Gobbledegook! The Bretton Woods System of Fixed Exchange Rates According to E.C. Harwood

– November 6, 2023 Reading Time: 8 minutes

Colonel E.C. Harwood, who founded the American Institute for Economic Research ninety years ago in 1933, adamantly opposed the first and second Bretton Woods systems because he believed that governments needed to face the hard budget constraint inherent in the retail gold standard. He was not invited to the Bretton Woods conference, and could not attend anyway. When it met in July 1944, Harwood was serving as an Army engineer stationed in New Guinea. Moreover, he viewed international monetary conferences with skepticism, later noting that “at international conferences of supposed experts, I have unhappily listened to more undiluted nonsense than I had thought the mind of man could conceive.” So Harwood might not have attended even if he were able and had been invited, which was unlikely anyway given that Lord Keynes had already publicly tangled with the AIER founder and MIT professor in 1934, and could not answer his criticisms in private correspondence. In the end, Keynes comes across as something of a Meno, the alleged expert who eventually gave up trying to debate Socrates by admitting that both his “mind and tongue” had grown “numb,” like the victim of a “torpedo fish.”

Despite his wartime duties, Harwood remained interested in the monetary debates that led to the conference. While the conference was taking place, in fact, he was busy critiquing McMaster University political economy professor Humfrey Michell’s pamphlet The Place of Silver in Monetary Reconstruction, which he assailed as unscientific and biased research. Michell was a relative nobody, erroneously identified as Mitchell by both Harwood and New York University economist Walter E. Spahr. But the big problem, pointed to by Harwood and Spahr, was that Michell provided no data to support his sweeping assertion that “there is not enough gold in the world to put the international exchanges upon a ‘hard money’ basis alone.” Clearly, Michell sought to create demand for silver, even though silver infusions during the Depression had done little other than to distort trade with China.

Harwood also assailed Michell’s assumption that the gold-silver ratio was stable enough to allow international bimetallism to work. “The rates at which gold and silver have exchanged,” he explained, “vary over a wide range.” He then explained how market deviations from the initial ratio would induce people to prefer gold over silver or vice versa. After that, Harwood disputed Michell’s claim that no serious student of international bimetallism has ever doubted its workability. “Every monetary economist who has read the literature on the subject,” Harwood explained, “well knows” that bimetallism had suffered withering critique. Spahr also questioned what Michell had “read on the subject” given that even some of the pamphlets preceding his in the series he published in had questioned it!

Harwood next explained that Michell, like others who believed that “continuing dosages of inflation could cure the monetary ills of the world” were “modern John Laws” more interested in their theories of gold scarcity than empirical facts. Harwood wondered if the nonprofit behind the study, the Monetary Standards Inquiry, was funded by the same silver interests that “foisted the silver purchase program on the American people and who will scruple at nothing to perpetrate the source of their ill-gotten gains.”

In December 1944, Harwood also referred to Keynes as a “modern John Law” due to “his dexterity with words and his capacity for self-hallucination.” “One of the most interesting and perhaps most significant omissions from all seventeen plans,” Harwood complained, “is the lack of any proposal to restore what used to be called ‘sound money’. It seems to be taken for granted that the gold standard failed; there is not even a hint that the money jugglers who tried to ‘outsmart’ it were the ones who failed, first by creating an unsound and inflated prosperity during the boom decade, and second by refusing to see or at least to admit their own responsibility for the aftermath.” “This failure to appreciate the merits of the gold standard,” he continued, “probably indicates that the simple notions of an earlier day will become even more old-fashioned during the years immediately ahead.” “Until there is more consistent and more fruitful application of the scientific method to economic problems,” he warned, “we shall not have the right answers; we delude ourselves when we accept as cures, economic medicine that only alleviate symptoms.”

The gold exchange system of fixed exchange rates proposed at Bretton Woods went into effect despite Harwood’s protests. A full decade later, in 1954, Harwood testified in the US Senate about the “advantages of returning to the full gold standard with the nation’s currency redeemable in gold coin on demand,” as it had been throughout most of the nation’s history before the New Deal. After explaining the Humean specie-flow price mechanism, he argued that retail restoration would:

Prevent further and indefinitely prolonged depreciation or loss of the dollar’s buying power.
Obtain the best available insurance against a flight from the dollar with a resulting distorted boom on the one hand and against severe and prolonged unemployment on the other hand.
Preserve confidence in the dollar.
Inhibit unwise fiscal and banking policies that might jeopardize the future of the Nation.
Assure equitable treatment to both parties to long-term contracts.
Assure that life-insurance benefits, pensions, and Social Security benefits shall have some real worth comparable to the sacrifices people make to obtain those benefits for themselves and their dependents. (An important consideration given that 88 million life insurance holders had already lost $158 billion in purchasing power since 1939).
Assure all those who labor that higher wages will be higher in real buying power rather than a monetary illusion.
Tear away the veil of the ‘money illusion’ and facilitate the economic calculations essential to ordered progress.
Encourage investment and assure a rapid resumption of investment whenever savings accumulated.
Promote maximum employment, production, and purchasing power.
End the discrimination against American citizens and in favor of foreign governments and central banks.
Minimize the need for elaborate controls. (by which Harwood meant the capital controls necessary to maintain fixed exchange rates while the Federal Reserve exerted domestic monetary policy discretion).
Reinforce the independence of the Federal Reserve Board.
Facilitate the sound and long-term financing of the public debt outside of the banking system.
Facilitate foreign trade.

Most importantly, returning to the full retail gold standard would “bulwark the freedom of American citizens.”

Again, his admonitions did not sway enough policymakers, many of whom were confused about key concepts. “To talk about ‘freeing’ a market for a commodity by freezing two-thirds of the world supply and holding it off the market,” he chided, “is an interesting exercise in gobbledegook.” By statute, he reminded his audience, the word dollar referred to 1/35^th of an ounce of gold. To speak of the price of gold being $40 or $50 was “nonsensical,” he reasoned, because what was offered was not so much gold but 40 or 50 “paper promises to pay dollars … mere promises to pay dollars at some indefinite future date.”

To further explain the gobbledegook, he referred to monetary history, as he often did in his voluminous writings. After the Civil War, the gold value of the greenback, the fiat dollar, sank to as low as $.35 due to the uncertainty of when their redemption in gold would occur. In 1954, the same problem confronted Americans, in addition to the prospect of further devaluation or even payment in something other than gold.

Harwood recognized that redemption of dollars at $35 an ounce with foreign central banks somewhat tethered expectations, so he conceded that the Bretton Woods system was better than the free float idea that already floated about because “no currency in the history of the world to date has yet survived for long” being untethered completely from gold. The free float, he reminded readers, “has an unbroken record of dismal failures.”

A few years before, Harwood had used the work of renowned international monetary expert Franz Pick to discuss major postwar hyperinflations and their effects. He cited Pick’s estimate that $7 billion in gold, including $4 billion in France alone, sat in private hoards. All those people, he argued, could not be wrong. “These facts,” Harwood noted, “suggest that the gold standard offers economic benefits that have been inadequately appreciated by its opponents.”

Most importantly, perhaps, Harwood explained that “the veil of manipulated money … obscured … the Nation’s greatest economic problem,” which was an “increasing departure from economic freedom.” That diminution of economic freedom, he claimed, anticipating research initiated decades after his death, was “destroying Western Civilization including our own country.”

It should be noted that Harwood conceded that the retail gold standard is “not a panacea for all economic ills.” Anyone who says otherwise, he argued, is a monetary quack. Most importantly, the retail convertibility of gold does not prevent business cycles. He insisted, however, that it does decrease the transaction costs of the “rubber dollar.” Inflation’s relative price changes befuddled most people, including government statisticians. “But all too few who read and use such figures,” he explained, “realize how greatly the statisticians themselves distrust the adjustments that they have been forced to make and how serious the distortions still may be even after honest and painstaking attempts to present the truth have been made.” As a result, “expedient adaptation to the exigencies of the near future becomes the dominating policy; long-range considerations are forgotten or disregarded.”

In other words, “removing the veil called the money illusion would not guarantee that the basic economic ills would be seen, much less remedied, by those in a position to correct them, but there is no reason to hope for wise corrective action until the nature of those ills can be more easily seen.” For example, the costs of “monopoly privilege for organized labor in basic industries” are hidden by “the subtle embezzlement facilitated by a depreciating dollar.”

“The longer the basic issue is postponed,” he claimed, “the more difficult and disruptive the final settlement probably will be.” Moreover, “resumption of the gold standard would at least shorten the credit rope with which we have chosen periodically to hang ourselves.”

Interestingly, a strong foreign policy perspective ran through Harwood’s critique of the Bretton Woods system of fixed exchange rates. The US, he reasoned, needed to achieve optimal growth for strategic military reasons, and optimal growth was more likely under a retail gold standard than the gold exchange system or free float. There is no empirical or theoretical reason, he noted, to suppose that inflation aids economic growth. Returning to a retail gold standard would bring a slow, steady, long-term deflation based on productivity increases, just as it did after the Civil War. If the US experienced gentle deflation instead of inflation again, Americans would save instead of potentially destabilizing the economy, and hence the nation’s defense readiness, by buying everything as soon as possible on the installment plan.

Harwood rightly considered “nonsensical” fears that Russian gold could pose a “threat” to Western democracies. Gold, he explained, remains “the primary war reserve of last resort” because with it, “any nation can buy, somewhere in the world, whatever it needs” including “the traitor or fifth-columnists within the enemy nation.” Russian leaders therefore would more likely shoot anyone who suggested exchanging Russian gold for US dollars than engage in any gold-dumping operation. “The leaders of Russia,” Harwood noted, “long have maintained [that] inflation was their most potent weapon against other nations, and certainly the United States will become increasingly vulnerable to inflation as its gold reserve diminishes.”

As Harwood stated in 1945, “the Bretton Woods Agreement and the International Monetary Fund proved to be a powerful ‘engine of inflation.’ Including claims on dollars as reserves of their central banks was an effective means by which other countries imported the US inflating, albeit with some time lags in the more conservatively oriented countries such as West Germany and Switzerland.” “By 1958,” he continued, “the dollar clearly had become overvalued in relation to other currencies: That is, it had lost more of its buying power. That was the year when AIER first recommended gold stocks.”

In 1964, Harwood again dispensed with claims that there wasn’t enough gold in the world to return to a retail gold standard. As wages increase in nominal dollar terms, he pointed out, the incentive to mine gold for a fixed-dollar amount decreases, reducing its rate of production. In other words, when the price of gold is fixed in nominal terms as it was under Bretton Woods, “gold production is discouraged and lessened as costs increase.”

“Rising prices,” he explained, “may result in a decreasing rate of increase in gold production long before an absolute decrease occurs in the amount of gold produced.” So, no shortage of gold prevented returning to retail gold, just shortages of “common sense and of sound commercial banking procedures.”

As Harwood predicted, inflation and federal government deficits soon after brought the first Bretton Woods system to an end. Instead of returning to the retail gold standard, Nixon decided instead to try the fiat money, floating-exchange rate system that Harwood had also warned against. Nixon’s policy at least ended the need for international capital controls, but soon brought even-higher inflation, domestic price controls, and a decade of shortages, stagflation, malaise, and turmoil. The fiat float has lasted longer than many, including Harwood, thought it would, or could, but the unique conditions that allowed it to continue for over half a century are rapidly deteriorating. Americans may yet again come to appreciate the benefits of a monetary system based on retail gold convertibility.

Robert E. Wright is the (co)author or (co)editor of over two dozen major books, book series, and edited collections, including AIER’s The Best of Thomas Paine (2021) and Financial Exclusion (2019). He has also (co)authored numerous articles for important journals, including the American Economic Review, Business History Review, Independent Review, Journal of Private Enterprise, Review of Finance, and Southern Economic Review. Robert has taught business, economics, and policy courses at Augustana University, NYU’s Stern School of Business, Temple University, the University of Virginia, and elsewhere since taking his Ph.D. in History from SUNY Buffalo in 1997. Robert E. Wright was formerly a Senior Research Faculty at the American Institute for Economic Research.