and the other on reform of the present monetary system, and the volume concludes with an epilogue by Barry Eichengreen. Every paper in this book is well worth reading, including the panelists’ paper, and the discussants’ comments are unusually useful. It will be noted that most of the principal authors began their professional careers after the demise of the Bretton Woods system, so that they bring new methods and fresh questions to the study of the system. The panelists and discussants, however, include economists who contributed importantly to earlier debates and research on the system, such as Robert Aliber, Richard Cooper, Max
Book
reviews
189
Corden, Ronald McKinnon, Robert Mundell, and John Williamson, and two who were involved in managing the system, Edward M. Bernstein at the IMF and Robert Solomon at the Federal Reserve. Their recollections and reflections offset the tendency of several authors to rely on highly stylized versions of monetary history. Four questions are raised by the papers in this book: What were the defining characteristics of the Bretton Woods system? How well did it work? Why did it collapse? What lessons can we learn from it? Eichengreen’s epilogue answers these questions. The reader would be well advised to read it before reading Bordo’s overview, which is rather idiosyncratic. But Eichengreen poses a questions of his own: How have recent events and analytical innovations affected this book’s answers to the first four questions? I focus here on Eichengreen’s question, which gives us a way of measuring the value added by this book. Although the papers in the book use models and techniques that were not available two decades ago, and they include important empirical work inspired by other recent studies, they do not produce a new consensus on the nature of the Bretton Woods system, nor do they greatly deepen our understanding of the way in which it worked. In fact, recent events and innovations have produced new disagreements, because they have led many economists, including contributors to this book, to interpret the nature, functioning, and collapse of the Bretton Woods system in terms of concerns and objectives far different from those of its founders or, for that matter, its earlier critics. At the 1944 Bretton Woods conference, the participants were determined to make sure that benevolent governments would be free to achieve and maintain full employment. Giovannini and Obstfeld both emphasize this fundamental point and its chief corollary - that the Bretton Woods system was aimed at this objective, not at constraining short-sighted governments from springing inflationary ‘surprises’ or inflating away their debts. The plan designed by Harry Dexter White was tighter in this particular respect than the plan designed by John Maynard Keynes. But the final design of the Bretton Woods system came closer to the British view that exchange-rate changes would be needed to maintain external balance at high levels of employment. Yet several papers in this book, including Bordo’s overview, treat the Bretton Woods system as a fixed-rate regime, not a pegged-rate regime, and even treat the price of gold as the nominal anchor of the system. Some go so far as to say that the Bretton Woods system collapsed in 1968, with the end of the attempt to stabilize the market price of gold in London. Those who hold this view, moroever, are prone to blame U.S. monetary policy for the collapse of the Bretton Woods system, because it was inconsistent with fixing the price of gold. Looking forward from 1944, it would make more sense to
190
Book reviews
argue that the collapse of the Bretton Woods system resulted from the ossification of the exchange-rate regime and the peculiar constraints it imposed on the freedom of the United States to alter its own exchange rate, not from the constraints it failed to impose on U.S. monetary policy. There were two important exchange-rate realignments during the Bretton Woods era - the general revaluation of the dollar in 1949, brought about by the first devaluation of the pound, and Smithsonian realignment in 1971, brought about by the closing of the gold window. (That was, indeed, its principal purpose.) Between those two events, however, there were very few changes in key-currency exchange rates. The French franc was devaluated in 1957, 1958, and 1969; the Deutschemark was revalued in 1961 and in 1969, after a brief float; the pound was devalued in 1967; there was no change whatsoever in the yen-dollar rate. We will never know whether these changes were fewer or less frequent than the founders of the Bretton Woods system had expected. It is fair to say, however, that the exchange-rate regime became more rigid as capital movements were liberalized - a process that began even before the return to current-account convertibility at the start of the 1960s. The game played between markets and governments forced the latter to deny that they would alter their exchange rates and thus made it increasingly hard to do that without a devastating loss of credibility - as well as the risk of losing the next election. Unfortunately, the papers in this book were written after 1987, when the ‘new EMS was born, but before 1992, when it died. It would be possible today not only to model and compare the dynamics of the two pegged-rate regimes but also to compare the two end games. There are remarkable similarities. In both cases the key-currency country was the prisoner of its partners’ exchange-rate policies, and the tactics it used to achieve its objectives, although different in detail, had grave effects on the exchange-rate regime. What was the role of the gold price in the Bretton Woods System? Robert Mundell tells part of the story in his paper for the final panel. Under the Articles of Agreement of the IMF, gold was the numeraire used to define par values for national currencies. But once those values were defined, members of the Fund could discharge their obligation to peg their exchange rates by intervening on the foreign-exchange market. They did not have to deal in gold. By intervening in dollars, moreover, they pegged exchange rates for the dollar, leaving the United States without any operational obligation. To achieve operational symmetry, then, the United States undertook to deal in gold. By doing that, moreover, it allowed other governments to hold their to satisfy their reserve-asset reserves in gold or dollars and, therefore, preferences. Thus, Britain was able to hold most of its reserves in gold; it held only a small working balance in dollars, which it used for intervention. At no point, however, did the United States undertake formally to stabilize
Book
reviews
191
the market price of gold. The U.S. Treasury dealt only with foreign central banks and governments. At the end of 1960, however, several events conspired to raise the market price of gold, and the flare-up was widely interpreted as a disparaging comment on the incoming Kennedy administration. Therefore, the U.S. Treasury began to work with the Bank of England to stabilize the market price, and these arrangements led soon to the formation of the so-called London gold pool, involving several countries. Hence, Dale Henderson was quite right to say that the London gold pool represented a multilateralization of the obligation to stabilize the market price of gold. But he should perhaps have added that this had been an obligation of the Bank of England, not of the United States. In brief, the price of gold played three roles in the Bretton Woods system ~ and the confounding of those roles helped to make the system rigid: (1) The fixed official price of gold represented the legal commitment of the United States to keep its exchange rate pegged; the United States could not alter its exchange rate, even with the concurrence of the IMF, without changing the official price. At the same time, however, it could not alter its exchange rate merely by changing that offtcial price; other countries could nullify the exchange-rate change by changing their par values and, more importantly, by refusing to change the dollar exchange rates at which they intervened on the foreign-exchange market. (2) The fixed official price of gold represented a commitment by the United States to accommodate other countries’ reserve-asset preference, which became increasingly important as several of those countries, notably Germany, built up their dollar reserves. Washington’s reluctance to change the gold price reflected its implicit bargain with foreign official holders of dollars, not its distaste for conferring a windfall on South Africa and the Soviet Union - the two main gold-producing countries. (3) The stabilization of the market price via the London gold pool came to symbolize the collective commitment of the major industrial countries to defend the existing exchange-rate regime. Hence, the 1986 decision to disband the gold pool was important in eroding the credibility of that commitment ~ along with the earlier devaluation of the pound, the subsequent devaluation of the franc, and the revaluation of the mark. It was not, however, a unilateral repudiation of any U.S. obligation. The Bretton Woods system was not a gold standard, de jure or de facto, and the London gold price was not viewed as the nominal anchor of the system. Can U.S. monetary policy be blamed for the demise of the Bretton Woods system? Tautologically, yes. A sufficient tightening of U.S. monetary policy would have sustained the competitiveness of the United States; it could have produced and maintained a current-account surplus large enough to match the ongoing capital outflow. But the critics of U.S. monetary policy have something else in mind. Genberg and Swoboda, for example, maintain that
192
Book
rehws
credit creation in the United States was directly responsible for the U.S. balance-of-payments deficit (i.e. the growth of dollar holdings by foreign central banks) and thus for the growth of the money supply in the outside world. Hence, the United States was exporting inflation, and foreign central banks had to break away from the Bretton Woods system to keep from importing it. There are three problems with this story. The first was noted by Richard Cooper. In 1970-1971, on the eve of the crisis that brought down the system, the dollar reserves of foreign central banks were growing far more rapidly than the monetary base in the United States. (That is why the GenbergSwoboda model underpredicts the growth of foreign dollar holdings.) Second, the validity of the Genberg-Swoboda model must be judged by the ability of its stock-adjustment equation to explain the behavior of the U.S. balance of payments, but it accounts for less than 50 percent of the variance. Third, Genberg and Swoboda ignore completely the systematic and partially successful efforts of foreign central banks, including the Bundesbank, to sterilize increases in their dollar reserves; the domestic assets of foreign central banks are exogenous in their model. Stylized facts become fiction. There was a huge deterioration in the U.S. balance of payments on the eve of the 1971 crisis. It reflected in part an easing of U.S. monetary policy after the credit crunch of 19681969; the crunch had attracted huge capital inflows, which turned around in 1970. It also reflected a very large shift in the U.S. trade balance, which the trade equations of the day could not begin to explain. The adverse shift in the trade balance helps in turn to account for the sudden building up of protectionist pressures in the U.S. Congress - the Burke-Hartke Amendment, the Mills Bill, and all that - and they in their turn help to account for John Connally’s strategy in 1971. The gold window was not closed in panic. It was closed quite deliberately as part of a campaign to engineer a devaluation of the dollar. There is an intriguing analogy here - a tale of two Texans ~ between Connally’s strategy in 1971 and James Baker’s strategy in 1985, when he engineered the Plaza Agreement to reverse the appreciation of the dollar and thus combat another outbreak of protectionism. Unhappily, that tale is not told in this book, which does not devote enough attention to the political economy of exchange-rate policy under the Bretton Woods system. Peter B. Kenen Princeton University
of International
Economics
36 (1994)
187-199.
North-Holland
Book reviews Michael D. Bordo and Barry Eichengreen, eds., A Retrospective Bretton Woods System: Lessons for International Monetary (University of Chicago Press, Chicago, IL, 1993) pp. xiii+675
on the Reform
The Mt. Washington Hotel, in Bretton Woods, New Hampshire, was the site of the 1944 conference that established the rules and institutions of the international monetary system that came into being after the Second World War. That system lasted for 25 years, until 15 August 1971, when the United States severed the link between gold and the dollar, and it was interred officially five years later, when the Interim Committee of the International Monetary Fund (IMF) agreed on the terms of the Second Amendment to the Articles of Agreement of the IMF, legalizing the shift to floating exchange rates. Twenty years after the closing of the gold window, the National Bureau of Economic Research held another conference at the Mt. Washington Hotel to revisit the Bretton Woods system. This book is the result. The book begins with an overview of the Bretton Woods system, by Michael Bordo, and two other papers on the origins of the system. Albert0 Giovannini examines the roles of rules and discretion in the Bretton Woods system and in earlier monetary systems. John Ikenberry examines the political origins of the system. These papers are followed by six more on the functioning and ultimate collapse of the system. Maurice Obstfeld offers a persuasive interpretation of the balance-ofpayments adjustment process. He argues that the risk of exchange-rate changes inherent in the Bretton Woods system prevented private capital markets from financing imbalances freely, making the system heavily dependent on the availability of official reserves, but also exposed the system to speculative pressures too big to be contained by available reserves. Hans Genberg and Alexander Swoboda examine the provision of liquidity under the Bretton Woods system. Treating the system as a pure dollar standard and using a long-run monetary model, they rely on a simple stockadjustment process to explain how U.S. monetary policy determined global reserves and the evolution of the money supply outside the United States. Alan Stockman studies the transmission of real and monetary shocks. The first part of his paper develops an equilibrium model amended by a stylized form of price stickiness to explain the behavior of real variables, including 0022-1996/94/$07.00 0 1994-Elsevier SSDI 0022-1996(93)01301-T
Science
B.V. All rights
reserved
188
Book
reviews
the real exchange rate; the second part presents empirical work on the transmission of inflation. Kathryn Dominguez uses game-theoretic models to show why rules against beggar-thy-neighbor policies cannot be sustained in the absence of penalties or rewards, and she argues that the institutions of the postwar system, the IMF and the GATT, were not equipped to mete them out. The chief contributiuon of those institutions, she concludes, was to help markets and governments monitor national policies. Sebastian Edwards and Julio Santaella revisit the exchange-rate and adjustment problems of the developing countries. They use a variety of economic and political indexes to explain why certain countries devalued unilaterally, whereas others did so in conjunction with IMF programs, and why some devaluations were more successful than others. Finally, Peter Garber models the demise of the Bretton Woods system as a speculative attack, but not the attack predicted by the celebrated TrifIin paradox - a rush by official institutions to sell dollars for gold. As domestic credit expanded in the United States, he says, market participants came to believe that the dollar was overvalued in terms of other currencies, and they started to sell dollars, exhausting the willingness of foreign central banks to buy and hold additional dollars. The book includes two papers on more recent matters: Richard Marston tries carefully to measure the effects of capital controls and exchange-rate risk on interest-rate differentials under the Bretton Woods system and under the subsequent float. Susan Collins and Francesco Giavazzi use survey data on European households’ views about future inflation and unemployment and about their own well-being to trace changes in attitudes towards inflation and the contribution of those changes to the viability of the European Monetary System (EMS). (Oddly, none of the papers in this book uses the target-zone model to interpret exchange-rate behavior under the Bretton Woods system, although it was a target-zone regime in the same sense that the EMS is a target-zone regime. I should like to believe that this omission reflects the editors’ judgment concerning the limitations of the target-zone model rather than the authors’ unwillingness to do the hard work of compiling daily exchange-rate data.) Finally, there are two panel discussions, one on the Bretton Woods system itself and the other on reform of the present monetary system, and the volume concludes with an epilogue by Barry Eichengreen. Every paper in this book is well worth reading, including the panelists’ paper, and the discussants’ comments are unusually useful. It will be noted that most of the principal authors began their professional careers after the demise of the Bretton Woods system, so that they bring new methods and fresh questions to the study of the system. The panelists and discussants, however, include economists who contributed importantly to earlier debates and research on the system, such as Robert Aliber, Richard Cooper, Max
Book
reviews
189
Corden, Ronald McKinnon, Robert Mundell, and John Williamson, and two who were involved in managing the system, Edward M. Bernstein at the IMF and Robert Solomon at the Federal Reserve. Their recollections and reflections offset the tendency of several authors to rely on highly stylized versions of monetary history. Four questions are raised by the papers in this book: What were the defining characteristics of the Bretton Woods system? How well did it work? Why did it collapse? What lessons can we learn from it? Eichengreen’s epilogue answers these questions. The reader would be well advised to read it before reading Bordo’s overview, which is rather idiosyncratic. But Eichengreen poses a questions of his own: How have recent events and analytical innovations affected this book’s answers to the first four questions? I focus here on Eichengreen’s question, which gives us a way of measuring the value added by this book. Although the papers in the book use models and techniques that were not available two decades ago, and they include important empirical work inspired by other recent studies, they do not produce a new consensus on the nature of the Bretton Woods system, nor do they greatly deepen our understanding of the way in which it worked. In fact, recent events and innovations have produced new disagreements, because they have led many economists, including contributors to this book, to interpret the nature, functioning, and collapse of the Bretton Woods system in terms of concerns and objectives far different from those of its founders or, for that matter, its earlier critics. At the 1944 Bretton Woods conference, the participants were determined to make sure that benevolent governments would be free to achieve and maintain full employment. Giovannini and Obstfeld both emphasize this fundamental point and its chief corollary - that the Bretton Woods system was aimed at this objective, not at constraining short-sighted governments from springing inflationary ‘surprises’ or inflating away their debts. The plan designed by Harry Dexter White was tighter in this particular respect than the plan designed by John Maynard Keynes. But the final design of the Bretton Woods system came closer to the British view that exchange-rate changes would be needed to maintain external balance at high levels of employment. Yet several papers in this book, including Bordo’s overview, treat the Bretton Woods system as a fixed-rate regime, not a pegged-rate regime, and even treat the price of gold as the nominal anchor of the system. Some go so far as to say that the Bretton Woods system collapsed in 1968, with the end of the attempt to stabilize the market price of gold in London. Those who hold this view, moroever, are prone to blame U.S. monetary policy for the collapse of the Bretton Woods system, because it was inconsistent with fixing the price of gold. Looking forward from 1944, it would make more sense to
190
Book reviews
argue that the collapse of the Bretton Woods system resulted from the ossification of the exchange-rate regime and the peculiar constraints it imposed on the freedom of the United States to alter its own exchange rate, not from the constraints it failed to impose on U.S. monetary policy. There were two important exchange-rate realignments during the Bretton Woods era - the general revaluation of the dollar in 1949, brought about by the first devaluation of the pound, and Smithsonian realignment in 1971, brought about by the closing of the gold window. (That was, indeed, its principal purpose.) Between those two events, however, there were very few changes in key-currency exchange rates. The French franc was devaluated in 1957, 1958, and 1969; the Deutschemark was revalued in 1961 and in 1969, after a brief float; the pound was devalued in 1967; there was no change whatsoever in the yen-dollar rate. We will never know whether these changes were fewer or less frequent than the founders of the Bretton Woods system had expected. It is fair to say, however, that the exchange-rate regime became more rigid as capital movements were liberalized - a process that began even before the return to current-account convertibility at the start of the 1960s. The game played between markets and governments forced the latter to deny that they would alter their exchange rates and thus made it increasingly hard to do that without a devastating loss of credibility - as well as the risk of losing the next election. Unfortunately, the papers in this book were written after 1987, when the ‘new EMS was born, but before 1992, when it died. It would be possible today not only to model and compare the dynamics of the two pegged-rate regimes but also to compare the two end games. There are remarkable similarities. In both cases the key-currency country was the prisoner of its partners’ exchange-rate policies, and the tactics it used to achieve its objectives, although different in detail, had grave effects on the exchange-rate regime. What was the role of the gold price in the Bretton Woods System? Robert Mundell tells part of the story in his paper for the final panel. Under the Articles of Agreement of the IMF, gold was the numeraire used to define par values for national currencies. But once those values were defined, members of the Fund could discharge their obligation to peg their exchange rates by intervening on the foreign-exchange market. They did not have to deal in gold. By intervening in dollars, moreover, they pegged exchange rates for the dollar, leaving the United States without any operational obligation. To achieve operational symmetry, then, the United States undertook to deal in gold. By doing that, moreover, it allowed other governments to hold their to satisfy their reserve-asset reserves in gold or dollars and, therefore, preferences. Thus, Britain was able to hold most of its reserves in gold; it held only a small working balance in dollars, which it used for intervention. At no point, however, did the United States undertake formally to stabilize
Book
reviews
191
the market price of gold. The U.S. Treasury dealt only with foreign central banks and governments. At the end of 1960, however, several events conspired to raise the market price of gold, and the flare-up was widely interpreted as a disparaging comment on the incoming Kennedy administration. Therefore, the U.S. Treasury began to work with the Bank of England to stabilize the market price, and these arrangements led soon to the formation of the so-called London gold pool, involving several countries. Hence, Dale Henderson was quite right to say that the London gold pool represented a multilateralization of the obligation to stabilize the market price of gold. But he should perhaps have added that this had been an obligation of the Bank of England, not of the United States. In brief, the price of gold played three roles in the Bretton Woods system ~ and the confounding of those roles helped to make the system rigid: (1) The fixed official price of gold represented the legal commitment of the United States to keep its exchange rate pegged; the United States could not alter its exchange rate, even with the concurrence of the IMF, without changing the official price. At the same time, however, it could not alter its exchange rate merely by changing that offtcial price; other countries could nullify the exchange-rate change by changing their par values and, more importantly, by refusing to change the dollar exchange rates at which they intervened on the foreign-exchange market. (2) The fixed official price of gold represented a commitment by the United States to accommodate other countries’ reserve-asset preference, which became increasingly important as several of those countries, notably Germany, built up their dollar reserves. Washington’s reluctance to change the gold price reflected its implicit bargain with foreign official holders of dollars, not its distaste for conferring a windfall on South Africa and the Soviet Union - the two main gold-producing countries. (3) The stabilization of the market price via the London gold pool came to symbolize the collective commitment of the major industrial countries to defend the existing exchange-rate regime. Hence, the 1986 decision to disband the gold pool was important in eroding the credibility of that commitment ~ along with the earlier devaluation of the pound, the subsequent devaluation of the franc, and the revaluation of the mark. It was not, however, a unilateral repudiation of any U.S. obligation. The Bretton Woods system was not a gold standard, de jure or de facto, and the London gold price was not viewed as the nominal anchor of the system. Can U.S. monetary policy be blamed for the demise of the Bretton Woods system? Tautologically, yes. A sufficient tightening of U.S. monetary policy would have sustained the competitiveness of the United States; it could have produced and maintained a current-account surplus large enough to match the ongoing capital outflow. But the critics of U.S. monetary policy have something else in mind. Genberg and Swoboda, for example, maintain that
192
Book
rehws
credit creation in the United States was directly responsible for the U.S. balance-of-payments deficit (i.e. the growth of dollar holdings by foreign central banks) and thus for the growth of the money supply in the outside world. Hence, the United States was exporting inflation, and foreign central banks had to break away from the Bretton Woods system to keep from importing it. There are three problems with this story. The first was noted by Richard Cooper. In 1970-1971, on the eve of the crisis that brought down the system, the dollar reserves of foreign central banks were growing far more rapidly than the monetary base in the United States. (That is why the GenbergSwoboda model underpredicts the growth of foreign dollar holdings.) Second, the validity of the Genberg-Swoboda model must be judged by the ability of its stock-adjustment equation to explain the behavior of the U.S. balance of payments, but it accounts for less than 50 percent of the variance. Third, Genberg and Swoboda ignore completely the systematic and partially successful efforts of foreign central banks, including the Bundesbank, to sterilize increases in their dollar reserves; the domestic assets of foreign central banks are exogenous in their model. Stylized facts become fiction. There was a huge deterioration in the U.S. balance of payments on the eve of the 1971 crisis. It reflected in part an easing of U.S. monetary policy after the credit crunch of 19681969; the crunch had attracted huge capital inflows, which turned around in 1970. It also reflected a very large shift in the U.S. trade balance, which the trade equations of the day could not begin to explain. The adverse shift in the trade balance helps in turn to account for the sudden building up of protectionist pressures in the U.S. Congress - the Burke-Hartke Amendment, the Mills Bill, and all that - and they in their turn help to account for John Connally’s strategy in 1971. The gold window was not closed in panic. It was closed quite deliberately as part of a campaign to engineer a devaluation of the dollar. There is an intriguing analogy here - a tale of two Texans ~ between Connally’s strategy in 1971 and James Baker’s strategy in 1985, when he engineered the Plaza Agreement to reverse the appreciation of the dollar and thus combat another outbreak of protectionism. Unhappily, that tale is not told in this book, which does not devote enough attention to the political economy of exchange-rate policy under the Bretton Woods system. Peter B. Kenen Princeton University