The Decline and Fall of Bretton Woods

Robert Leeson

Economics Department
Murdoch University

Working Paper No. 178

November 1999

ISSN: 1440-5059
ISBN: 0-86905-722-7

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In 1975, the US Treasury Secretary informed the IMF annual meeting that "We strongly believe that countries must be free to choose their own exchange rate system". As flexible exchange rates were legitimised, several leading countries began to experiment with monetary targeting. These two revolutionary policy changes were inter-related: a flexible exchange rate is a precondition for independent national monetary policy. Having lost one "sacred" symbol or anchor (fixed exchange rates), central bankers began to experiment with another. Both these developments were the successful culmination of 'campaigns' led by Milton Friedman during the previous quarter of a century. This essay examines the process by which Friedman's case for flexible exchange rates was transformed from heresy to majority academic recommendation and from there (via two Treasury Secretaries) to become the corner stone of the post-1973 international monetary order (or "non system"). The primary focus of this study of political economy is on the organisation and the dissemination of the intellectual and political forces which undermined the Bretton Woods system.

Journal of Economic Literature Classifications: B 20; F 31.

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Submitted for consideration for publication to the History of Political Economy

Robert Leeson

11 November 1999

1. Introductioni

1.1 On the frontispiece of Alfred Marshall's Principles of Economics is the statement: natura non facit saltum (nature does not proceed by sudden leaps). Yet, in the early 1970s, after a quarter of a century of bureaucratically determined exchange rates, the world appeared to leap into a regime of market determined exchange rates. In the previous decade those who administered and policed the Bretton Woods international monetary system considered a variety of reforms but "firmly and unanimously discarded at the very outset" the two reforms that were subsequently implemented: flexible exchange rates and gold prices (Triffin 1968, 105; 1976, 49). Those who policed the system appeared to be utterly confused by what they feared would be a leap backwards to the competitive devaluations of the 1930s. The role played by academic economists in this international revolution has usually been relegated to minor proportions or ignored altogether. Yet, what appeared to be a sudden policy leap had been preceded by years of academic campaigning - a campaign that is documented and analysed in this essay.

John Maynard Keynes shared with Karl Marx the belief that capitalism was inherently unstable. Keynes' (1936, 383) hope for a 'middle way' solution to the instability of the 1930s rested on the belief that the "power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas". The debate over flexible exchange rates pitted private sector bankers with "unlimited faith in the ability of government bureaucrats" against academics with faith in private market outcomes (Friedman 1967, 76). This essay documents the process by which the idea of allowing the price of foreign exchange to be determined largely by market forces rather than forces under the supervision of the International Monetary Fund gradually encroached on the policy making process. This free market idea was opposed by those who had a vested interest in the preservation of the writ of the IMF edict and who were haunted by the "specter" of institutional impotence (Southard 1979, 45). This vested interest intermingled with the idea that floating exchange rates would unleash all the furies of the 1930s.

Paul Volcker described the "intellectual and institutional base" for the Bretton Woods international order (Volcker and Gyohten 1992, 3). Milton Friedman assaulted first the intellectual base and then the institutional base. Although Friedman's (1953) case for flexible exchange rates was a classic example of the gradual encroachment of ideas, in 1968 he presented his case so as to appeal to President Richard Nixon's vested interest in being re-elected for a second term. What Nixon (1980, 245) described as Friedman's "escape" route began to appeal to those who were averse to the crises that appeared to be endemic to the Bretton Woods system. Simultaneously, Friedman's case for monetary targeting appealed to those who grappled with the apparently intractable problems of restraining price and wage inflation, which was all too frequently accompanied by industrial disputation.

After the Bretton Woods system collapsed, Friedman (1988a) wrote the introduction to an anthology for the American Coalition for Flexible Exchange Rates, which had been formed to prevent a return to exchange rate fixity (Melamed 1988a, xvi). Earlier, before the collapse of the par value system, academic economists behaved 'as if' they were members of a coordinated coalition pressing for flexible exchange rates. This essay documents the process by which Friedman's case converted academic economists into what amounted to an organised pressure group and then permeated (marginally) into the international monetary bureaucracy and then penetrated (forcefully) into Nixon's White House. The fourth phase, the establishment of a futures market in foreign exchange, was undertaken by the Chicago Mercantile Exchange as the Bretton Woods system was collapsing. The first and second processes were 'organised' by Fritz Machlup; the third stage was facilitated by US Treasury Secretaries George Shultz, William Simon and their deputies, (including Paul Volcker) and to a lesser extent by Gottfried Haberler. Friedman played pivotal roles in all four stages.

This essay therefore examines the points of tangency between three agents: academic economists, the international monetary 'policemen' and US policy makers. Section 2 examines the relationship between fixed exchange rates and the two goals of Full Employment and Free Trade. Section 3 describes the academic process: the origins of Friedman's case for flexible exchange rates (3.1); the specifics of Friedman's argument (3.2); the conflict between the attitudes of the international policemen and the academic consensus that emerged around the year 1964 (3.3); four academic conferences in 1966 (3.4); plus the 1967 debate between Friedman and Robert Roosa (3.5).

At the end of the 1960s, a purely "academic" issue became a "live policy question" (de Vries 1987, 94). But with respect to exchange rate regimes the term "academic" had pejorative connotations for those in the IMF. Yet within a very short period of time, it was the IMF solutions which obviously had a "distinct air of unreality or of having been an academic exercise" (de Vries 1985a, 140). The Committee of Twenty was established in September 1972 to salvage the par value system. But when, in September 1973, it was "first surmised that the US authorities wanted 'absolute freedom to float' ... this came as a shock" (de Vries 1985a, 239). Henceforth the Committee were left to indulge themselves in "a purely theoretical exercise without any practical meaning" (Emminger 1978a, 403). It was a "very low point" when they realised the Shultz-Volcker position. Henceforth they realised it was "pointless to keep on arguing" (de Vries 1985a, 241, 239).

Section 4 describes the policy process from Nixon's 1968 election victory to the revised IMF Articles of Agreement which legitimised floating. The system of fixed exchange rates collapsed for a variety of reasons. In 1973, efforts to revive the system were abandoned in large part because of the attitudes of the Nixon-Ford Treasury Secretaries. The success of their (and Friedman's) advocacy in favour of a floating system was conditional on the attitude of "benign neglect" that they encouraged Presidents Nixon and Ford to adopt.

As the fixed exchange rate system collapsed, Nixon was preoccupied with the Watergate crisis. From Victory in Europe to Defeat in Vietnam, Americans had been spared the choice of being for or against Nixon in only two national elections (1948 and 1964). When his Treasury Secretary John Connally wanted to "hit Nixon right where he lived" he taunted him with the prospect of being the one-term Herbert Hoover of his time (Rather and Gates 1974, 279). Between Hoover's Presidency (1929-1933) and the policy hegemony of the Hoover Institution economists (1981-1989), Franklin Roosevelt was the perennial President and then Nixon was the perennial candidate. Sections 4.1 and 4.2 outline Friedman's influence on Nixon and his attempt to persuade Nixon that flexible exchange rates were an ideal vehicle for his re-election. In March 1933, Roosevelt suspended the internal convertibility of the dollar into gold (the nationalisation of gold). In August 1971, Nixon's New Economic Policy (NEP) froze wages and prices and suspended the external convertibility of the dollar into gold (the demonetisation of gold). The following section describe Nixon's NEP (4.3), Friedman's attempt to persuade Nixon to disburden himself of the "cross of gold" (4.4) and the Smithsonian attempt to rescue the par value system (4.5). The remaining sections analyse the final collapse of the par value system, first as an orthodox narrative (4.6), and then by integrating these international developments with the domestic Watergate crisis (4.7) and then by describing the process by which this de facto US declaration of independence was provided with an ex post "legalised" status (4.8). Concluding comments are provided in section 5.

1.2 Four clarifications may be helpful. First, this essay is concerned with competing attitudes towards the "Eleusinian mysteries" of the international monetary system (Schlesinger 1965, 494). It is largely organised around the intellectual battles between the International Monetary Fund and the international influence of Milton Friedman. Both sides have no shortage of detractors; both sides have a tendency to generate polemical heat. Indeed, unsympathetic critics have detected faith and mythology at the heart of both the Chicago and IMF views of the world. According to John Kenneth Galbraith, the market was perceived by Chicago economists as "a mystique, a supernatural endowment which evokes, not technical, but religious, attitudes" (cited by Navatsky 1967, 3). According to Charles Kindleberger (1976, 29) flexible exchange rates were synonymous for Chicago economists with "God", although Harry Johnson, not Friedman, was the Archbishop of Canterbury. But under a floating system, Robert Triffin (1970, 57) argued, it would not be "God or his angels – that is to say the economists" who would determine when central banks would intervene. Vested interest groups, it was believed, would capture that power.

In the alternative, Chicago view, the IMF was an integral part of the post-war planning system which sought to override market forces. In Johnson's judgement, this IMF system "rested on a foundation of mythological belief and conventional assumption". Fixed exchange rates delivered power and prestige to those who administered the system and "practical" bankers found it impossible to comprehend how a floating rate system would work. Johnson, therefore, invoked economic sociology and "institutionalism" as appropriate vehicles to explain international monetary arrangements (1976c, 414, 416; 1969, 12; see also Caves 1963, 129).

Mainstream economists, such as Rudiger Dornbusch (1993, 103) reflected that "When it counts, the IMF can be relied upon to be disappointing". Others, such as Senator Paul Douglas, complained in 1963 that attempts to discuss flexible exchange rates with American IMF representatives or officials of the US Treasury elicited only a "tropismatic response" (cited by Yeager 1976, 651, n16). Numerous observers detected in the official world a "theological aversion to exchange rate flexibility" (Williamson 1978, 162). Prior to the advent of the IMF there were "no rules of the game except the devil take the hindmost". Under the IMF system, "the cardinal rule of the game was consultation" (Coombs 1976, 2-3). The IMF Deputy Managing Director described how those who flaunted the IMF rules were abandoned to the Soviet 'devil'. In 1953, the IMF decided that an unauthorised change in the par value of the Czechoslovakian koruna transformed that country into "a sheep so black that it should not be allowed to run with the flock". The offending country was informed that they could retain IMF membership only if it "confessed" its "sin" and "purged itself of the charges", which it refused to do (Southard 1979, 14). This essay attempts to explain why fixed exchange rates were embraced with such determination and to explain why the solutions proposed by par value advocates became "swamped and lost to sight" (Fleming 1974, 3).

Part of the reason for their failure was that they were confronted by an academic heretic who, having nailed his theses (first in Germany, just as a predecessor had done four and quarter centuries before) pursued his heresy with extraordinary tenacity. Friedman's intellectual rebellion against 'papal' authority invoked the right of national economic sovereignty, and after almost 'thirty years' of intellectual and political schism, the 1976 'Treaty' of Jamaica resembled the 1648 Treaty of Westphalia in terms of the toleration offered to 'heretical' floaters. The IMF sat at the centre of the monetary universe until it was replaced at the centre by market forces in "a sort of 'Copernican revolution'" (Emminger 1976, 13).

These international bankers regarded themselves as members of a "club" who policed the international monetary order (Jacobsson 1979, 95). Roosa, a prominent member of the club, described their activities in terms of "military doctrine: rings of outer and inner defences for the defence of the dollar and for the system" (Volcker and Gyohten 1992, 32). They regarded themselves as pugilists going into combat against any undisciplined or self-interested national economic policy which might deliver a price of foreign currency different from that which the policemen had decreed. No account of the fall of the Bretton Woods system would be complete without an attempt to discuss their role and the intellectual consequences of their "undeviating" devotion to the par value system (Southard 1979, 23; de Vries 1985a, 105).

They took their responsibilities seriously. The IMF was regarded as having come of age in the late 1950s (Krause 1971, 14). Nixon (1987, 25) recalled that Arthur Burns launched a "titanic" rearguard action to preserve the par value system. As their system entered the 'iceberg years' the official IMF historian recounts that they literally rearranged their chairs so as to pretend that it was not the Executive Directors who were discussing "limited" flexibility of exchange rates. Moreover, "there was stress on the word 'limited' ... Pointedly, they did not discuss regimes which were inconsistent with the par value system". These "fourth floor" deliberations, which took place during the first nine months of the First Nixon Administration, reinforced their view that they should maintain their course (de Vries 1976a, 501-2; McChesney Martin 1970, 21). Within the first two months of the Second Nixon Administration these prizefighters were forced to "throw in the towel" (Emminger 1978a, 401). They "seemed to be more buffeted than in control of events" (de Vries 1985a, 118). Within a remarkably short period of time, speculation about a return to a par value system was regarded as a "consolation for traditionalists sick with nostalgia" (Machlup 1976, 33). As the IMF Deputy Managing Director reflected "A policeman's lot is not a happy one" (Southard 1979, 21).

Secondly, this essay does not attempt to adjudicate between fixed and floating diehards. Instead, it seeks to analyse the process by which Friedman's case became fertile: first by converting the academic community and then by transforming the international monetary system. Thirdly, Friedman was neither the first nor the only economist to make the case for flexible exchange rates (Machlup 1964, 79-80). Others such as James Meade (1949, 101, 4) patiently spelt out the limitations which might prevent the price mechanism from working effectively with respect to exchange rates. But Meade (1963, 311, 316) described his preference for increased flexibility as "an academic exercise ... frankly utopian in form". The "dangers" of flexibility were "real possibilities. For this reason the authorities of the Western countries are extremely unlikely to adopt an uncontrolled system of freely floating exchange rates". In comparison, Meade's (1967, 122-3) 'case' could hardly be described as advocacy: "I am not absolutely convinced myself that fluctuating exchange rates necessarily lead to inflation". Friedman's case, while cautious about the possibilities of persuading policy makers, contained no such self-disparaging caveats and was by far the most influential in the debates that followed. As the IMF officials rearranged their chairs so as to navigate the international monetary system through turbulent waters, Friedman pressed Nixon to destroy the Bretton Woods system.

Finally, Section 2 describes a process that may display some 'general' characteristics about the interaction between economists and the policy process. Section 3 is more likely to display the 'special' characteristics associated with the atypical political processes of the Nixon Administration. As the international monetary policemen struggled to patch-up the fixed exchange rate system and began to consider allowing more elastic 'bands' around the par values, Nixon was utterly consumed by Watergate and foreign policy (especially relations with China and the Soviet Union and the wars in Vietnam and the Middle East). His Treasury advisers wished to bury Bretton Woods: in international negotiations they offered 'faint praise' for a revised par value system whilst guaranteeing their right to float the dollar. The system had been in crisis throughout the 1960s, but the advice that Nixon received from his task force on the balance of payments and from his Treasury Secretaries was very different from the advice that Presidents Johnson, Kennedy and Eisenhower had been offered. The crucial American participants in the efforts to patch up the system were motivated by a different perspective about the desirable end-state than were their predecessors.

The collapse of the patched up Bretton Woods system has usually been attributed to the failure to transcend national self-interest or, more often, to the insurmountable problems associated with maintaining exchange rate fixity after the oil price shocks of the 1970s. One historian asked why the outcome (the legitimisation of flexible exchange rates) differed "so totally" from the original intentions of those who sought to save the system (Williamson 1987, 18). Events may have moved too fast to save the system (de Vries 1987, 96). But the world had also been turned intellectually upside down by the revolutionary advocacy of flexible exchange rates. One of Friedman's co-authors offered a four word paragraph by way of explanation: "Market forces had triumphed" (Schwartz 1987, 350). There was also, however, an intellectual triumph for those who advocated the ascendancy of market forces.

Certainly, the final outcome may well have been different had Nixon and Ford and their Treasury Secretaries been committed to fixed exchange rates. This has previously been acknowledged, as has the importance of "key personalities" pressing for flexible exchange rates (Scammell 1983, 184; Williamson 1987, 19). But the intellectual dimension of this policy volte-face has usually not been brought to the forefront. Friedman (1968a, 186) reflected about the "extraordinary importance of accidents of personality" with respect to monetary outcomes; and Shultz and Simon were both firm advocates of flexible exchange rates. Nixon, under their influence, was also not inclined to defend the patched up Bretton Woods system. It is impossible to quantify these direct and indirect intellectual influences, but it seems reasonable to conclude that such influences were highly significant and therefore worthy of detailed scrutiny. But Friedman's case was not mentioned in the 1946-65 volume of the official IMF history nor in The IMF Experience nor in Economic Policy Behind the Headlines (Shultz and Dam 1977a) nor in Closing the Gold Window: Domestic Politics and the End of Bretton Woods (Gowa 1983). It was accorded three sentences in both the 1966-1971 volume and the monumental National Bureau of Economic Research Retrospective on the Bretton Woods System; plus eight sentences in the official history of the 1972-78 period, sixteen sentences plus footnotes in Yeager's (1976) history and one sentence in Solomon's (1982) history (Horsefield 1969a, 1969b; de Vries and Horsefield 1969; de Vries 1987, 1976, 1985a; Bordo and Eichengreen 1991). This essay therefore supplements the orthodox chronology and analysis.

2. Full Employment, Free Trade and Fixed Exchange Rates

From Adam Smith to Alfred Marshall (1926 [1903], 394) most respectable economic opinion accepted the "simplicity and naturalness of Free Trade" over the corruption and "moral harm" associated with Protection. The 1944 Bretton Woods agreement was designed to provide the post-war international stability to facilitate the approach towards both Free Trade and Full Employment. Per Jacobsson (1959, 12, 14) and his associates who policed the fixed exchange rate system believed that they were providing a vital ingredient that relieved businesses of the uncertainty associated with exchange rate instability, thus lowering costs and contributing to the expansion of world trade. They also believed that the IMF was the institution which guaranteed exchange stability. They did "not think that anyone would seriously dispute" the "purposes" of the IMF in this regard. The "strengthening of the existing exchange structure" was believed to be "in the general interest".

The simultaneous pursuit of these three post-war policy objectives posed a dilemma. According to one influential Keynesian observer, it was "hardly an exaggeration to say that instead of being on a Gold Standard we are on a Labour Standard" (Hicks 1959, 55, 64, 52-3, 88-9, 155). But Bretton Woods was a dollar standard (backed by gold) and the single instrument of monetary policy had to target the two objectives of maintaining a fixed exchange rate and low levels of unemployment. John Hicks noted that the international repercussions of these national Labour Standards were a "very grave preoccupation". This led to the conclusion "from which we can hardly escape" that a second policy instrument was required: "there really is something in the Employment argument for Protection". Since fixing exchange rates in terms of gold was "the best guarantee of solidity that mankind had yet discovered", this created "a strong case for Import Restrictions, as a means of facilitating expansion without weakening the Balance of Payments".

Friedman (1968a, 7-8) believed that underpinning these sentiments lay an undue emphasis on the short rather than the long run consequences of policy. Certainly, Robert Solow (1966a, 60-1), a leading advocate of Full Employment, favoured Free Trade, but "elementary realism" led him to conclude that "significant steps" towards Free Trade "will come very slowly, if indeed they come at all ... in the meantime the immediate problem remains". Influential players in the political arena such as George Meany (1973, 3-15), the President of the American Federation of Labor and Congress of Industrial Organisations, calculated that between 1966-71 'unfair' imports had cost 900,000 job opportunities for Americans. In 1971, the US Labor movement was actively campaigning for the Burke-Hartke Bill which sought to impose import quotas on a wide spectrum of goods (Shultz and Dam 1977a, 113). As Full Employment advocates went on the offensive, Free Trade advocates were "on the defensive" (Irwin 1996, 206). Within Nixon's White House, the 1971 devaluation of the dollar was regarded as "the strongest argument we had to repel protectionism" (Volcker 1978-9, 7).

Between Marshall and Friedman (a leading Marshallian) lay the evolving advocacy of John Maynard Keynes. The younger Keynes (JMK XVII [1923], 451) advocated that "We should hold to Free Trade as a principle of international morals, and not merely as a doctrine of economic advantage". Later, as part of his "long struggle of escape" from his Marshallian heritage, Keynes (1936, chapter 23; JMK IX [1931], 238-42) found wisdom in mercantilist writings. As Friedman (1968a, 2) highlighted, Keynes advocated a tariff in 1931 as a remedy for unemployment. In the struggle for policy influence in the 1960s, Keynes' self-appointed bulldog offered what she believed to be a further debunking of the Free Trade "façade of a dogma with solid interests behind it ... the free-trade doctrine is just a more subtle form of mercantilism. It is believed only by those who gain an advantage from it" (Joan Robinson 1966, 6, 24).

This essay examines the interaction of these three revolutionary or reforming imperatives. The Free Trade reforming cause dates from the Smith-Ricardo attacks on mercantilism; the Full Employment imperative dates from the Keynesian revolution of the 1930s. But the Bretton Woods "founding fathers" were also revolutionaries. These "zealots" had given institutional expression to the "revolutionary ideas" of banishing the "twin devils" of the 1930s: depression and beggar-thy-neighbour trade policy, involving competitive currency devaluation (Reisman 1996, 82; de Vries 1996, 129; Campos 1996, 99). Indeed, some of the bankers, such as Federal Reserve Board chairman William McChesney Martin (1970, 9-10, 12, 15-6) invoked the authority of Keynes to justify "the restraining conscience" that they exerted on those who might be tempted to pursue Full Employment without an appropriate anti-inflationary discipline. It was necessary "to pool some of our sovereignty", that is, to relinquish national power to the IMF, the institution that was evolving into a world central bank. The public servants who policed the international economy believed that before 'us' lay the deluge of competitive devaluations. They also assumed that after 'us' lay a similar fate: "a path leading into unknown darkness" (Caves 1963, 129). In this sense, they came to display some of the characteristics of an ancien regime.

The leading post war textbook asserted that flexible exchange rates would reduce the volume of international trade by increasing risk (Samuelson 1958, 697). Fixed exchange rates and a fixed price of gold were the Newtonian certainties upon which the Bretton Woods system rested (Volcker and Gyohten 1992, 7). The League of Nations (1944, 210-1 118, 137, 128, 159) outlined the "proved disadvantages of freely fluctuating exchanges ... If there is anything that inter-war experience has clearly demonstrated, it is that paper currency exchanges cannot be left free to fluctuate". This system "would almost certainly result in chaos". The actual system adopted in the thirties ("The Devaluation Cycle") was believed to be "associated with disturbances not very different from those associated with freely fluctuating exchanges". In addition to the 1930s analogy, apocryphal Swiss bankers were often conjured up to demonstrate the compelling nature of the case against floating rates. Galbraith's (1964, 117, n9) banker informed him that the Swiss response to a devaluation of the US dollar might be a competitive devaluation "late the same afternoon".

The "art" of central banking was regarded as "one of the keystones in the arch of our civilisation" (McChesney Martin 1970, 11). This civilisation had been challenged in the 1930s by the "economic barbarism" associated with floating exchange rates (Coombs 1976, 4). The history of the IMF was "the record of one of the ways in which that challenge was met" (Horsefield 1969a, 5). But the IMF historians who chronicled the response to that challenge barely mentioned the intellectual forces that would help to destroy the Bretton Woods system. Fixed exchange rates were the "central core of the new international cooperation" and the IMF "opposed all suggestions" which resembled the system that prevailed after 1973 (de Vries 1969, 40, 152). This was both "the critical fact" and the critical weakness of the position taken by the international policemen (de Vries 1987, 91). Those who supported par values were perceived to have been "trapped in channels that were far too conventional" (Volcker and Gyohten 1992, 115). According to one influential Chicago floating advocate the obsession with the 1930s was based on a misconception about the realities of the world economy: they were "guarding the gates of hell rather than guarding legitimate business". The "old central bank devil" tended to "believe that they know better than the market does". Academic economists, therefore, had to provide an "educational process" for the bankers (Johnson 1970, 45-6, 48; 1969, 25).

This essay explores the process by which the international policemen responded to this educational process. They first ignored, then confronted and then were defeated by the challenge of Friedman's case for flexible exchange rates.

For Friedman (1968a, 30, 182, 71; 1972a, 54-5), the macroeconomic pursuit of Full Employment was "a modern invention for producing inflation". The system of extensive controls over foreign exchange transactions was "one of the few really new economic inventions of modern times". This system had been "perfected" in 1934 by Hjalmar Schacht "primarily in order to despoil the Jews". Friedman advised an Israeli audience that "As a Jew, rather than an economist, I say to you, why don't you get rid of the false appearance, why don't you abolish the exchange controls and make your practise conform to your values. Set your people free". Friedman first formulated his case for flexible exchange rates in 1950 as part of his contribution to the rehabilitation of Germany. His memo formed the basis of his famous 1953 case which transformed academic perceptions and which helped to undermine the Bretton Woods system.

As the par value system finally collapsed, IMF officials were acutely aware that "funeral orations" were being preached over their "casket" (Southard 1979, 1). Friedman (1975 [1973], 178) was delighted to see "another nail in the coffin". The IMF historians (unintentionally perhaps) conjured up the image of a living organism equipped with head, heart, backbone and self-interest. With the inauguration of the fixed exchange rate system, the "world consciously took control of the international monetary system" (Gold 1969, 513). The Bretton Woods Founding Fathers intended that within this world currency bloc "fundamental disequilibrium" could also be corrected by changes in exchange rates. But the Articles had a "protean quality" and the IMF sought to be "mistress in her own house". According to Jacobsson, the IMF Charter was "a living tree capable of growth and expansion within its natural limits" over which they had the authority to adopt "final" interpretations. Officials apparently reached decisions about what was in the interest of the world and then searched for a legal authority on which to base a pronouncement (Gold 1969, 574). It was envisaged that the power of this body would relentlessly expand until it became "an International Federal Reserve System" (Roosa 1962, 346). In 1947 the policemen decided that "jurisdiction over rates of exchange is at the heart of the Fund's function and that constriction of that jurisdiction could maim the Fund's authority" (Gold 1969, 567, 571-3, 548). As the international monetary system was collapsing the IMF Managing Director reassured the Governors that the Fund was still "at the heart of the system" (de Vries 1976a, 483-4).

The dollar was regarded as the "backbone" of the IMF system (Blessing 1970, 35). But for the dollar to provide the backbone for this living organism to flourish required the willing cooperation of US officials. The bankers were very protective towards their creature: par value changes were regarded as "comparable to major surgery on a human patient ... inherently dangerous" (Coombs 1976, x). But this supposedly benign Frankenstein could not withstand the attitude of "benign neglect" on the part of US Treasury Secretaries and Haberler, the chairman of President-elect Nixon taskforce on the balance of payments and Consultant to the US Treasury (Volcker and Gyothen 1992, 62). Shultz agreed that the international monetary system "had a life of its own", but reflected also about the "self-deception" of some key players (Shultz and Dam 1977a, 130).

The proponents of exchange rate fixity were regarded by their opponents as doomed to play the role of the monstrous "Cerberus-like" dog preventing re-entry into the mythological hell of the 1930s (Johnson 1970a, 43). This artificially constructed body began to associate its own prestige with the health of the world economy. Perceived national self-interest had to be constrained by the obligation to abstain from any policy discretion that might break the "rules" of their membership and to respond to the disciplinary alarm bells of an outflow of gold and foreign exchange reserves. The Fund imposed a "Code of Conduct" on the world: exchange rates were "at the heart of the code" (Gold 1969, 564). When obliged to discuss exchange rates in 1969, the IMF insisted that "The fulfilment of national needs demands the protection of international safeguards" the abandonment of which would pose "grave risks" (de Vries 1976b, 275, 324). Thus fixed exchange rates allowed the international Leviathan to impose an almost Hobbesian contract by asserting "the primacy of the general interest in a matter which concerns the welfare of all" (Witteveen 1975, 262).

Friedman (1967, 117-19, 183, 17-8) argued that one of the major advantages of flexible rates was that "it makes it so much easier for the layman to understand the merits of free trade". This debate over the relative merits of the price mechanism as a social organiser involved two rival perceptions of what constituted the authentic American tradition. The Chicago view was that liberalised international trade, capitalism and therefore liberty were being undermined by the Frankensteins of trading blocks and the State. Capitalism and Freedom was organised around the theme "How can we keep the government we create from becoming a Frankenstein that will destroy the very freedom we establish it to protect" (Friedman 1962, 2).

In the post-war period closer and closer approximations to Full Employment were visibly associated with higher and higher rates of open wage and price inflation. Some national policy makers wanted the discretion to pursue Full Employment, but since adverse inflation differentials were usually inconsistent with the maintenance of a fixed exchange rate (the "sacred" symbol of national strength), price and wage inflation had to be suppressed through Exhortation and Controls (Goodwin 1975). By 1965, moral suasion in the US had been supplemented by Guidelines: specific numbers attached to targeted productivity gains and tolerable wage settlements. Also in 1965, foreign trade and investment guidelines (including tariffs and import quotas) were extended and a 15-20% improvement in the US balance of payments was specified (Shultz and Aliber 1966, 294, 333, 340). Chicago economists opposed these controls and Shultz was frustrated that he had to wait until 1974 to remove them (Shultz and Dam 1977a, 19). But according to the 1965 Council of Economic Advisers (CEA) Report, the Guidelines were "in the tradition of America, asking those to whom the society has entrusted economic power to exercise it in ways consistent with the national interest" (cited by Shultz and Aliber 1966, 312-3). The CEA chairman explained that the Guidelines attempted to "harness this sense of social responsibility to the national interest in price stability or balance of payments equilibrium" (Ackley 1966, 73).

It was thus becoming increasingly clear that fixed exchange rates, the pursuit of Full Employment and the absence of exchange controls were three sides of a triangle, only two of which could be connected by the same straight line. Typically, politicians 'solved' the problem by trampling on the Free Trade tradition by imposing import surcharges and capital controls (thus maintaining reforming credentials and electoral respectability with respect to the pursuit of Full Employment). The policy responses to the adjustment crises experienced by the three dominant parties at the Bretton Woods conference raised the spectre of the protectionist 'solution' of the 1930s. In the late 1950s, high unemployment led the Canadian authorities to seek a competitive advantage by depreciating the Canadian dollar while the Governor of the Bank of Canada advocated import controls (Marsh 1970, 341). In 1964, the British Labour Government imposed a 15% import surcharge: Protection to defend a fixed exchange rate. In 1971, President Nixon imposed a 10% import surcharge to make certain "that American products will not be at a disadvantage because of unfair exchange rates". Paul Samuelson (1974 [1971], 433) warned that this import surcharge might "feed the fires of protectionism ... we are playing with dynamite in terms of certain sentiments that run very deep in American life". The internal aim of Nixon's NEP was to reduce both inflation and unemployment; the external aim looked suspiciously similar to the protectionist sentiments that spawned the 1930 Smoot-Hawley tariffs (Plumptre 1977, 251).

Much of the literature on Bretton Woods has been organised around the "holy trinity" of adjustment, liquidity and confidence (Eichengreen 1993, 621). Yet there was another "holy trinity": the three apparently inconsistent post war policy objectives of Full Employment, Free Trade and fixed exchange rates. Friedman's counter-revolution has been described as the "monism of monetarists" (Sargent and Wallace 1976, 171). Yet Friedman raised the standard of revolt against both the Labour Standard and the Bretton Woods standard of fixed exchange rates. The fulfilment of the second (international) objective was a necessary though not sufficient condition for the achievement of the first (domestic) objective. Indeed, some of Friedman's domestic proposals were designed to facilitate the introduction of flexible exchange rates. For example, there was no x% money growth rule in the 'Monetary and Fiscal Framework for Economic Stability' because the money supply had been "select[ed]" for counter-cyclical "domestic stability". It was therefore also incapable of defending a fixed exchange rate. But Friedman (1953 [1948], 142, n13) noted that "it would be equally appropriate to present the proposed domestic framework as a means of implementing flexible exchange rates".

Fixed exchange rates, Friedman believed led to suppressed inflation, which subverted the price mechanism and opened the door for Protection. Floating exchange rates would stimulate international trade and capital flows because they were "a substitute for present or prospective restrictions" (Friedman 1968b). Friedman (1968c, 14-5) supplemented the case for Free Trade with the notion that there was a "natural" end-point for the macroeconomic pursuit of Full Employment: using monetary policy to target unemployment was akin to "a space vehicle that has taken a fix on the wrong star". Removing 'restrictions' or 'imperfections' at both the international and the microeconomic level would produce better inflation-unemployment outcomes. The macroeconomic pursuit of Full Employment would be defeated by microeconomic reality (the short-run Phillips curve would shift out in an adverse direction). The Chicago view was that Free Trade was required to permanently shift the Phillips curve downwards (Shultz and Aliber 1966, 3-4, 13). Thus policy activism at a microeconomic and international level would produce better outcomes than macroeconomic discretion.

The Chicago choice lay between a permanent shift of the Phillips curve (a) in a beneficial direction through Free Trade and microeconomic reform or (b) in an adverse direction following the macroeconomic pursuit of Full Employment (through the operation of the forces expressed by neoclassical price theory). In contrast, Friedman's Keynesian opponents hoped that restricting prices and wages would allow macroeconomic policy to produce better inflation-unemployment outcomes (by interfering with the allocative mechanism of neoclassical price theory). In his AEA Presidential Address, Friedman (1968c, 4) referred to an AEA "official attempt to codify the state of economic thought of the time" edited by Howard Ellis (1948). Ellis (1949, 437) specifically discussed the constraint imposed by the IMF commitment to "exchange rate revisions only at infrequent intervals" and asked: "What is going to give? Does not full employment achieved under a system of rigid prices almost inevitably imply ... the outright control of international trade?" Since the choice for many Keynesians lay between Full Employment plus some form of incomes policy (which displaced the economy in a downwards vertical direction away from a Phillips curve), or abandoning Full Employment (disinflation which shifted the economy downwards and outwards along a Phillips curve), the first alternative was regarded as a "bargain" (Solow 1970, 314).ii

For Friedman any short run benefits from this Faustian "bargain" were countered by the long run threat it posed to Free Trade (the reforming imperative with the longest lineage). He sought to undermine two of the three pillars of the post-war order, in part, because they had combined to subvert the third. Those who argued for fixed exchange rates were guilty of the same perverted logic as the military strategists whose televised exploits in Vietnam were traumatising the world: "It was necessary to destroy the city to save it" (Friedman 1972b, 104). An extraordinarily successful campaign was conducted to convert economists, bureaucrats, Prime Ministers and Presidents. In 1960, Presidential Candidate Kennedy declared his unalterable commitment to defend the dollar and his opposition to monetary policy as the "sole means" of controlling inflation (Roosa 1967a, 269). The two years or so straddling Nixon's resignation (1973-5) witnessed the 'Transition from Fixed Exchange Rates to Money Supply Targets'. Two "sacred" symbols (Full Employment and the Bretton Woods system) were jettisoned and replaced by another "sacred" symbol: monetary targeting (Parkin 1977). As Nixon (1980, 238-9, 245) reflected, Friedman's "magic" solution of floating exchange rates "offered an appealing escape".

3. The Academic Process: From the 1940s to the Friedman and Nixon Presidencies
3.1 The origins of Friedman's case

The "only regret" that Friedman had in leaving his position in the wartime US Treasury was that he played no role in the construction of the Bretton Woods system (Friedman and Friedman 1998, 124). Not only might he have been one of the architects of the regime of fixed exchange rates, but had he stayed at the Treasury he might also have attended the first annual IMF meeting in Washington in September 1946. Friedman (1972b, 13-4; 1975, 59; 1953 [1942], 253, n2) reflected about what he believed to be the corrosive short sightedness that the Washington atmosphere generates. He also acknowledged the 'corrupting' influence that "the prevailing Keynesian temper" exerted over his own thinking. However, in September 1946, he returned to the University of Chicago. Henceforth, he would be one of the leading players in the "intellectual Bretton Woods" that preoccupied economists and policy makers in the 1960s and early 1970s (Caves 1963, 120).

Friedman dates the beginning of his "active involvement in the political process" to the founding meeting of the Mont Pelerin Society in April 1947. Describing himself as a "young, naïve provincial American" on his first trip outside the US, Friedman found that the Mont Pelerin reformers were "all beleaguered in their own countries". He observed that in post-war England "price, wage and exchange controls were extensive and rigid" (Friedman and Friedman 1998, 159). Shortly afterwards, the Bretton Woods system faced one of its earliest crises, and Friedman played an important role in persuading one of the founders of the post-war international monetary system to float their exchange rate.

On 17 November 1947, Canada imposed what Donald Gordon (1948, 22), the Deputy Governor of the Bank of Canada, described as "drastic limitations" on imports so as to preserve the fixed external value of the Canadian dollar. On 17 April 1948, Friedman made the case for floating the Canadian dollar to Gordon, prior to a University of Chicago Round Table radio broadcast the following day. Friedman formed the distinct impression that Gordon had never properly encountered the argument before (Friedman and Friedman 1998, 189). In the broadcast, Gordon emphasised that Canadian policy was driven, in part, by the desire to prevent "the spread of communism". Unfortunately, these responsibilities had generated inflation. Friedman (1948, 22) replied that "direct controls through rationing and price controls" were "bad ways of fighting inflation". Friedman then outlined the policy agenda to which he devoted his professional life: "the most effective and efficient way of solving problems is by using the traditional mechanism of a free price system and the general mechanism of broad credit control, foreign exchange rate change".

Gordon's (1948, 22) initial response to Friedman was to draw the same distinction that Solow (1966a, 60-61) later made between long-run objectives and short-run possibilities. Gordon also remarked that Canadians had to "keep in mind our obligations under the International Monetary Fund". Friedman (1948, 22) replied that he welcomed the attachment to the "long-run virtues" of relying on the price mechanism but "heartily" disagreed with the view that controls were required to "solve the short-run problem".

Galbraith's (1981, 164, n1) efforts to control wartime prices in the United States were redoubled as a result of an envious glance north at the apparent successes achieved by the Canadian Wartime Prices and Trade Board, which had been directed first by James Coyne and then by Gordon. Coyne (1949, 1), a future and highly controversial Bank Governor, was the apparent author of a Bank memorandum dated 31 January 1949 and labelled "SECRET" which advocated that the Canadian dollar should be free to find its "natural rate". In September 1950, the Canadian dollar was allowed to float and one of the sponsors of the Bretton Woods system was perceived by an IMF official to be "embarking on a piratical pursuit" (Muirhead 1999, 137, 141, 145). At the same time, the remaining restrictions on imports imposed in November 1947 were lifted (Powell 1999, 37).

In 1969, Friedman acquired the opportunity to influence the major sponsor of the par value system. Just before, in March 1968, Friedman (1968d, 9) reminded Samuelson during a televised discussion of the surprising events that had unfolded in Canada twenty years before. Samuelson (1968, 5, 3) replied: "If that happens, and the chance that Professor Friedman even with his eloquence can make it happen, is not one in ten billion, if that happens, I will look upon the situation and rather approve, because ninety per cent of us academic economists, when we're academic say that that's a very interesting set up and maybe better than the present one. It isn't going to happen. I don't know whether we should waste the time of adults in discussing this". Samuelson predicted that if the dollar exhibited greater disequilibrium "then I think we'll have more direct controls of the sort which we have already have seen".

In the immediate post-war period, American support for the Bretton Woods agreement derived from the desire to avoid "another world war". Treasury Secretary John Synder exclaimed that "we cannot permit economic warfare to weaken the bonds which hold the United Nations together" (Gardner 1956, 288). IMF officials viewed their activities as "the key to securing world peace" (de Vries 1985a, xvi). Academic opinion also tended to favour the view that fluctuating exchange rates were an obstacle to free international trade (e.g. Nurkse 1945, 3; Hawtrey 1946, 99). According to Triffin (1948, 413), until a decade or so before, most experts on international disequilibrium "could dismiss the whole problem summarily with the observation that exchange control is the most harmful of all interferences with freedom of trade ... Lesser writers would be carried further by their arguments and demonstrate easily the superiority of free and stable exchanges over any system of exchange control". Likewise, doubts expressed by Alvin Hansen (1948, 379)iii and Samuelson about the "equilibrating efficiency of exchange rate variations" were widely held in the academic community. A case could be made, Samuelson (1948, 404-6, 401) argued, "if we still believe, as did Cassel, that Central Banks can, and do, easily control the quantity of money and, through the Quantity Theory, the level of prices". But, Samuelson concluded, the activities of trade unions had more to do with the determination of inflation than did the Federal Reserve Board. The possibility of an endless inflation-devaluation spiral was "entirely germane to the present scene". Theoretically, "a new free exchange rate" might be found to eliminate the post-war dollar shortage but it would be an unstable equilibrium "so that any momentary departure from equilibrium would be self-aggravating and cumulative". Samuelson (1948, 411-12, 398) also argued that if a European socialist government imposed import restrictions on luxury goods the US could "privately disapprove. But without risking the charge of supporting imperialism and being a propagandist, we cannot raise objections. Yet that is what insisting on free exchanges comes close to doing". Samuelson concluded that "the strong burden of proof must be thrown onto any doctrine that favors an extreme, and generally unpopular, departure from the prevailing state".

That was precisely what Friedman set out to do. He spent autumn 1950 in Europe as Special Representative attached to the Marshall Plan agency. On 6 November 1950, Friedman wrote to Don Patinkin about his experiences: "on coming into Germany, Rose and I had a tremendous feeling of revulsion, the hatred of years came to the surface + we saw a Nazi in every German face. That softened a bit but did not disappear in a few days ... Industrially, Europe is a mess. By comparison, the U.S. is the purest of pure competitive economies. Everything here is rigid + controlled and competition almost nonexistent. God knows what can be done about it" (cited by Leeson 1998, 442). One of his assignments was to analyse the proposal to establish a European Coal and Steel Community, the precursor to the European Community. Another was to find a solution to the German balance-of-payments problem. He concluded that he had provided "dramatic evidence of the superiority of a flexible exchange rate to other currently available devices; but he could "elicit no sympathy whatsoever" for his recommendation to allow the mark to float (Friedman and Friedman 1998, 156, 159, 182). His memorandum on 'Flexible Exchange Rates as a Solution to the German Exchange Crisis' formed the basis of his 1953 case. He was led to write the memorandum after "contemplation of the problem of ... a common market ... In the absence of political unification, the only alternative that will permit a true common market – in fact and all the time, not on paper and from time to time – is flexible exchange rates among the member countries" (1969a, 16).

Friedman had two academic obstacles to overcome. First, he had to construct a compelling Chicago case for flexible exchange rates. Dollars and Deficits was dedicated to Friedman's (1968a, iv) "teachers and colleagues at the University of Chicago who kept alive a tradition and a body of thought that nearly expired in the rest of the academic world". However, the previous 'Chicago case' was (despite an acknowledged input from Friedman) somewhat hesitant: "it must be conceded that there would be [costs of exchange fluctuation] and that they would have some influence in the direction of reducing the volume of international trade" (Mints 1950, vii, 94).iv Then there was another obstacle to overcome, as expressed by Seymour Harris (1948, 483, 378): "Unfortunately, the theorist is able to give the practical man only limited help". There were "so many economists" addressing the problem of international disequilibrium and the "practitioner who seeks advice from the economist will find support" for a variety of solutions: "How much reliance should be put upon one or the other will be the difficult problem". But by the mid-1960s, this diversity of academic advice was replaced by an academic consensus around the need for increased, if not complete, flexibility of exchange rates. Three fellow Mont Pelerin reformers played important supporting roles. In addition to George Stigler (who organised an important 1966 Chicago conference), Haberler and Machlup 'mobilised' the academic consensus that began to operate 'as if' they were a pressure group.

3.2 Friedman's case

Friedman advanced floating exchange rates as the only reliable method of facilitating Free Trade, about which "there has been virtual unanimity among economists". In this way "international cartels would disappear" and the US "could come close to eliminating any danger of significant internal monopolies" (Friedman and Friedman 1980, 60-1, 76-7). Friedman (1953, 158, 187, 197, 164-5, 167, 171) took "unrestricted multilateral trade" as an axiomatic objective: "the fundamental requirement is that governments not use restrictions on trade of any kind to protect exchange rates". The "absence of flexible exchange rates is almost certain to be incompatible with unrestricted multilateral trade". According to Friedman (1962, 40-2, 57, 71) the "liberal's dilemma: a stable monetary framework without the danger of the irresponsible exercise of monetary powers" could be solved by an "honest-to-goodness gold standard". But such arrangements had never existed and "certainly the situation is now more extreme as a result of the adoption by country after country of the view that government has responsibility for 'full employment'". The liberal's nightmare was that "we shall be led to adopt far-reaching economic controls in order to 'solve' balance of payments problems ... there are few interferences which are capable of spreading so far and ultimately being so destructive of free enterprise". Government price control was "inconsistent with a free economy"; flexible exchange rates were the antidote to the "never ending spiral" of increasing government intervention. Such a system "would solve the balance of payments problem once and for all ... So long as we are firmly committed to the straight jacket of fixed exchange rates, we cannot move definitively to free trade".

Friedman (1953, 165, 195; see also 1967, 12) opposed fixed exchange rates partly because of "the inflexibility of [internal] prices, or different degrees of flexibility ... The adjustment [to changes in external conditions] takes the form primarily of price changes in some sectors, primarily of output changes in others ... The consequent decline in real income ... is clearly a highly inefficient method of adjusting to external changes ... the adjustment will not have been completed until the deflation has run its sorry course". It was the strong commitment to "a full employment policy which greatly limits the possibility of using changes in the internal price and wage structure as a means of adjusting to changes in internal conditions".

The solution Friedman (1953, 173) argued was to "Let the government simply stay out of the picture". Restraining prices occupied an enormous amount of bureaucratic effort: the argument for flexible exchange rates was "very nearly identical with the argument for daylight saving time. Isn't it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? ... The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely the price of foreign exchange, than to rely upon changes in the multitude of prices that constitute the internal price structure".

The "widespread emphasis on full employment" and the emergence of "independence of internal monetary policy as a major policy goal" undermined the case for changes in internal prices or income as adjustment mechanisms: "after the Great Depression completed the elevation of full employment to the primary goal of economic policy, nations have been unwilling to allow deficits to exert any deflationary effect". Friedman (1967, 137-8) thought that influential people needed to be "educated on this issue"; the "alternatives have not been made clear". After being informed of the alternatives, nobody would choose "a substantial recession or depression" over a "slight fluctuation" in exchange rates. Given that the commitment to full employment was a constraint, the limited remaining adjustment capacity should not be "fritter[ed] away on forcing prices up and down, on introducing exchange controls or capital controls" (1953, 181).

The lynchpin of Friedman's (1953, 200; 1967, 17) argument was that removing the fixed exchange rate constraint allowed each country to pick a point on a 'Phillips curve' "according to its own lights … flexible exchange rates are a means of combining interdependence among countries through trade with a maximum of internal monetary independence". Friedman (1953, 177-8, 199) dismissed the argument that the exchange rate was a potent national symbol and a superior mobiliser of anti-inflationary forces. If, under a flexible rate system, "any one country inflates, the primary effect is a deterioration of the exchange rate". But "public recognition that a substantial decline in the exchange rate is a symptom of or portends internal inflation is by no means an unmixed evil. It means that a flexible exchange rate would provide something of a barrier to a highly inflationary domestic policy". Because foreign trade was a small part of total trade, the idea that removing the discipline of fixed rates would "open the door to irresponsible inflationary policy ... has negligible merits for the United States" (1967, 21-2). Friedman objected to "administrative rather than market control" over exchange rates: "we have been driven as if by an invisible hand" to employ all the other expedients such as trade restrictions. One of the arguments against these expedients was that "they are politically degrading and demeaning. We are a great and wealthy nation". Flexible exchange rates would allow us to "again become masters in our own house … the monetary authorities could concentrate on domestic prices and employment". According to Friedman (1974a [1963], 394-5; 1962, 66; see also 1967, 11), fixed exchange rates prevented the US from expanding its money supply: "for at least some 4 years now we have followed a less expansive monetary policy than would have been healthy".

It was fear of an inflation-devaluation spiral which underpinned part of the opposition to flexible exchange rates (Roosa 1967b, 47; Robbins 1967, 11). Friedman (1953, 180-1) argued that the standard inflation-depreciation argument was defective: if "the monetary authorities are ready to [increase the money supply] to validate any rise in particular prices or wages, then the situation is fundamentally unstable". Friedman disputed the argument that "this innate instability is held in check by some sort of political compromise and that this compromise would be disturbed by the change in the exchange rate". The "wage-price spiral" was a "crucial fallacy ... a term that is impressive enough to conceal the emptiness of the argument that it generally adorns". The depreciation-induced rise in the price of foreign goods increased the cost of living and generated the demand for wage increases, but this "does not in and of itself provide the economic conditions for a wage rise – or, at any rate, for a wage rise without unemployment. A general wage rise – or a general rise in domestic prices – becomes possible only if the monetary authorities create the additional money to finance the higher level of prices". The "Chicago position today" was that "what is interpreted as cost push is … the delayed impact of earlier demand pull inflation" (Friedman 1974b [1971], 375).

3.3 An emerging academic consensus

From its inception, the IMF paid an unusual degree of attention to the theoretical underpinnings of the analysis it provided and consequently cultivated its connections with mainstream academic economists (Haberler 1978, 198, n1). Advice from heretics was less welcome. At least once in the early 1950s one of the policemen (Jacobsson) was confronted, in debate, by a heretic (Friedman). Once was probably more than enough. Jacobsson suggested that Friedman was "too inflexible" in his opposition to monetary discretion. The organisers of the debate were then obliged to curtail the evening with Friedman and Jacobsson "standing, shouting, gesticulating and banging their chairs on the floor". Jacobsson confided to his diary: "Why do I quarrel so easily with economists ... Is it (according to Freud) that I have never been reconciled to the fact that I left University and have been just a marginal economist? ... when I meet the 'real' economists – I have a deep 'envie' – more than the French 'envie', longing – I should have liked to have done what they have succeeded in doing" (Jacobsson 1979, 262, 260, 367, 401, 402, 398).

Volcker recalled in the early 1960s "a second great period of international institution building took place, all with the purpose of defending and supporting the Bretton Woods system". These institutions included the G-10, various IMF committees and Working Party No.3 (WP3) of the Economic Policy Committee of the OECD (Volcker and Gyohten 1992, 27). Behind these efforts apparently lay the final objective of "a world central bank [which] is the ultimate to which all efforts towards international cooperation tend". The "scattered limbs" of a world central bank already existed in the guise of the IMF, the OECD and the Bank for International Settlement (Morse 1972, 78-9). Jacobsson was regarded as "Mr World Central Bank" (McChesney Martin 1970, 6). Their shared vision was of "a one world system, integrated by fixed exchange rates" (Wallich 1972, 19). In the early 1960s, they saw their opponents as offering "some 'gadget' that can free them from the impact of balance of payments considerations" (Jacobsson 1979, 361).

Roosa (1967a, 27-9, 77, 102, 114-5, 222, 258) was under the impression that the bankers' discussions exhibited an "uninhibited freedom of inquiry ... within a limited group and behind closed doors, have permitted what is undoubtedly the most sustained, penetrating, frank and responsible exploration ... that has ever occurred". They had considered even "the more extreme critics of the evolutionary approach we were following". That elaborating upon some proposals was a "fruitless exercise" was "the inescapable conclusion dictated by the actual ways of the world – today and for any foreseeable future". The case for flexible rates was dismissed as "a long succession of neatly argued academic demonstrations" and as antithetical to the "thinking and practice" of the IMF with "little or no prospect" of success. According to Roosa these meetings forced "the critics" (whoever they were) to recognise the unwisdom of taking any of the "supposed shortcuts to 'balance of payments independence'". Yet the conclusion that flowed from all of these uninhibited discussions was simply a repetition of the belief that "there was no better alternative" than the par value system (Southard 1979, 24). The bureaucratic response emphasised the traditional mechanisms of adjustment: exchange rate flexibility was a "taboo" subject (Brittan 1970, 88). Changes in exchange rates continued to be regarded as a last resort (Volcker and Gyohten 1992, 13).

According to their critics, the bankers regarded themselves as a "Pythagorean priesthood possessing the vital mysteries whose power is diminished if they are exposed to vulgar eyes" (Gordon 1961, 22). Their preference was for an international monetary system run through "large meetings" which were both "effective and interesting" (Morse 1974, 189). The "inner sanctum" of the bankers' system was often a regular dinner from which the lower ranks were excluded (Coombs 1976, 27). Through this institutional apparatus these senior officials from treasuries and central banks built up "a growing intimacy of understanding" (Roosa 1967a, 258). When the Bretton Woods system was "in full flower" there was a "special sense of collegiality" among the international banking community (Volcker 1990, 6). These "high priests, or perhaps stateless princes" met frequently, sometimes every six or eight weeks: "It is hard today to reconstruct the atmosphere" (Volcker and Gyohten 1992, 29). The frequency of the WP3 meeting to find solutions to the liquidity problems were made possible by the introduction of transatlantic jet transport which allowed "incessant trans-Atlantic journeys" (Roosa 1967a, 27, 77, 79). Roosa and his fellow officials began to "eat, sleep and dream the balance of payments".

International monetary reform was quite literally a moveable feast. Not only were the Bretton Woods veterans among the first of the international jetsetters, they also floated on the "gilded surface of Washington". Jacobsson, in his capacity as IMF Managing Director (1956-63), "could have gone to several cocktail parties each evening and always had a choice of dinner parties". He loved dancing and insisted that the IMF Annual Meeting should always end with a formal dance. He also "liked to have ladies around" and expected husbands to take as a compliment the attention he paid to their wives. In these social gatherings, judgements were made about the "quality" of the people invited. Those who gained acceptance in this world reminded each other of their value. Jacobsson, for example, informed McChesney Martin that as Fed chairman he was worth $1,000 million to the US balance of payments.

In this environment authoritative pronouncements were issued. For example, Jacobsson declared to the 1959 IMF Annual Meeting that "In all likelihood world inflation is over". Two years later, he declared that "We have saved the monetary system for the next generation" (cited by Jacobsson 1979, 314, 316, 327, 330). Jacobsson (1959, 30-1) left the 1959 meeting with "no reason for pessimism about the outcome of our efforts". It took him three years to "get the Christmas party the way he wanted" (Jacobsson 1979, 316); it also took three years to feel the "general impression ... that a much greater unanimity had been reached" (Jacobsson 1959, 30-1). But then Jacobsson was fondly remembered for his didactic monologues and for being oblivious to discomfort of his audience (McChesney Martin 1970, 5-6).

Jacobsson objected that the New York Fed only served iced water, but not wine, with lunch (Coombs 1976, 23). When in London, Jacobsson would first call on the Swedish Ambassador to collect the gossip, then spend three hours extemporising with the Governor of the Bank of England and then ask: "Do you think I should go and visit the Prime Minister?" He was often surrounded by obsequiousness. He courted and flattered the press and they responded in kind. When asked in 1962 by a Russian about the price of gold, he explained that he was a Marxian on the issue. After offering some nonsensical witticism about the current price being the proper price because it reflected the cost of production he confided to his diary: "There was laughter!! When they left the Russians asked me to visit Moscow. I would be well received" (Jacobsson 1979, 387, 388, 395, 393).

His successor, Pierre-Paul Schweitzer (1976, 209) asserted that the Fund possessed "intellectually, the best possible staff you could find … they give their whole loyalty to the institution they are serving". The Executive Directors had "all evolved a kind of feeling of solidarity for the Fund". He appeared to be especially impressed with the fact that the British contingent were a "collection of lords and past and future knights!" Some of the advice offered to member countries was couched in the language of pre-revolutionary France ("Richesse oblige"). In 1962, Jacobsson explained to the Governor of the Bank of Canada that the IMF wished Canada to return to a parity system pour encourager les autres. The opposition to floating rates was "for theological reasons". Latin American countries with floating rates "confess their sins and promise to mend their ways. But Canada rather defends its system. It persists in sin without any wish to mend its ways". Jacobsson refused to recognise that the Canadian dollar was floating: it was "merely a widening of the margin" thus minimising the extent of the heresy (Jacobsson 1979, 330, 383, 335, 354).

Newcomers were introduced to the "custom" of the police force through what could be described as a vow of loyalty accompanied by threats. In public, the policemen made countless "speeches and toasts ... to the god of international cooperation". But after his first WP3 meeting, Volcker found that he had been selected to join a secret "core group" that regularly met for dinner at "a rather mysterious hideaway". Members of this nationally segregated group had taken an 'oath' of silence: "It was not long before a European finger was being shaken in my face with this remark: 'If all this talk about flexible exchange rates brings down the system, the blood will be on your American head'" (Volcker and Gyohten 1992, 144, 68).v

One of the IMF historians thought that it was "so enlightened" to leave undefined the crucial concept of "fundamental disequilibrium" (Gold 1969, 581). Others were concerned about the dangers associated with rates being too rigid (Hawtrey 1946, 4; Graham 1940; 1954, 10). Neither issue worried Jacobsson who exclaimed that he could no more define equilibrium than he could define "a pretty girl, but you can recognise one when you meet one" (cited by Volcker and Ghoyten 1992, 14). The "consensus" coagulated around the need to prevent the par value system from being undermined. In the early years there had been several devaluations and several renegade currencies floating. But after 1957, the IMF was pleased to report a reversal of these tendencies. The return of the prodigal Italian, Greek and Canadian currencies was especially welcomed: these experiences reinforced IMF prejudices against fluctuating rates (de Vries 1969, 164). In the 1960s, to preserve the par value system, the international policemen began insisting that exchange rate adjustment could only be considered under very exceptional conditions (Machlup 1966a, 65).

After 1964, the Joint Economic Committee of the US Congress continually bemoaned the lack of serious bureaucratic consideration given to floating exchange rates (Halm 1969, 3; de Vries 1976a 528, n3, 536-7). The Annex Prepared by Deputies (published in August 1964) "explicitly ruled out" flexible exchange rates (de Vries 1969, 50; Solomon 1982, 42, 65-7). The 1964 IMF Annual Report (1964, 27-28, 117) advocated "less expansionary policies than they would otherwise prefer" as the antidote to persistent deficits. The need to adjust par values "should arise less frequently to the extent that the policies described above are followed". By the end of 1965, the IMF Board had not even discussed the general role of exchange rates in the adjustment mechanism (de Vries 1969, 116).

In the 1960s there were tensions within the White House about international monetary reform. The Treasury was "foursquare" behind the "wonderful totem" of Bretton Woods, and Kennedy insisted that the gold-dollar price was "immutable" (Coombs 1976, 20). The idea of altering either of these prices was "not a respectable matter for discussion in the halls of the Treasury" (Volcker and Gyohten 1992, 20, 22, 25). Academics such as James Tobin indignantly believed that international financial policy was too important to be left to financiers. The crisis managers were, he believed, obsessed with their virtuosity as net-less tightrope walkers to the detriment of the performance of the American economy. But when reforming ideas about the international monetary system were presented, Treasury Secretary Douglas Dillon "regularly and gracefully shot them down" (Schlesinger 1965, 515-517).

Jacobsson informed Dillon that "we could not do all that some professors proposed" to which Dillon agreed: "that would not be the way" (Jacobsson 1979, 360-1). Dillon, with his eight years of international diplomatic experience, appeared to insult academic economists at the October 1963 IMF meeting by ruling out their involvement in the discussions about the future of the international monetary system. Academic economists were portrayed as being "so much in disagreement with one another that their advice was practically useless to those in charge of decision-making". Secret deliberations by responsible officials were required. Three academic economists (Machlup, Triffin and William Fellner) present at the IMF meeting as guests decided "on the spot" to organise a response (Machlup, Malkeil et al. 1964, 5-6, 9; Malkeil 1978, 17; Triffin 1978, 147).vi The 'organised' case for flexible exchange rates was about to enter a new phase.

Between December 1963-June 1964, the insulted economists held four conferences and a Report was placed in the hands of the printers. One of the selection criteria for attendance was to capture "the notorious divergence" of views held on international monetary reform. (Government economists, however, were specifically excluded). The Report's publication coincided with the publication of the Annex Prepared by Deputies and 1964 IMF Annual Report which were, by design, released to the public on 10 August 1964 (de Vries 1976a, 36). The conclusions of the economists' Report contrasted sharply with those of the bureaucrats. Although "it was regarded as a miracle", through an elaborate questionnaire system with drafting committees working late into the night, an academic consensus had emerged "on the importance of exchange-rate change as a method of adjustment" (Machlup, Malkeil et al. 1964, 9, 20, 106, 14, 104, 97).

This consensus was in sharp contrast to the plethora of proposals that had surfaced just immediately before. Between the first and second editions of Fritz Machlup's Plans for the Reform of the International Monetary System (May 1962-October 1963) there had been 37 new "pronouncements" about how to patch up the Bretton Woods system: "spawned at an extraordinary rate" (Machlup 1964, preface). These academic exercises were uncoordinated and often contradicted each other. For example, Herb Gruebel's (1963) World Monetary Reform Plans and Issues contained twenty-four separately drafted proposals or comments. There were a smorgasbord of Plans on offer (Jacobsson, Rooth, Poole, Harrod, Stamp, Bernstein, Lutz, Zolotas, Postuma, Triffin, Rueff, Maudling, Barber, Volcker etc) plus Roosa bonds, the GAB, CRU's, gold tranches, rings of swaps etc.

There was another issue complicating this "apparently unbridgeable gulf" between the attitudes of economists and bankers (Halm 1965, preface). When WP3 was formed, Jacobsson stressed that those in the Fund "talked over problems in a friendly manner". With his faith in a "managed 'invisible hand'" and "intelligent planning" he forged "a remarkable degree of consensus ... not to rock the international system" (Jacobsson 1979, 401, 402, 398). Not only were academic economists "rocking the boat", but their rhetoric and models could hardly be described as banker-friendly. Embarrassment-averse central bankers were often seen as a constraint and the choice between fixed or floating rates often involved a 'comparative embarrassment analysis' about whether a loss of reserves or a fall in the value of the currency was "the greater embarrassment to the central banker" (Machlup 1964, 82). It was believed that the strengthening of the international monetary structure "of the West, and indeed of the world itself" was being inhibited by "the enormous inertia of timorous, tradition-bound bureaucrats" who always opposed changes to the "modes of thought to which they are accustomed" (Triffin 1963, 438-9).

The balance of payments difficulties that in the mid-1960s began to appear to be endemic to the Bretton Woods system enabled floating rate advocates to "muster additional adherents". Yet their arguments were still regarded in official circles as "untenable" (de Veries and Horsefield 1969, 173). The IMF Managing Director saw the devaluation of sterling in 1967 as "good" for the international monetary system: few if any of those in official circles saw the collapse of the par value system as "imminent". By 1969, the arguments of the "detractors" of the way in which the Bretton Woods was being operated had spread outwards from academia to official circles and were being taken up by "leading newspapers and public personalities". Yet, the subsequent Executive Directors' Report published in August 1970 eulogised the par value system (de Vries 1976a, 447-8, 501, 513; Williamson 1987, 85).

Within a remarkably short period these international policemen appeared utterly confused by the "collapse of the old order" (de Vries 1976a, 650). When the system that they were pledged to defend broke down, the IMF was "shaken to its roots" (Southard 1979, 1). IMF officials "conceded that the institution's future was uncertain" (de Vries 1987, 117). Lawrence Krause (1971, 50) emphasised that "ideological intransigence is more damaging to the [Bretton Woods] system than lack of foresight". The policemen appeared to suffer both handicaps. Jacques Polak (1979, 39) referred to their "lack of foresight" and also to the "assumption" held until the early 1970s that "fixed exchange rates would have to stay". A second component of this ideological intransigence was the "unthinkable" proposal to increase the price of gold. These orthodox views were, Polak thought, held by "virtually everyone". He discussed the forces which set certain "limits to our ability to influence the system", but there was little apparent realisation of the intellectual dimension: the pressure exerted by economists from outside the international banking fraternity.

3.4 1966: Four Conferences
3.4.1 Princeton

After the publication of the two competing Reports in August 1964 a series of joint bureaucrat-academic conferences were held. The first was in April 1966 in Princeton. Fellner (1966, 112, 122) presented a statement signed by an impressive array of economists including Friedman, Johnson, Meade, Hansen and Jan Tinbergen complaining (among other things) that exchange rate flexibility had "received little attention in official circles". Haberler (1966, 128, 134) complained that those involved in "practical discussions" often tacitly assumed that wages and prices were entirely flexible. In reality, wages were rigid downwards and contraction would violate "the modern view, to which almost everyone subscribes, that, in principle, unemployment must be avoided. To that extent everybody is a Keynesian now". Haberler pressed for exchange rate variations as "the only alternative to more and more controls". Tibor Scitovsky (1966, 197) complained that exchange rate adjustment was regarded as "an extreme emergency measure". This contrasted with the "greater faith – or hopes ... of most of the academic specialists today – towards greater exchange rate flexibility" as opposed to selective restrictions and controls which were "counsels of despair" (Fellner, Machlup and Triffin 1966, 5-6). The choice was perceived to be between exchange rate or aggregate demand adjustment and direct controls. Many economists had "deep-seated aversions to direct controls" which, in any case, was "no solution to the problem". To use controls instead of floating rates was "either a thoughtless perversion of thought or a disingenuous use of a pretext for a concealed real purpose of the restrictions". An increase in exchange rate flexibility was "the only genuine alternative" (Machlup 1966a, 63, 71, 73).

Having been apparently dismissed as irrelevant by Secretary Dillon less than two and a half years before, the academic economists had mobilised themselves and were making an impression on the bureaucracy. WP3 chairman, Jonkheer Lennep (1966, v-vi), politely thought the conferences had been illuminating: "The mixture of theorists and practitioners turned out to be a most productive one". But within the IMF a less welcoming attitude was taken. These "heated" debates were described as emanating largely from "academic circles". In any event, they were perceived as having lapsed into insignificance as the Bretton Woods system reached maturity. The IMF rejoiced that between 1954-65 the proportion of Fund members with fixed or very "stable" rates had increased from 59% to 86%, representing the "effective attainment of the par value system" (de Vries 1969, 48-9).

3.4.2 Chicago

Stigler organised an April 1966 Chicago conference on 'Policy Choices in a Full Employment Economy'. Stigler (1966, 278) was "interested in how weak the criticisms of flexible exchange rates were … the opposition is inarticulate and unrationalised ... From this, I deduce that the opposition to flexible exchange rates is not based upon analytically defensible criticisms of how the economy would behave. Rather the opposition rests upon an instinctive and possibly atavistic belief, on the century-old history of the gold standard, that a fixed price of gold serves to discipline dangerous fiscal and monetary tendencies".

In the opening conference paper, Friedman (1966, 18, 22, 31-2, 34-6, 39) disparaged "the gospel according to the Council of Economic Advisers".vii In contrast, "inflation was always and everywhere a monetary phenomenon" - the popularity of the cost-push explanation resulted from "the desire of government authorities to shift the blame for inflation". The Kennedy-Johnson Guidelines were a "foretaste of what suppressed inflation implies … disquieting harbingers of what currently looks like the wave of the future". Suppressing inflation was like breaking a thermometer: "it simply adds to our ignorance", it destroyed political freedom and created a collectivist economy. The price system was "the only technique that has so far been discovered or invented for efficiently allocating resources. The only substitute was "some kind of clumsy physical control. A striking example is provided by India ... the pegging of the exchange rate is the key to India's economic failure ... As in India, the pegging of exchange rates is the most conspicuous example of the suppression of inflation in the United States". Moderate and steady inflation was moderately harmful but "so long as prices are free to move [emphasis in text], the extremely flexible private enterprise system will adapt to it, take it in its stride and continue to operate efficiently". Friedman predicted that (in the absence of a major war) inflation would continue in the moderate range of 3-10%. This would not be "disastrous. The greatest harm will continue to be done by the measures taken to peg exchange rates".

Solow (1966b, 42-5, 50, 63-5) responded in 'The Case Against the Case Against the Guideposts'. The Phillips curve was the "dilemma" for public policy: movement up the Phillips curve was constrained by the fact that "in our rather international trading world, governments may not be able to ... acquiesce in an inflationary spiral". One solution was "to accept the universe" and live with the unemployment and output costs of zero inflation, estimated by Solow to be an annual loss of $10 billion of output at 1965 prices. The alternative was "to accept some inflation" and rely on "an informed and mobilized public opinion" to modify the inflationary costs of rising up the Phillips curve. This was a "far cry from wage and price control". Solow's attempted rebuttal stimulated Friedman (1966, 60) to construct the natural-rate expectations augmented Phillips curve which undermined the theoretical legitimacy of the macroeconomic pursuit of Full Employment.

Gardiner Ackley (1966, 68, 72-3, 74, 78), the CEA Chairman, dismissed Friedman's monetary explanation of inflation as a "doctrinal matter … of limited importance to this discussion". The Guideposts made a "modest but significant contribution to price stability" by checking "premature inflation". Corporations were prepared to accept their social responsibility with respect to inflation and balance of payments outcomes; the threat that education and social responsibility would lead to the corporate state was "hardly supported by history". The guidelines were aimed at the "real" problem of the existence of the Phillips curve: but "All of us in government will appreciate your participation in helping to find ... alternatives which are constructive and superior".

3.4.3 Princeton

In May 1966, immediately following his Chicago experiences, Solow (1966a, 57, 59, 61, 73) appeared to be somewhat on the defensive: "It begins to seem as if I am the only respectable economist, not in the employ of Lyndon Johnson, who is willing to say anything good about the wage-price guideposts". The existence of the Phillips curve was a "discouraging fact" and a "genuine dilemma" and the guidelines deserved to be "kept alive" and used in the battle to "keep inflationary expectations from hardening". An "educated and mobilized public opinion may be able to exert some pressure in the right direction". Solow (1966a, 57, 58) repeated his objections to what he saw as the role of "automatic ideology" in the case against the guidelines and dismissed Allen Wallis' advocacy of the "simple" Chicago proposition that monetary policy was the sole cause of and sole solution to inflation as being unworthy of consideration. Solow simply "pressume[d] that "not many" would like to see unemployment above current levels of 3.75%. But the tide was turning with respect to the pursuit of full employment. Publicly, Friedman (1967, 91) stated that "in the present situation you have relatively full employment and I trust you will continue to". Confidentially, Friedman (1988b [1968], 433) informed President-elect Nixon that "Today, the worldwide problem is over-employment".

3.4.4 Chicago

In September 1966, a second Chicago conference was opened by Valery Giscard d'Estaing. The previous year, d'Estaing had made it clear to the British Chancellor that he believed that the gold exchange standard was doomed (Callaghan 1987, 185). In opening the Chicago conference he complained that "exchange rates are fixed much too firmly" (1969, 13-4). d'Estaing rallied the conference by stating that this "fetish … must be combated". When d'Estaing first proposed reform in 1963, he had violated the unwritten code of the international policemen who remained "friendly" with each other by ignoring such suggestions and agreeing "not to raise too complicated or too violent questions". He explained that the Chicago organisers had invited him to provide inside information about "the attitude and position of various parties in the present action for international monetary reform".

The conference organisers explained that they sought to "mobilize our intellectual resources to make a frontal assault on scientific problems that have thus far resisted solution" (Mundell 1969, 3). The conference began with a "commercial from Chicago", which stated that the bureaucrats' "easy panacea" of controls had been framed in ignorance of the long term consequences: "the deeper destruction of the legal and moral values [which] make the system worthwhile" (Mundell 1969, 5). There were "tactical" discussions of where "to concentrate propaganda for reform of the international monetary system" and references to "disguises" being "effective" or not. If the "disguise is too thin: it will not deceive anybody and the resistance will be just as strong as against the real thing" (Haberler 1969a, 179). As one of the conference organisers put it, economists had "to put Humpty Dumpty together again" (Mundell 1969, 4).

3.5 1967: The AEA President versus the American Finance Association President

An editor of Fortune magazine described the May 1967 Friedman-Roosa debate about exchange rates as "the most important money debate" he had ever heard.viii Roosa, the current President of the American Finance Association, was regarded as "the foremost American expert on international monetary affairs" (Volcker and Gyohten 1992, 21). Friedman, the current President of the American Economic Association, continued to demonstrate to the satisfaction of increasing numbers of academic observers that his solution to the US balance of payments problem could achieve what all the king's men could not.

Roosa (1967a, 10, 169-70) had been chairman of the group of deputies of the Ministers and Governors of the Group of Ten who had been commissioned to undertake a thorough examination of the functioning of the international monetary system. Through "multilateral surveillance", the international monetary policemen had "provided a tight ring of defences around the world's leading currencies". The 1966 WP3 Report on The Balance of Payments Adjustment Process (1966, 18, 27) established an early warning system to alert the international community to impending national problems and recommended the speedier dissemination of improved balance of payments statistics. Only the traditional solutions were canvassed; there was almost no discussion of the "distasteful" subject of changing exchange rates (Williamson 1987, 84). There was an awareness of the existence of a potential shortage of liquidity: "a crack in the structure that could require its abandonment". But Roosa (1967b, 32) believed that the crack could be patched over not by Friedman's solution of flexible exchange rates but by an international version of his domestic proposal to expand the supply of money by x% per year. IMF credit facilities had (in quantity theory terms) "added to the M' and the V' of the world's monetary system" (Roosa 1967a, 189). Thus the search for a stable volume of international liquidity was viewed as a desirable international form of the monetarism that Friedman was preaching at a domestic level. Roosa recalled that there was little sympathy for "supposed shortcuts to 'balance of payments independence'" (Roosa 1967a, 26, 28-9; 1967b, 28, 46).ix The received view was that any suggestion of US willingness to "scrap important pieces of the existing system ... would have brought a deluge of new problems" (Roosa 1967a, 8).

The banker's view of international competition corresponded more closely to Marxian analysis than to the view prevalent in Chicago. The "real world" was "a world of red bloodied competition" and "mutual combativeness" in which, without fixed rates, "each successive episode of internal domestic difficulty" would lead to cumulative depreciations "to gain a momentary trade advantage" which would reinforce "potential inflationary developments" (Roosa 1967b, 87, 90, 98). The lynchpin of Roosa's (1967b, 50-1, 67, 82, 85) argument was that the alternative to Bretton Woods was "the anarchy of an entire world on flexible exchange rates, or (and this would be the more probable) the protectionism and economic autarchy of the sort of currency blocs that prevailed in the 1930s". The choice was not fixed or floating but stable or unstable rates. Roosa regarded the Bretton Woods system of fixed exchange rates as the peace treaty or "armed truce" that prevented a return to the "anarchy" of the competitive devaluations of the 1930s, an experience that was "all too searing still in our memories to forget". Flexible exchange rates were both "defensive wall[s]" and aggressive instruments of "open economic warfare" - in effect, the captured creatures of the tradeable goods sector (1967b, 167; 1967a, 166). Canada, the only major floating country, had responded to excess unemployment in 1961-2 by attempting to engineer a 1930s style beggar-thy-neighbour depreciation. In the 1960s, slightly wider (but still constrained) bands of permissible par adjustments were entertained as a superior domestic adjustment mechanism; but removing the internationally agreed constraints on further flexibility was regarded as a species of mutually assured destruction.

The central bankers and officials responsible for patching up the Bretton Woods system sought to perform "modern alchemy … the world's first effort to create ... a money that can be universally acceptable among the central banks of the world". With a banker's mentality, they assumed that confidence in the system would be best maintained through stability: that is, if changes in exchange rates were viewed as the 'last resort'. They believed that they had considered the proposals of even the "most extreme critics" of their evolutionary approach. But until just before the system collapsed they apparently excluded from serious discussion any detailed consideration of the system that 'they' would be replaced by, namely, flexible exchange rates (Roosa 1967a, 261, 4, 268, 29; 1967b, 87, 90, 98). There was no reference to Friedman and only brief dismissive references to the case for flexible exchange rates in Roosa's The Dollar and World Liquidity. Instead, Roosa wrote of his preference for the "secrecy and aloofness" of the central banker and he disclosed that the White House bureaucrats sought to "establish a very tight control over matters that were being considered".

According to Roosa (1967b, 82, 85), if the Bretton Woods system was abandoned, the world would slide down into the abyss of bartering trading blocks. The high employment domestic 'truce' required anti-inflationary guidelines for wages and prices; without the international guidelines of fixed exchange rates "the whole system ... would break down into a sequence of competitive devaluations which would create the conditions of bilateralism". If the exchange rate was free to fall, this would increase import prices and "an all-round sequence of other internal cost and wage increases, and the initiation of internal inflationary pressures" (Roosa 1967b, 61). Roosa (1967b, 85-6, 83) saw the conflict as a choice between stable or unstable exchange rates and feared that governments, if let loose, would not follow a consistent policy of internal stability. Roosa (1967b, 176) acknowledged that there had been a "regrettable trend" towards increased capital controls, but "we are fighting a war" in Vietnam.

Friedman had carefully considered both the strengths and weaknesses of his opponents' arguments and the likely persuasiveness of his assault on orthodoxy. As always, Friedman's analysis was mixed with perceptive sociological observations about the nature of knowledge construction and destruction in the market place for economic ideas and policy advice. Friedman (1953, 203, 198) noted that the case for flexible exchange rates had been dismissed "partly because of a questionable interpretation of limited historical evidence".x Flexible exchange rates had been ruled out as a result of an intellectual agreement between "a curious coalition of the most unreconstructed believers in the price system, in all its other roles, and its most extreme opponents": the "traditionalists" for whom internal policy was determined by the discipline of the gold standard and "the dominant strain of reformers, who distrusted the price mechanism in all its manifestations". The "political reluctance to use changes in exchange rates ... reflects a cultural lag ... it is a consequence of tradition and lack of understanding".

Fixed rates were perceived by their supporters as providing "the most hospitable environment for encouraging market-orientated adjustments within and among nations" (Roosa 1967b, 30). For Friedman (1967, 4, 13-4) the "truth" was simple: "Let the fixed price differ from the price that would clear the market and it will take herculean efforts to hold it ... Fix prices – and the problem will multiply; let prices find their own level in free markets – and the problem will disappear". Controls, Friedman (1967, 117-19, 183, 17-8) argued, were "congealing the blood of capitalism"; it was fixed rates which "keeps forcing more and more quotas, more and more restrictions upon us". Friedman appeared to suggest that import quotas were impossible under floating rates: "Why should [other countries] impose import quotas? They can't -under floating rates they can only import more from us if they export more to us". With floating rates, "we could behave in foreign trade like a great nation, not like a mendicant, by unilaterally moving towards freer trade without having to be concerned about our balance-of-payments problems". A reduction in tariffs simultaneously increases imports and exports (via a rise in the price of foreign exchange): "There is not even a temporary importation of unemployment".

The "administrative freezing" of exchange rates led to crises which insured "a maximum of destabilising speculation … the worst of two worlds". When Friedman (1967, 20-1) first began campaigning for flexible rates, he took seriously the fear of destabilising speculation. The post-war experience led him to dismiss this objection: "it is time therefore that this bug-a-boo is given a decent burial – at least until someone can come along with some real evidence that it is more than a bug-a-boo".

Friedman denied that Bretton Woods was a successful peace treaty or "armed truce". With respect to the domestic 'truce', he denied that there was any truth in the argument that "this innate instability is held in check by some sort of political compromise and that this compromise would be disturbed by the change in the exchange rate". The "wage-price spiral" was a "crucial fallacy". The standard argument about an inflation-depreciation spiral was defective. Moreover, the 'economic consequences of the peace' were throttling the quest for freer trade: the "absence of flexible exchange rates is almost certain to be incompatible with unrestricted multilateral trade" (Friedman 1967; 1953, 180-1).

Friedman jangled the nerves of those involved in patching up the Bretton Woods system at a time when the patching up was as unglamorous and as unsuccessful as attempts to control domestic wage and price increases. The orthodox pursuit of greater international liquidity was "the standard answer of the man who cannot manage his affairs" (Friedman 1969a, 4). Friedman (1967, 14-16, 79) mocked the Bretton Woods 'veterans' who undertook the "herculean" labour of restraining market forces, and sarcastically referred to the "grave problems" and "frantic scurrying of high government officials from capital to capital ... one of the major sources of the opposition to floating exchange rates [is that] the people engaged in these activities are important people and they are all persuaded that they are engaged in important activities". With flexible exchange rates, the international jetsetters who "man the emergency phones ... could be released to do some truly productive work". Friedman (1967, 22) taunted these jetsetters with the jibe that it was simply the "tyranny of the status quo" and their emotional attachment to the Bretton Woods system which were the real reasons that it was "very likely" that floating rates would be eschewed. Friedman (1967, 72-4) found in his opponents only "bland faith" and a determination to avoid reality by discussing "a glittering gold man with only an occasional side glance at reality it conceals ... I rubbed my eyes as I read all of this". His opponents were setting up "a straw man, a scarecrow of shreds and patches to frighten children with".

Roosa was a partner of Brown Brothers Harriman, a leading Wall Street bank (Galbraith 1971, 80). He had recently been Vice President of the Federal Reserve Bank of New York and Under Secretary of the Treasury of Monetary Affairs. He possessed a PhD and had been a Rhodes scholar and was highly regarded by Samuelson and Dillon (Schlesinger 1965, 136, 515; Coombs 1976, 16). Jacobsson ranked Roosa second only to McChesney Martin "in quality of judgement". Jacobsson also repeatedly stated that those who advocated altering either the value of the dollar or the dollar price of gold "knew nothing about exchange markets" (Jacobsson 1979, 320, 324). Friedman (1967, 95) deferred to Roosa's superior knowledge about the day-to-day operations of the foreign exchange market but was incredulous when Roosa denied that a market in foreign exchange would actually exist without fixed rates: "because there isn't a real going and lasting market, the relationship that will begin to develop will be the kind which will lead to the creation of the bloc system ... fixed rates within each bloc and barter among them" (Roosa 1967b, 185; see also Robbins 1967, 11).xi Roosa (1967b, 53) predicted that foreign exchange traders would not wish to be "crushed between the pressures generated by central bank giants in a free-for-all ... I am not trying to confront Professor Friedman with an organised strike of my fellow traders in the foreign exchange markets of the world ... [but] there would surely ... be no little recruiting problem in getting the trading desks capably manned for the launching of his system".

As always, Friedman found the weakest link in his opponent's argument. Roosa (1967b, 189-90) acknowledged that Friedman's "most telling thrust" had isolated "a fundamental defect" of the Bretton Woods system: the asymmetry of the adjustment burden with respect to deficit as opposed to surplus countries. Others had highlighted the same weakness but few had combined their analysis with such a dazzling description of such a radically different alternative. Roosa (1967b, 192) left his debate with Friedman with "even more respect, if that's possible, for [Friedman's] capacity for making any case plausible and persuasive and I will undertake to study a little further the offer that you have given me to find the conditions under which a flexible exchange rate could possibly be considered". Roosa's parting words were "there has to be a presumption, I confess, that such a brilliant jockey could not have chosen a horse as poor as the one I think I see". Within months, the Bretton Woods 'horse' was on its last legs; within a decade, Roosa (1976, 43-4) was obliged to describe the agreement that legitimised floating exchange rates as a move "forward" for the international monetary system.

4. The Policy Process: 1968-1976
4.1 Friedman, Haberler, Shultz and Nixon

In 1945, 90% of AEA economists polled favoured the adoption of the Bretton Woods agreement (Meier 1982, 52). Eli Shapiro (1970, 84) doubted that 1% of post-war monetary economists would have predicted the extent of Friedman's "Plaguing of the Central Bankers". But in the fifteen years from his seminal 1953 essay to his occupancy of the AEA Presidency, Friedman's case was transformed from minority to a majority academic position. Friedman (1967, 133-4) estimated that in this period, the proportion of academic economists favouring increased flexibility of exchange rates had risen from less than 5% to greater than 75%.xii Others thought that towards the end, at least 90% of academic economists accepted the theoretically soundness of the case for floating rates (Roosa 1967b, 177; Fellner, Machlup and Triffin 1966, 5-6; Sohmen 1961, xi; Halm 1970, vi-vii; Laffer 1973, 25). Friedman (1975, 162, 166, 178) modestly down-played his own "powers of persuasion", but noted that his "fellow believers" in flexible exchange rates had grown from "a meagre platoon to an army". Some of his opponents (such as Burns and Roosa) maintained their faith in a par value system. But within a remarkably short space of time they had been relegated to "the fringes of debate" (Volcker and Gyohten 1992, 136, 154).

Further academic conferences were held in Burgenstock,xiii Madridxiv and New Hampshire where the Deputy Governor of the Bank of England highlighted the bankers' framework of perceived choice: either a fully fledged gold standard, or siege economies with some barter or the "disastrous" regime of floating exchange rates which, he was "afraid" commanded support "in some quarters". Since all three were defective the ideal "compromise" was the existing Bretton Woods system (Parsons 1970, 42-3). But by now the centre of attention had shifted to the decision making process. Within the Bretton Woods bureaucracy, Friedman's case "began to be taken more seriously" (Volcker and Gyohten 1992, 46). Also, within the IMF there was thought to be a minority "team" in favour of increased flexibility (Halm 1971, 14, 19).xv But after 1968, those who sought to patch up the Bretton Woods system were confronted by powerful adversaries in the US Treasury: Shultz, Simon and Haberler (and to a lesser extent, Secretaries Kennedy and Connally).

Friedman was recruited by Burns to serve on Nixon's Advisory Group on the Economy (together with Pierre Rinfret, Alan Greenspan, Maurice Stans, Don Paarlberg and Paul McCracken). This Group organised twenty or so task forces. Friedman later reflected that "perhaps the most important positive effect of the task force process was to bring George Shultz to Nixon's notice". With respect to policy outcomes, Friedman placed a great deal of emphasis on the qualities and attitudes of those who wield power.xvi Referring to Shultz, Friedman reflected that "Personalities do matter.xvii He was very keen for Shultz to be involved in the White House and apparently complained that Shultz had got his priorities wrong by turning down the opportunity to coordinate all the Nixon task forces in favour of finishing an academic book (Evans and Novak 1971, 25, n; Reichley 1981, 75). As it turned out Friedman (1975, 55) was highly pleased with Shultz's contribution: "He favoured the initial closing of the gold window, resisted repeated pressures from the Federal Reserve and from foreign central banks to intervene in exchange markets and pressed for the prompt end of exchange controls. He has played the major role in establishing a workable international economic order".

With a witch hunting reputation to live down, Nixon's chances of winning in 1968 were regarded as "dim". Both Edward Kennedy and Hubert Humphrey were in favour of the draft and Nixon's narrow victory has been partly attributed to Nixon's conversion to Friedman's long-held advocacy of an all-volunteer army: the marriage of ideas and vested interests (Friedman 1977, 12; Anderson 1993, 173-4; Friedman and Friedman 1998, 377-381). Nixon never needed any encouragement to consider his own political self-interest, and after the 1968 election Friedman framed his exchange rate proposal as a mechanism by which Nixon could achieve a second term.

4.2 Flexible exchange rates as a vehicle for Nixon's re-election

Although Nixon was not the first President to wish for a second term, it was the excessive activities of the Committee to Re-elect the President (CREEP) and the attempted cover up which finally drove him from office. Friedman (1967, 114-5) calculated that in the absence of a major crisis, the only way to achieve flexible rates was to persuade an incoming government of the merits of the case within two weeks of coming to power and before they had committed themselves to defending the Bretton Woods system. For Nixon, the international monetary system only figured as an unwanted constraint that must not be allowed to impede his determination to be a great foreign policy president. He just didn't want "any more crises" (Nixon cited by Volcker and Gyohten 1992, 104).

After the election all the members of the task forces met with President-elect Nixon to present their conclusions. The task force on international economic policy was split with two members, Walter Hoadley and Tilford Gaines issuing a dissenting statement which declared that "the suspension of convertibility early in the new Administration would be a major threat to world stability".xviii Friedman was not a member of this task force but nevertheless pursued Nixon on his own initiative. On May 9, 1968, Peter Fannigan, the moderator of the Nixon Advisory Group on the Economy, informed Friedman that the value of any proposal would "ultimately be determined by its political usefulness during the coming campaign". On October 15, 1968 Friedman (1988b) completed the second draft of a "CONFIDENTIAL" memorandum entitled 'A Proposal for Resolving U.S. Balance of Payments Problems'. On December 5, Friedman sent his memorandum to Bryce Harlow to "show the kind of rhetoric that can be marshalled in favor of the proposal to set the dollar free". Friedman requested a meeting with President-elect Nixon "sometime in the next month ... I shall be glad to come to New York or anywhere else for that purpose at your or his command. There is no other economic issue on which I feel that prompt courageous action could contribute so much to the cause we both serve". Shortly afterwards, Friedman presented his memorandum to Nixon in person (Friedman and Friedman 1996, 376).

Friedman's (1988b [1968], 429-30) advocacy of flexible exchange rates pandered both to Nixon's interconnected desires for re-election and for a crisis-free system. He informed Nixon that "On one Sunday afternoon in 1948, Ludwig Erhard abolished price controls, setting the mark free ... He therefore unleashed the German economic miracle and assured the Christian Democratic Party unquestioned political dominance for several decades". Friedman compared the political longevity of Erhard to Harold Wilson's "gruesome cautionary tale ... If he had floated the pound on first gaining office, putting all the blame, as he could then have done, on the alleged 'irresponsible policies of the prior Tory government, it is very likely that he would still be firmly in the saddle, and that the Labour Party would hold unquestioned political power. His failure to take this step forced on him one unpopular expedient after another – and did not even prevent later devaluation".

Enoch Powell figured in Friedman's advocacy. In 1957, Powell was one of three Treasury ministers who were engaged in a "crusade" to maintain the value of the pound: "After the humiliation of Suez the sterling exchange rate ... was one of the few status symbols we had left". Because the Conservative Prime Minister would not accept their anti-inflationary crusade the ministers resigned (Brittan 1964, 190-6). As the Bretton Woods system was weakened by the devaluation of sterling, Powell (1967, 7), on a speaking tour of the US, broke ranks with respect to the "sedulously eschewed" topic of flexible exchange rates. Powell also broke ranks in other areas on his way to becoming the most controversial figure in British politics. Nine months before Friedman's confidential memorandum, Powell had been sacked by Edward Heath from the Conservative Shadow Cabinet for making an inflammatory speech on immigration.xix Friedman (1988b [1968], 438) described Powell as "the most intelligent and courageous of the Tory leaders" who would "jump at the chance" of floating the pound. The other Tory leaders were described as "less brilliant and more stodgy" who "may well pass the opportunity by".xx

Friedman (1967, 15) had publicly asked: "Why not have the dog wag the tail, instead of the tail wag the dog ... a system of flexible exchange rates completely eliminates the balance of payments problem". Friedman (1988b [1968], 429-433) confidentially recommended to Nixon that he acquire the "courage and wisdom to cut off the dog's tail in one stroke". Freeing the dollar would cause a temporary depreciation which might "momentarily" set "off a trade war". But for a trade war to "spread and last is equivalent to water flowing uphill". Friedman (1988b [1968], 437-8) informed Nixon that "on the economic front, there appear to be only gains and no costs" from floating the dollar: "there is probably no other economic measure that the new administration will have the power to take that can contribute anything like so much simultaneously to greater freedom of US citizens from government control, increased economic prosperity, liberalization of international trade, and the freedom of manoeuvre of the US government in foreign affairs".

Although economists as policy advisers sometimes act as salesmen, they don't usually offer unsolicited advice about timing and covering rhetoric. But this is precisely what Friedman (1988b [1968], 430-1) offered Nixon: a draft speech announcing the end of the Bretton Woods system. On the second or third Friday evening or Saturday after his Inauguration, Nixon should announce that he was "shocked at the state in which the preceding administration had left the balance of payments ... the measures taken by the Johnson Administration have so distorted the situation that it is impossible to know what the appropriate rates of exchange are. The new administration therefore proposes to put its faith in the strength of the economy and its free enterprise system, not in a growing network of bureaucratic controls".

The gold standard had been the institutional arrangement for Pax Brittanica; Bretton Woods performed a similar function for Pax Americana. Successive Presidents had been inculcated with the belief that national strength was synonymous with the strength of the dollar. Roosa had co-authored the Kennedy task force report on the balance of payments (Schlesinger 1965, 140). President-elect Kennedy had been advised by this task force that the "first task of economic statesmanship" was to "dispel fears about the value of the dollar ... a cornerstone of our banking responsibility". The post war international monetary arrangements had been "slowly and laboriously built up", and what was required was "quiet negotiation" and "frequent consultation between financial authorities" (Roosa 1967a, 285, 287, 291, 307). The official US position was that any discussion of flexible exchange rates or a change in the official price of gold was "off limits" (Emminger 1978b, 176). Kennedy was obliged to promise that "If elected, I shall not devalue the dollar" (cited by Volcker and Gyohten 1992, 21). McChesney Martin, chairman of the Federal Reserve Board, told President Johnson that defeat in Vietnam was preferable to the financial defeat of devaluation, which no President could politically survive (Brandon 1973, 218). Friedman (1988b [1968], 436) associated greatness with not having to negotiate within the Bretton Woods system: "We are a great nation. The dollar is the leading currency in the world. We should behave like a great nation, not engage in demeaning and niggling negotiations to get other countries to agree to 'let' us depreciate by x per cent vis-à-vis this currency, by y per cent vis-à-vis that currency".

The taskforce report on international economic policy was not made public, but those who had helped to write the report had no doubt about its strategic importance (Volcker and Gyothen 1992, 65). The final product was believed to have been "greatly influenced" by Friedman, although Haberler was the major author (Mayer 1981, 151). One of its members, Hendrik Houthakker (1978, 51) recalled that the policy recommended by the taskforce was to curtail or prevent the conversion of surplus dollars into gold so as to force a devaluation of the dollar. The report also concluded that "a solution along these lines may prove impossible to attain. A perhaps more promising avenue for bringing about exchange rate adjustment would be to work towards introducing greater exchange flexibility into the Bretton Woods system". Also canvassed was the proposal that "inconvertibility could be adopted not just temporarily. Decisions on the price of gold and on exchange rates could be postponed indefinitely. This would allow other countries to decide whether they want to peg to the dollar or allow it to float. In fact, suspension of convertibility, if coupled with reasonable monetary and fiscal policies on the part of the United States and close international consultation and cooperation, might prove a viable long-run system under which most countries would continue pegging their currencies to the dollar" (Report of the Task Force on International Economic Policy 1968, 2-3).

Simultaneously, Haberler (1969b, 12, 41-2, 47-8, 25, 11) publicly assaulted the analysis provided by the officials responsible for monetary policy who "still cling" to the system of fixed rates and who represented a minority opinion among economists. Dillon's advice was discounted, as were other "wild exaggerations" underpinning the case for Bretton Woods. Open inflation was preferable to suppressed inflation because of the tendency to resort to "controllitis": an "Ersatz" change in the exchange rate through dishonest exchange controls. Haberler (1969c, 359) found it "exceedingly difficult to think of valid objections to flexible exchange rates". Henry Kissinger (1979, 953) recognised that the policy of "benign neglect" meant, in effect, allowing the dollar to eventually float. Coombs (1976, 207-8) noted that the policy also involved maintaining an indignant public position to the contrary.

4.3 The NEP

Nixon was disinclined to jeopardise his re-election chances by tolerating unemployment, especially for the purposes of salvaging the Bretton Woods system. Nixon (1962, 309-11) attributed his defeat by Kennedy to an insufficient degree of political sensitivity within Eisenhower's cabinet with respect to the forthcoming election. Publicly, Burns played an important role in the 1960 "Scholars for Nixon and Lodge" organisation (Wells 1994, 17). Privately, Burns warned Nixon of an impending economic downturn which would reach its nadir in October 1960, just before the election. Burns recommended "decisive government action" to head off this threat to Nixon's election campaign. Nixon reflected that Burns was "a good prophet". Unemployment increased to 452,000 in October: "All the speeches, television broadcasts and precinct work in the world could not counter that one hard fact". Nixon (1978, 342) was keen to appoint Burns as Fed Chairman, but the incumbent refused to leave before his contract expired. Nixon therefore created a special interim position for Burns of Counsellor to the President. Nixon (1978, 519) claimed that he always gave "great weight to Burn's opinions", but added that he hoped that Burns would "independently conclude that my views are the ones that should be followed" (cited by Ambrose 1989, 456).

Friedman expected that the newly appointed Fed Chairman would be highly sympathetic to the Chicago cause. On February 2, 1970, Friedman (1972b, 54, 57, xii, 27) welcomed Burns as "the right man in the right place at the right time". Friedman predicted that under the influence of his "close friend and former teacher" the nation could "for the first time in its history, have a monetary framework for stable economic growth". Yet, on 30 January 1970, Burns wrote to Edwin Nourse that he wished "the world were as simple as the Friedmanites and Keynesians wish to make it, but it never has been, and I dare say, it never will be" (cited by Wells 1994, 25). By June 1970, Friedman (1975, 121-3) was "utterly disheartened" by Burns' advocacy of the "dangerous expedient" of an incomes policy as an antidote to inflation. Privately, Friedman informed Burns that he felt "betrayed" by his advocacy of an incomes policy (cited by Wells 1994, 57).

On 1 March 1971, and again later, Friedman (1975, 70; [27 August 1973], 84; 1972b, xiv; 1972c, 13) complained about the "inexcusable" inability of the Fed to measure the monetary aggregates it was targeting. The Fed had become "an engine of inflation" and "terrible" monetary policy had been driven by "erroneous economic theories". The Fed, not the President, was the "culprit". In the private sector "Heads would roll. So should they at the Fed". On 19 March 1971, Burns had lunch with Shultz who immediately began to raise questions about monetary policy. Burns replied that if anyone from the White House raised the matter with him again, he would "throw him out bodily" (cited by Woolley 1984, 158). Friedman wrote to Burns asking "What in God's name is happening?" (cited by Wells 1994, 84). Later, Friedman attributed his lack of influence in the early years of Nixon's Presidency to Burns' influence (Friedman and Friedman 1998, 376).

Friedman's frustrated expectations appeared to drive him to despair. The early rhetoric of the Nixon Administration had been highly congenial to the Chicago cause. Indeed, the price of Shultz's acceptance of Nixon's offer of the post of Secretary of Labor was an apparent agreement to end the Kennedy-Johnson practice of 'jawboning' and intervening in industrial disputes. Nixon repeatedly denounced controls as "the wrong road for America". Just after his Inauguration, Nixon stated that the "primary responsibility for controlling inflation rests with the national administration and its handling of fiscal and monetary affairs". The business community had to be guided by "the interests of the organisation that they represent" and should not be controlled by guidelines and exhortation (cited by Evans and Novak 1971, 185). One consequence of this disavowal of presidential responsibility for wage outcomes was the adoption of sole presidential responsibility for inflation without having the alibi of "irresponsible" labour and management.

Nixon's advocacy of the repudiation of the 'social responsibility of business' thesis had not gone down well with some in the business community, and had led instead to the development of an "inflationary psychology". This was threatening to derail the Administration into a more interventionist position. One of Nixon's friends, Pierre Rinfret, an influential New York investment adviser, had been under consideration both as a CEA member and as Secretary of the Treasury (Ehrlichman 1982, 258). On July 3 1969, Rinfret circulated a two-page memorandum to his clients accusing the new administration of entering office with "slogans and little else" and in believing that "inflation could easily be turned off" through monetary policy alone. In reality the administration was "fostering, abetting and creating inflation" through the "abandonment of the wage and price guidelines, which created 'open sesame' on prices and wages". Rinfret advised his clients to raise their prices, since controlling inflation was now the responsibility of the monetary authorities (Evans and Novak 1971, 186, 189; Galbraith 1971, 74). Friedman (1986, 86) believed he had "escaped [Washington] before I caught Potomac Fever".xxi However, on December 22, 1969, Friedman (1972b, 6) wrote about the "near-hysterical tones [of] the current flood of talk about inflation". On April 27, 1970, Friedman met with Nixon and Rinfret in the Oval Office. According to Rinfret, Friedman tried to persuade Nixon that the unemployment rate would not be a factor in the forthcoming election. According to Nixon's press officer, Friedman "nearly came to blows" with Rinfret over the issue, "but the President asked me not to take notes of those fireworks" (Safire 1975, 183).xxii The following year, Friedman (1975 [July 1971], 72) ridiculed the forecasts of the "Ebullient Pierre Rinfret ... New Economists, 0; monetarists, 3".

On June 11 1969, David Kennedy, Nixon's first Treasury Secretary publicly suggested that the country was on the brink of a "runaway inflation" (Evans and Novak 1971, 189). In August 1969, Burns, dissatisfied with the Administration's use of fiscal policy to restrain inflation, began canvassing the possibility of a return to jawboning or an incomes policy. In September 1969, Nixon announced the creation of a tripartite Construction Industry Collective Bargaining Commission with powers to intervene in labor disputes. There was renewed emphasis on defeating cost-push inflation. Shultz believed that talk of controls would stimulate pre-control price increases, and was opposed to a reversion to guidelines. Shultz's views on anti-inflation policy "carried considerable weight" within the White House. Shultz's influence can be detected in Nixon's June 1970 proposed series of "inflation alerts" as the acceptable limits of such anti-inflation supplements to fiscal and monetary policy (de Marchi 1975, 299, 306, 308, 310-22).

Nixon's initial response to stagflation was to order his aides to root out the "Jewish cabal" at the Bureau of Labor Statistics whose selective statistics, he believed, were designed to impair his re-election chances (Ambrose 1989, 457; Woodward and Bernstein 1976, 185). The Republican defeats in the 1970 elections stimulated demands for something more drastic than gradualism. In August 1969, Friedman warned in his Newsweek column and in conversations with McChesney Martin and others that restrictive monetary policy was in danger of creating a recession (Evans and Novak 1971, 193). When Shultz became OMB Director in July 1970, he echoed Friedman's analysis and was "the first in the administration to call publicly for an easing of monetary restraint" (de Marchi 1975, 325, 328, 308, 336). Nixon's attitude was that "We'll take inflation if necessary, but we can't take unemployment" (cited by Ehrlichman 1982, 254). When Burns was appointed to succeed McChesney Martin, Nixon bluntly instructed him: "You see to it: no recession" (cited by Wells 1994, 42). On November 20 1970, Nixon again urged Burns to expand the money supply at a faster rate. Burns replied that some form of incomes policy was required (Evans and Novak 1971, 370). On December 7, 1970 Burns publicly argued for an incomes policy in a speech at Pepperdine College. Nixon began to appeal to labor and management to "start help fighting inflation".

At an impromptu press conference on 4 August 1971, Nixon declared that he was "unalterably opposed ... to the Galbraithian scheme ... of permanent price and wage controls ... the extremists on the left of the economy spectrum have always favored a totally government controlled economy" (Diamond 1972, 150, 152). But eleven days later the Administration embraced the "Nixon shock" (Safire 1975, 527). In two Monday night sessions (August 2 and 9) Nixon, with Shultz and Connally, designed the NEP which both introduced a wage and price freeze and allowed the dollar to float (de Marchi 1975, 345). Nixon's strategy appeared to the 1972 AEA President as evidence of the bankruptcy of neoclassical economics (Galbraith 1973, 4). In reality, as Friedman recognised, it was the death rattle for the Bretton Woods system.

Friedman devoted his last Newsweek column (26 July 1971) before the NEP to Shultz's "little-noticed talk" at Chicago on the theme of 'Steady as you go'. Friedman (1972b, 13-4) pleaded against some of the proposals that would form the basis of the NEP. Friedman cited Shultz's Chicago talk: what is required is "time and guts to take the time, not additional medicine ... The voice from the bridge [the President] says 'Steady as you go'". But hitherto, Nixon had "not received the credit he deserves. Washington generates an atmosphere in which it takes great will power and moral courage to look very far ahead...Just when [his] policy is producing demonstrable results, there is increasing pressure on the President to alter course ... to establish a wage-price review board, or to freeze wages and prices … Mr. Nixon has not given into the pressure. Instead, he has announced that he is sticking with his policies. Once again, he has shown the vision and courage to pursue long-run stability rather than short-term gains".xxiii

Friedman (1968a, 19) had predicted that price controls would be "resuscitated" in the near future. Some aspects of the NEP about-face horrified the Chicagoans: the "jerry-built freeze" and the controls were "deeply and inherently immoral ... [they] threaten the very foundations of a free society" (Friedman 1975, 126, 129). Shultz (1993, 176, 819-820) thought that they were "an inexorable spiral of escalating disaster". Other aspects of the NEP were more congenial to the Chicago cause. Shultz had been forewarned by Nixon to be ready for the crisis weekend of August 13-15, and he arrived with five to seven billion dollars of prepared budget cuts (Safire 1975, 509, 515, 521; Weinberger 1990, 40). Friedman (1974b [1971], 366) "applaud[ed]" these cuts. More importantly, the NEP helped destroy the system of fixed exchange rates.

Burns' major disagreement with the NEP was the "gold move" (Safire 1975, 519; Volcker and Gyohten 1992, 113; de Vries 1985a, 134). When the proposal to let the dollar float (as a prelude to a realignment) was discussed, Burns warned Nixon (1978, 519) that "Pravda would write that this was a sign of the collapse of capitalism". Burns (1979, 6) favoured fixed exchange rates as the exercise of the "the rule of law" in international monetary affairs and he believed that "floating would surely bring misery to mankind" (Volcker and Gyohten 1992, 130). On this occasion Nixon (1978, 519-20) overrode Burns' advice: "This was one of the few cases in which I did not follow his recommendations. I decided to close the gold window and let the dollar float ... the best thing that came out of the whole economic program that I announced on August 15, 1971".

4.4 The cross of gold

Appropriately for a story about revolution, the ghost of Lenin began to haunt deliberations. The IMF officials appeared to regard themselves as a politburo established to defend the Bretton Woods revolution. They were confronted by a counter-revolutionary who was aware of Keynes' (probably fictitious) reference to Lenin's dictum about debauching a currency as a prelude to revolution (Friedman 1968a, 174). Friedman (1988a, xix, xxiv) regarded the NEP as "a sharp break in the monetary regime adopted by the major Western countries". But the NEPers were apparently unaware that they were rhetorically the heirs of Lenin.xxiv The first NEP was Lenin's attempt to reach a temporary compromise with the domestic forces of capitalism; Nixon's NEP fatally compromised the Bretton Woods system (Friedman 1974a [1971], 426). As frantic efforts were being made to revive the Bretton Woods system, Friedman advanced the prospects for international monetary revolution by pressing Nixon to debauch still further the currency of the Bretton Woods system, not through inflation but through undermining the role of gold.

Between March 6, 1933 (when Roosevelt fixed the price of gold at $35 per ounce and ended the internal convertibility of dollars into gold) and August 15, 1971 (when Nixon suspended the external convertibility of dollars into gold) events "unfolded with the inevitability of a Greek tragedy". It was a "beautiful example" how the hubris and "prejudices of central bankers and government officials" were destined to meet their nemesis in the form of "basic economic forces" (Friedman 1975, 162, 166, 178). Friedman realised "how economists like me exercise influence ... we exert influence by keeping options available when something has to be done at a time of crisis" (Friedman and Friedman 1998, 220). Friedman (1967, 115) estimated that major international crises only happened every 20-30 years. The crisis that led to the NEP also led Friedman to offer Nixon again his "option": "as I predicted, the pressure of events forced the president to take essentially the same measures on August 15, 1971" (Friedman and Friedman 1998, 377).

In 1945, the US owned over half the world's stock of official gold (Volcker and Gyohten 1992, 12). Between 1946-51 the IMF had sought to enforce a restriction in the price of gold; from 1951-1960 it relied on moral suasion (Horsefield 1969a, 598; Horsefield 1969b, 310, 225). On 20 October 1960, during the Nixon-Kennedy Presidential election campaign, the "London gold rush" drove the dollar price of gold towards $40 per ounce. The Gold Pool (a "gentleman's agreement" between certain European central banks and the New York Fed) was formed to prevent fluctuation in the price of gold in the free market "such as might undermine the stability of exchanges". The IMF (1964, 131-2) believed that this selling consortium and buying syndicate helped to "maintain confidence in the existing international monetary structure". But the gold outflow continued: in early 1971, Washington's gold holdings had dropped from their 1960 level of $17.8 billion to $10.7 billion. By 1970, US official reserves (monetary gold, reserve currencies and IMF reserves) had fallen to 15.7% of the world's total (Eckes 1975, 238, 255). By August 15, 1971, foreign official holdings of dollars were more than three times greater than US gold holdings when valued at $35 per ounce (Shultz and Dam 1977a, 114).

Yet as the system collapsed it commanded an almost mystical confidence. Kennedy's 1963 Message to Congress had referred to the fixed price of gold as the "foundation stone of the free world's trade and payments system" (Mayer 1981, 75). After the 1964 annual IMF meeting in Tokyo, a group of officials visited an ornamental Zen Bhuddist garden in which fifteen stones were arranged so that the viewer could never see more than fourteen stones at any one time. Roosa (1967a, 187-8) reflected that "It went without saying at Tokyo that the price of gold, having been fixed at $35 per ounce, is now taken as the cornerstone of the international monetary system ... as certain and secure as the fifteenth stone".xxv Friedman (1968a, 244) believed that such phrases were "ritual incantations to conceal the emptiness of thought".

In March 1968, less than four years after Roosa's semi-mystical insight, the Gold Pool collapsed and the link between the official and the private gold market was severed. The Gold Pool had lost $2.75 billion; the cost to the US Treasury alone was over $1 billion (Scammell 1983, 123; de Vries 1976a, 403). Henceforth, the price of gold fluctuated freely in the private market, although central banks continued to trade gold among themselves at $35 per ounce (Haberler and Willett 1971, 1). The IMF had always been "apprehensive" about the consequences for fixed exchange rates of a rise in the price of gold (Horsefield 1969a, 598, 614). At the 1968 IMF Annual Meeting (just before Nixon was elected), the US Governor reaffirmed the "vital stake" of the international community in maintaining a fixed price of official gold which should not be demonetised (de Vries 1969, 407-8). However, gold was ceasing to be the "firm anchor" of the international monetary system.

A former member of Nixon's CEA noted that there was "as yet little public knowledge of what exactly led to the President's decision to suspend the convertibility of the dollar into gold" (Houthakker cited by Brandon 1973, 225). It is now clear that Friedman played an important role in the removal of the fifteenth stone. Part of Friedman's (1953, 192) case for flexible exchange rates involved the institution of a free gold market. At the Chicago conference, one of the "Alternatives" was to replace the fixed relationship between gold and the dollar with more flexible exchange rates: "No one cited a cross of gold speech but the idea is very much alive" (Shultz and Aliber 1966, 3-4, 13).

Within days of the NEP, Friedman reformulated his proposals for gold and presented it to Nixon as a vehicle for the President's political advancement. Friedman (1988b [1968], 438, 430) had advised President-elect Nixon that pegging the price of gold had put a "loaded gun" in the hands of other countries; the new administration should therefore abstain from further gold transactions. Immediately after Nixon closed the gold window in August 1971, Friedman recommended to Nixon (via Shultz) that he should make it legal for Americans to own gold. H.R. Haldeman's "Action Paper" explained that Nixon was "very much interested … Friedman's point was that this is a move that would very much please the Conservatives, would be a very big marker with them and would have no appreciable significant effects otherwise. The point is that FDR took away the right for Americans to own gold and Richard Nixon could get the credit for getting it back. Friedman suggested this to Shultz. The President would like the research done on it and a proposal in to him as quickly as possible" (Oudes 1989, 312). But before Friedman's victory was complete there would be one final effort to resurrect the par value system.

4.5 The Smithsonian bargain

In the last fourteen months of the Johnson Administration, the pound and the franc were devalued and the mark revalued (a prelude to its float in May 1971). Within the Nixon White House there was a tension between the "Bretton Woods veterans" and those such as Shultz who believed passionately in the price mechanism (Safire 1975, 518; Volcker and Gyohten 1992, 114). In May 1971, Volcker drafted a speech for Connally which included a "vague paragraph" about the need for greater exchange rate flexibility. Instead, Connally publicly insisted that the decision not to devalue the dollar was "unalterable" (Volcker and Gyohten 1992, 74-5). On 26 September 1971, Connally proposed to the Group of Ten (of which he was chairman) "a general clean float" of major exchange rates. A clean float was one of the conditions for the removal of the US import surcharge. It became clear that the US wished to postpone perhaps indefinitely the re-establishment of the convertibility of the dollar into gold (de Vriers 1976a, 545-7, 551). Indeed, Connally stated that the US objective was to "reduce, if not eliminate the role of gold in any new monetary system" and offered to reduce the US import surcharge for any country that allowed its currency to float. Connally was content to "agree that we can't agree" and for the dollar to continue its float, but Burns and Kissinger persuaded Nixon that a return to a par value system was needed (Solomon 1982, 195-6, 199, 201, 205, 207, 217-8).

In December 1971, Friedman (1972b, 115-7, 217) unsuccessfully campaigned to "Keep the Dollar Free". When the pound began to float he argued that the "sooner the Smithsonian agreement is undermined the better". Within the White House there was "no evidence" of a commitment to preserve the Smithsonian realignment and the defence of the arranged parities was largely left to the Europeans (Volcker and Gyohten 1992, 82, 104). Besides, by 1972 the tide had turned against Burns. Having failed to prevail directly on Burns to "err on the side of inflation", Nixon, in June 1971, unsuccessfully attempted to persuade Friedman to urge Burns to accelerate the increase in the money supply before the 1972 election (Friedman and Friedman 1998, 386). Because Burns refused "a vendetta of sorts among White House staff" developed against him (Volcker and Gyohten 1992, 117). Nixon ordered Charles Colson (1976, 68, 203-4) to leak to the press the false information that Burns was planning to increase his own salary whilst pressing for wage controls for everyone else.

During the Smithsonian negotiations, Friedman (1975 [December 20, 1971], 175-8) warned Nixon and Connally that they would have "snatched defeat from the jaws of victory" by agreeing to realign rates. Shultz pushed Nixon and Connally in the same direction: "In reading over the years on this subject, I have never seen so many intelligent experts who disagree 180 degrees. George and others like the floating idea" (Nixon cited by Safire 1975, 514). Before the Smithsonian realignment, Shultz "made a very strong appeal" to Connally that floating rates should be at the centre of the new international order: the "Shultz bombshell" (Volcker and Gyohten 1992, 47, 114). Connally's resistance to the re-establishment of fixed rates may have reflected Shultz's influence, or it may have been a bargaining posture (Solomon 1982, 213). But an IMF Executive Director remarked that Connally treated the Fund as "a museum in which anything that wasn't already stuffed ought to be" (cited by Coombs 1976, 219). The IMF historian also noted that Shultz was "ideologically in favor" of floating rates (de Vries 1985a, 238).

Shultz bemoaned that economic policy had "too often been the enemy of the market economy". Abandoning "fashionable ideology" and relying instead on "the market system" offered a "brightly optimistic" future (Shultz and Dam 1977a, 205). Shultz (1993, 23, 29) noted that "the price of money is the most important price in an economy"; he also recalled that he had helped to "achieve a major transformation in the international monetary system", the emergence of "a flexible rate system". There was certainly no doubt in the minds of insiders such as Paul Volcker, the Under Secretary for Monetary Affairs (1969-1974) and the principal US participant in the negotiations that failed to rescue Bretton Woods that Shultz had been "captivated" by Friedman: "in terms of ideology there was no question as to who was the teacher and who was the student". Shultz exercised an enormous influence in pushing the case for floating exchange rates: "His tactics and approach were very different, but we ended up with floating rates" (Volcker and Gyohten 1992, xiv, 82, 107, 118, 120; see also Stigler 1988, 161; Brandon 1972, 221; Evans and Novak 1971, 194).

Shultz confronted an international monetary community that had long been unanimously committed to preserving Bretton Woods. Serious IMF consideration of more flexible exchange rates did not begin until 1968 (Solomon 1982, 59, 167-70). In September 1969, the IMF Executive Board were "instructed, under American pressure" to review exchange rate regimes (Williamson 1977, 7). Treasury Secretary Kennedy was "virtually alone" in wishing to consider a revision to the Articles of Agreement (de Vries 1976a, 504, 515). When the IMF review was complete, Schweitzer reported that the Executive Directors believed that "the basic principles of the Bretton Woods system are sound and should be maintained and strengthened". A wider band of allowable movement was acceptable; but there were "grave risks" associated with the "abandonment of the safeguards of the par value system". National exchange rate policies must continue to be influenced by "international opinion"; it wasn't wise to "leave a vacuum" in this area (IMF 1970, 67, 42, 30). The IMF Managing Director asserted that the Bretton Woods system had survived the "ordeal by fire ... and has emerged with improved foundations" (cited by Emminger 1973, 5). The Canadian authorities were informed that they had set "an extremely bad precedent" by allowing their dollar to float in May 1970. The IMF refused to consider that the Canadian float was anything other than "transitional" and pressed strongly for a return to the fold "at the earliest possible date". The IMF dispatched a mission to Ottawa – but their report was not even discussed by the Executive Directors because by the time it was ready the Bretton Woods system had collapsed (de Vries 1976a, 478, 481, 519).

Three months before Nixon's NEP, with three major currencies floating, the IMF issued a press statement proclaiming their determination to "strengthen the basic principles of the Bretton Woods system". The day after Nixon's NEP announcement, the IMF Executive Board called on the Economic Counsellor to provide a lodestar with the aid of MERM (the IMF multilateral exchange rate model). His advice was unambiguous. A floating regime was completely untenable: it could not "even in theory be expected to lead to a viable system of rates". What was required was the establishment of new parities derived "on the basis of analysis". The collapse of their system was considered likely to leave international monetary arrangements "beyond repair" (de Vries 1976a, 524, 537-8). All that was required was a once-and-for-all realignment based on the MERM computations (de Vries 1987, 93). When this was apparently achieved in December 1971, this left the IMF Research Department "euphoric" (de Vries 1985a, 126).

Schweitzer informed the 1971 IMF Annual Meeting that their first priority must be to re-establish the parity system (de Vries 1976a, 545-6). The Smithsonian realignment of December 1971, sought to find "the appropriate monetary means and division of responsibilities for defending stable exchange rates" (cited by Solomon 1982, 209). The IMF Managing Director argued against "dismantling the protection provided by the Articles of the Fund". Stability of exchange rates offered protection against "currency warfare". Given the post-war commitment to macroeconomic management, it was "unrealistic to suppose that governments would be prepared to accept alternative regimes that would put the rate of exchange at the mercy of market forces alone" (Schweitzer 1972, 124-5).

The "Smithsonian bargain", if not a Faustian bargain with the national forces of monetary independence, merely delayed the rendezvous with the political, economic and intellectual forces that were pushing hard against the system of fixed exchange rates. Nixon had hailed the realignment as "the most significant monetary agreement in world history"; but Volcker quipped "I hope it lasts three months" (Volcker and Gyohten 1992, 90). In retrospect, it became clear that it was a "one sided agreement" (Coombs 1976, 225). The reason for the lack of US commitment to the Smithsonian realignment was the perception that the negotiated devaluation was still insufficient (Volcker 1978-9, 7). Shultz recalled that "we" were actually seeking a more fundamental reform and that the Smithsonian agreement was merely a prelude to such a reform. Defending the Smithsonian realignment was, he believed, "a futile effort" (Shultz and Dam 1977a, 116-8, 127).

4.6 Secretary Shultz

Shultz was clearly a powerful figure inside the White House prior to becoming Treasury Secretary. One of the Governors of the Federal Reserve System observed that he was "the strongest economic voice in the Administration" (Maisel 1973, 268; see also Ehrlichman 1982, 89; Safire 1975, 10, 99, 192-3, 272, 282, 491, 523; Anderson 1990, 267; Solomon 1982, 220, 272; Rather and Gates 1974, 47; Evans and Novak 1971, 369; Ehrlichman 1982, 92). From his time at Chicago, Shultz (1993, 28; 1995, 2) "learned early on that I must be able to persuade if I was going to be effective". His "training as an economist has taught me also to be a strategist who tries to understand the constellation of forces present in a situation and arrange them to point towards a desirable result". Using these skills he became "the dominant member of every committee he joined" (Kissinger 1982, 81). When persuasion was insufficient, Shultz (1993, 13, n2) used other tactics to achieve his desired results.xxvi In particular, Shultz was determined that the Treasury maintain control of the negotiations about the future of the international monetary system (Shultz and Dam 1977a, 61, 122). One of his first acts as Treasury Secretary was to exert "concerted pressure to make progress" with monetary reform (Volcker and Gyohten 1992, 118-9).

Meanwhile, the IMF undertook a "marathon" series of meetings so that their report on the Reform of the International Monetary System could be agreed upon prior to the September 1972 Annual Meeting (de Vries 1985a, 136). It expressed a "touching faith" in prompt parity adjustments as the salvation of the system. But observers noticed evidence within the report of "strong differences of opinion" on the question of automatic adjustments of parity. The US was the only country that did not welcome the Reform Report (Williamson 1977, 61-2, 66). Shultz became Treasury Secretary as the report was being written.

The September 1972 IMF meeting provided an opportunity to reflect about the disturbing events of the previous year. Henry Wallich (1972, 45, 19, 49-50) noted that ten years ago "we were bitterly divided" with no common ground between the fixed and flexible diehards. Now there was a growing consensus on limited flexibility, at least in the short run. The 1971 experience of floating was "an unmitigated disaster", but a parity based on effective exchange rates might usher in his desired outcome of "one world of fixed exchange rates". I.G. Patel (1972, 67, 64) noted with alarm that the idea that flexible exchange rates allowed countries to pursue their national objectives in a more unfettered way was a "misguided psychology" that was "gaining ground".

Jeremy Morse (1972, 51, 54-8) reflected that the temporary period of disorder had not produced a "general mind-defeating disintegration" but had been "closed by the Smithsonian bargain". On this the international bankers could "stand with recovered confidence". A "massive exchange of views" had led to the creation of a "new slogan of 'a one-world system'". International cooperation, "the utopian vision of earlier times has become the accepted thing in the age of jet and telex". The Bretton Woods experience had reinforced the attachment to fixed rates: "Behind this satisfaction with the post war experience lie darker memories of the thirties". Some calculations made by WP3 revealed that the system contained a "depreciation bias". But the Smithsonian bureaucrats were determined to prevent a recurrence of the crisis by controlling the recurrent trend towards maintaining an undervalued exchange rate. The crisis of 1971 had been helpful in this respect: "Once the crisis exposed this trend, one could see that it had been running like an underground river through the twenty five years of the Bretton Woods system, generally suppressed by the acceptance of fixed rates". But - at least in Morse's lecture - there was no understanding of the intellectual currents which after twenty-five years were about to sweep away the foundations of the post war system.

At the September meeting the US delegation were unsuccessful in their attempts to prevent the Committee of Twenty electing Morse as Chairman of the Deputies. The US preferred Rinaldo Ossolo "partly because he was not hostile to floating exchange rates" (de Vries 1985a, 158). Morse (1974, 186) set himself the task of reconstructing Bretton Woods by providing "a complete design for an international monetary system that would last for 25 years". The reform deliberations of the Committee of Twenty were expected to last two years. Yet within six months the par value system collapsed. Henceforth the edicts of the international policemen lost their potency. Three weeks after the instigation of generalised floating in March 1973, the Deputies continued to insist that the system must be based on "stable but adjustable par values". But they were just "too out of touch with reality" (Williamson 1977, 67, 70-1).

Four months before the 1972 IMF meeting Shultz succeeded Connally as Treasury Secretary; the fixed exchange rate system evaporated rapidly thereafter. Anthony Barber's attack on floating exchange rates to the 1970 annual meeting of the IMF was regarded as "a sermon against atheism before a convocation of bishops". The British had fought for three years to avoid devaluation in the 1960s; in 1972 they resisted for about a week (Volcker and Gyohten 1992, 105). On 23 June 1972, the pound started to float for what was announced to be "a temporary period" (Solomon 1982, 175, 220-1). The Italian lira was also under pressure.

Nixon opened the 1972 IMF meeting by commending the various proposals that Secretary Shultz was about to make. Shultz sought to reassure his audience: he was aware that most countries were committed to fixing the value of their currency. However, he added that provision needed "to be made for countries which decide to float their currencies". This "surprised the world" and appeared to the Europeans to be evidence that the "religious war" was over and that the Americans would adopt a more cooperative international stance (Solomon 1982, 226, 228; Williamson 1977, 61-2, 66, 82). In reality, Shultz had spent his first summer as Treasury Secretary formulating an elaborate plan based on a "simple core idea ... a system in which exchange rates could move freely" (Shultz and Dam 1977a, 126). Kenneth Dam (1982, 224) recalled that the US proposal was formulated by Friedman and articulated to Shultz, Dam and Arthur Laffer over dinner on 22 May 1972. The US proposal was designed as a part of the transition to a floating system: "But it was not so presented", because of the opposition of Burns and others. Some have suggested that Friedman actually drafted Shultz's speech to the IMF (de Vries 1985b, 964; Volcker and Gyohten 1992, xiv, 82, 107, 118, 120). Friedman (correspondence 20 September 1999), however, denies that he played any drafting role but is prepared to accept that he may have discussed the speech with Shultz prior to the 1972 meeting.xxvii Certainly the proposal to allow the US to float whilst leaving other countries with the option to follow suit or peg against the dollar was similar to that outlined by Friedman (1969b) shortly after Nixon's first election victory. At the end of the IMF meeting, however, Schweitzer, the IMF Managing Director, was quoted as saying that he was "more convinced than ever" that the basic Smithsonian structure of exchange rates would prevail.

Six months later, the "final collapse" of the IMF system was "unexpected" within the Fund (de Vries 1985a, 119). Yet, White House rhetoric suggested a very different perspective than that of the Fund officials. With respect to the NEP Friedman (1974a [1971], 426) welcomed "the President's bold actions ... [which] gave a formal signal that the Bretton Woods system is dead, that it will no longer be revived". The 1973 Economic Report of the President echoed these words: Nixon's "bold initiatives ... gave public recognition to the fact that … the Bretton Woods system had become untenable" (cited by de Vries 1985a, 111). The IMF Executive Board expected to exercise a "leadership position" in reforming the international monetary system. But the US wished to exclude the IMF from discussions about the international economy because Fund officials "would be excessively influenced by the history and past operation of the Fund and excessively biased in favor of a system of par values". Also, shortly after Shultz became Treasury Secretary, there were reports that forces within Nixon's White House had placed Schweitzer on their enemies list and were opposed to his continuation as Managing Director. Thus as their system collapsed, the IMF was saddled with a lame duck leadership (Coombs 1976, 220; de Vries 1985a, 150, 130, 118; Solomon 1982, 225, 228).

After January 1973, Shultz combined his job as Treasury Secretary with new roles as Assistant to the President for Economic Policy, chairman of the newly formed Council on Economic Policy and chairman of the Council on International Economic Policy. This was the vehicle through which Shultz imposed his authority on US economic policy and through which the Treasury dominated international economic policy. Shultz's stated philosophy was to "do nothing" in response to both Presidential instructions to harass perceived enemies and to the expectation that the Administration should intervene to resolve industrial disputes (Shultz and Dam 1977a, 2, 7, 176-7). He now brought this market-based philosophy to bear on the par value system.

Shultz was regarded as "the creative synthesiser ... the man who could conjure up a surprisingly different way to an agreed upon objective" (Safire 1975, 215). His post Bretton Woods 'synthesis' was more conducive to floating rates than the fixed rate advocates would have wished. Between 1-9 February 1973, the Bundesbank spent almost US$6 billion defending the Smithsonian re-alignment. It was the "last gasp" of the Bretton Woods system (Haberler 1988, 135; Scammell 1983, 184; de Vries 1985a, 66). But between the Treasury and the Fed there was a "clear split" on the issue (Volcker and Gyohten 1992, 130). The Federal Reserve sold $320 million worth of marks, but the day after the defence began newspapers reported that Shultz was sympathetic to the float of the mark, thus rendering the defence an expensive but pointless exercise (Friedman 1975, 181). Charles Coombs (1976, 228) realised that "the ball game is over". On 12 February, Shultz announced a 10% devaluation of the dollar, noting that the US had "undertaken no obligation" to intervene in foreign exchange markets. Shultz used this "Volcker Agreement" as an opportunity to press for the removal of all remaining controls on capital outflow (Volcker and Gyohten 1992, 107).

Of great symbolic importance was the fact that Shultz sent Volcker to Europe and Japan to discuss the impending changes, rather than negotiate via the IMF who, he believed, had a vested institutional interest in maintaining a par value system (Shultz and Dam 1977a, 121). When the agreement had been reached, the IMF were given a copy of Shultz's press statement: "Perhaps for the first time in the Fund's history, the Executive Board did not have a paper prepared by the staff. In these circumstances there was little that the Executive Board could do ... Such a situation was far from welcome". The IMF had been deliberately excluded from decision-making about the issue that they believed defined their existence (de Vries 1985a, 66-9, 117).

By March 1973, the yen, the Swiss franc and the Italian lira were floating, in addition to sterling and the Canadian dollar. On March 1, 1973 the Bundesbank bought $2.7 billion in dollars, the largest amount ever purchased by a central bank in a single day (Emminger 1977, 36). Almost two years earlier, the Bundesbank had lost well over $500 million to postpone the floating of the mark by two weeks (Friedman 1972b, 112-3). Friedman (1971, 4) welcomed the May 1971 float by proclaiming that the Germans had (by taking his advice first offered in December 1950) established "an effective automatic mechanism that will eliminate crises". Throughout the 1973 crisis Friedman and Haberler exerted relentless pressure on Otto Emminger, the President of the Bundesbank, to again float the deutschmark (de Vries 1985a, 113). On March 2, the Bank of France was forced to close the Paris exchange market after ninety minutes trading. On that day, Volcker was presented with an IMF staff paper outlining the tools by which the US could use the Fund's resources for a concerted defence of the existing structure of rates. Volcker replied that the US had accepted the system of floating rates (de Vries 1985a, 76-7). On 27 March 1973, the IMF Committee of Twenty (1974, 215) recognised that "floating rates could provide a useful technique in particular situations". But Shultz successfully resisted the effort to insert the word "temporary" before "floating rates" (Solomon 1982, 228, 230, 248). This wording remained in the final report, although the IMF (1974, 8, 12) sought to make floating "subject to Fund authorisation, surveillance and review".

The system of fixed exchange rates thus collapsed into a generalised float. On March 9, 1973 Shultz "politely refused" a request from the EEC Finance Ministers to intervene in the exchange markets (Solomon 1982, 232). The six European countries of the 'snake' plus Sweden began to float jointly while attempting to fix exchange rates among themselves. Outside the IMF it was "universally" recognised that a new regime of floating rates had been initiated. But the IMF thought it best to pretend that the Europeans were not really floating and so decided to treat them not as separate countries but as a group: "The joint float might then be construed as a step towards the restoration of a system of adjustable parities" (de Vries 1985a, 80). But even this was short-lived: by the end of 1974 only Germany, the Benelux countries, Denmark, Norway and Sweden remained committed to the system (Greenspan 1988, 301). In 1973, there was also an effort to pretend that countries were committed to "central rates" even when a country's intervention currency was floating. It became necessary to dilute still further this rather meaningless concept, although the IMF Executive Board, apparently paralysed by indecision, took two months to agree on this "seemingly minor question" (de Vries 1985a, 281). Various further attempts were made to salvage something, but the futility and exhaustion were plain to see. As one official put it, "the most urgent aspect of international monetary reform is to return to a system of fixed weekends and free evenings with very wide bands around them" (cited by Solomon 1982, 336; see also Fleming 1974, 9). After the oil price rises, attempts to return to exchange rate fixity were simply overtaken by events (Greenspan 1988, 311). Henceforth, Shultz concluded "markets, rather than governments were explicitly in charge" of exchange rates (Shultz and Dam 1977a, 128).

4.7 Leaks, plumbers, floaters and fixers

This section provides an integrated narrative of three inter-related phenomena: Shultz's tenure as Treasury Secretary (May 1972-May 1974), Watergate and the demise of the par value system. Shultz joined the Nixon Administration from his position as Dean of the Graduate School of Business at the University of Chicago (1962-8); he was visibly shocked as some of the tragedies of the era unfolded.xxviii Vice President Agnew made several highly provocative speeches about the university community and the Administration generated unparalleled hostilities from American campuses. When Nixon welcomed home the first American prisoners of war from Vietnam, he compared them to "those snivelling Ivy Leaguers" (Ambrose 1991, 65).

What Shultz was expected to do by his employer must also have come as a shock. Nixon appointed Johnnie Walters as Commissioner of the Internal Revenue Service (IRS): "hand-picked for his presumed loyalty to Nixonian ideals" (Chester et al. 1973, 87). Within the White House an "enemies list" was compiled of people who "had been targeted for IRS and other government harassment". John Dean, the President's counsel, forced Walters to take the "enemies list" to Shultz so as to begin the harassment. Shultz refused and told Walters to do nothing with the lists (Price 1977, 232). Nixon instructed Shultz to "clean the house" at the IRS, in part, because there were "too many Jews" and to assault Ford, Brookings and other foundations that "had been used for left wing purposes" (Ambrose 1991, 19).

Ehrlichman told Nixon that Shultz was "just touchy as hell about cooperating with us on this sort of thing" (Kutler 1997, 113). Nixon was becoming impatient, and wanted the IRS to harass George McGovern, his 1972 Presidential opponent. Nixon reflected that "Everyone thinks Shultz is an honest, decent man". Haldeman asks "is there a way to cause him to do it externally, so that it isn't his initiative? ... Can we get an external tip that gives him a rationale for doing it". Nixon complained that "George has got a fantasy. What is George's – what's he trying to do, say that you can't play politics with IRS?" (Kutler 1997, 115, 119).

There may have been some surreptitious assistance: according to Haig, in June 1973 someone in the Treasury alerted him to a forthcoming IRS audit of Nixon's friend Bebe Rebozo (Kutler 1997, 591-2). But it was never enough. Haldeman spoke about getting "loyalists in various positions that were sensitive". Dean explained that the IRS bureaucrats were all Democrats and would not hand over the files. Nixon retorted: "There are ways to do it. Goddamit, sneak in in the middle of the night". On September 15 1972, Nixon told Haldeman that with respect to the IRS "The whole Goddamn bunch is to go out. And if he doesn't do it, he's out as Secretary of the Treasury" (Ambrose 1989, 588, 611; Kutler 1997, 119). Shultz "didn't get to be Secretary of the Treasury because he had nice blue eyes. It was a goddamn favor to get him the job" (Nixon cited by Woodward and Bernstein 1976, 97).

The international monetary world was turned upside down in the early 1970s and the process by which this happened became tangled up in the webs of Watergate. In 1961, President Kennedy appointed Dillon (an investment banker) as Treasury Secretary because he was "a reassuring symbol of financial rectitude" (Volcker and Gyohten 1992, 20). Charles Coombs (1976, 20, 16-7), the senior Vice President in charge of the foreign exchange desk at the New York Fed, recalled Kennedy insisting that the gold-dollar price was "immutable". Dillon had been Undersecretary of State during the Eisenhower Administration and was an "elegantly tailored, handsome man ... with the quiet assurance of someone having just achieved a pinnacle of personal success". When Coombs "watched him at international gatherings I could not help feeling a certain national pride". Under the Johnson Administration, Dillon organised a continuing seminar on international monetary policy through which the New York Fed and the Treasury could coordinate thinking.

Dillon had donated $30,000 to Nixon's 1960 campaign against Kennedy, and was a strong candidate to become Nixon's Secretary of State (Reeves 1993, 27; Reichley 1981, 65). The First Nixon Administration, however, dispensed with the Dillon Committee, thus creating a potential fissure between the Treasury and the Fed (Coombs 1976, 204; Mayer 1981, 149-50). More seriously threatening to Dillon's wellbeing was the plan hatched by G. Gordon Liddy (1980, 170-1, 239, 371), who had acquired forged Treasury authorisation to carry a gun. Liddy hated the "Beautiful People" and planned to launch "an undeclared war … for the President". This war escalated after June 1971, when the Supreme Court allowed the Washington Post to publish the leaked Pentagon Papers. Nixon did not take this judicial defeat well and demanded that a "Plumber's" unit be established to plug any future leaks. Nixon (1978, 512-3) "wanted someone to light a fire under the FBI in its investigations of [Daniel] Ellsberg" who Nixon believed had stolen the papers. Nixon thought that similar confidential information was being held at the Brookings Institution: an academic research organisation that he wanted to "smash" (Ambrose 1989, 448). Nixon (1978, 512) made it clear that he wanted the material returned "right now – even if it meant having to get it surreptitiously". Liddy therefore targeted the Brookings for fire bombing (Dean 1976, 316, 45; Woodward and Bernstein 1976, 324-5; Kutler 1997, 6, 8). Liddy (1980, 225-6, 276, 438) planned to acquire an authentic looking fire engine so that a group of Cubans (later of Watergate infamy) could imitate fire fighters whilst "calmly loading the 'rescued' material into a van".

Who knows what might have happened had Liddy been disturbed in this operation by Dillon, who was Chairman of the Board of Trustees of the Brookings Institution, or anyone else for that matter. Liddy appeared to have been obsessed with killing his 'enemies'. His first thought on being left alone with John Dean was to interpret the pencil lying on the desk as a coded instruction from someone in authority to kill: "In a second I could drive it up through the underside of his jaw, through the soft palate and deep into his brain". Had the fire bombing taken place Nixon could have been driven from office for covering up the Brookings scandal. As it happened it was Liddy's bungled operation GEMSTONE which lit that particular fuse. Meanwhile the "immutable" gold-dollar price was being further undermined by the benign neglect of Dillon's successors in the Treasury.

As Nixon opened the 1972 IMF meeting, Liddy, Howard Hunt, and the five Watergate burglars were indicted on Federal charges (twenty-five of the 'Watergate alumni' subsequently went to jail). By 1973-4, Nixon was preoccupied with salvaging his presidency from the quagmire of Watergate rather than rescuing a monetary arrangement that his Treasury advisers wished to see buried. Had Nixon been exclusively advised by fixed rate advocates such as Burns the par value system may have lasted much longer. Two months after the generalised float Nixon announced another sixty-day price freeze. Shultz (1993, 820) had been unhappy with the 1971 freeze and by his own account decided to "drop out" from public life in protest over this further interference with the price mechanism. Yet Shultz's disillusionment with the Administration was likely to have been more wide ranging. Certainly he did not resign for another year and Nixon (1978, 908) recalled that Shultz wished to resign in part because he was "disillusioned by my handling of Watergate".

As the European Finance Ministers struggled to defend the Smithsonian realignment, two political developments enhanced Nixon's prospects for re-election. As a bye-product of the first, Shultz became Treasury Secretary, thus enhancing the prospects of a final collapse of the par value system. Nixon had chosen Connally, a Texan Johnson Democrat, as Treasury Secretary because he was determined not to lose Texas in 1972 (Rather and Gates 1974, 276-7, 279). On May 16 1972, Connally resigned as Secretary to begin the 'Democrats for Nixon' campaign, thus facilitating Shultz's elevation to the position.xxix On May 12, 1972, Fed chairman Arthur Burns (1972, 545, 549) extolled the Smithsonian realignment as "solidly based". The alternative was "not pleasant to contemplate". In July 1972, following "interminable arguments" the Treasury agreed to provide a "shoestring" to support the dollar. Two days later, Shultz's Treasury removed even this "grudging" support. But as early as March 1972, Volcker made it clear that the Smithsonian agreement would have to be defended by the other leading countries (Coombs 1976, 226-7; Southard 1979, 42). Henceforth the Fed would have to attempt its defence of the Smithsonian system without support from Washington.

As Labor Secretary, Shultz recognised the "considerable political power" wielded by trade union leaders such as Meany. Shultz played golf with Meany and guaranteed him "quiet access to the President" (Shultz and Dam 1977a, 5; Shultz 1993). On June 18 1972, Shultz relayed to Nixon the message that Meany would not support McGovern in November. This secured the "benevolent neutrality" of a large part of organised labour by detaching Meany from the traditional Democratic coalition (Ambrose 1989, 585; Safire 1975, 584; Ehrlichman 1982, 94). Nixon (1978, 626, 672) recalled that Shultz's news provided "a tremendous boost" to his re-election chances.

On the same day that Nixon heard the news from Shultz about Meany, he also read that five men on the CREEP payroll had been arrested the day before inside the Democrats headquarters in Watergate. Three days after the break-in Nixon spoke with Haldeman about the arrests. The tape of this conversation was subsequently subpoenaed, but mysteriously there was an eighteen and a half-minute gap in the tape that was finally handed over. Three days later, on June 23, Nixon and Haldeman formulated a plan to call in the CIA to restrain the FBI investigation into the Watergate break-in (Kutler 1997, 69). Nixon (1978, 1057) later acknowledged that it was this "smoking gun" that ultimately made his Presidency untenable. Concerned to cover up a burglary, he showed no interest in patching up the Smithsonian agreement. On June 23 Haldeman informed him that the pound was floating, but Nixon replied "I don't care about it". Haldeman pressed him to take an interest in the international monetary crisis telling him that Burns, the Fed chairman was "concerned about speculation against the lira". But Nixon retorted: "Well, I don't give a [expletive deleted] about the lira" (cited by Williamson 1977, 175; Ambrose 1991, 414).

Harvard and MIT also appeared on Nixon's list of enemies. Two days after Shultz was appointed Secretary, Nixon told Haldeman: "I want those funds cut off for that MIT ... Slice them". Archibald Cox was appointed as Watergate Special Prosecutor in May 1973, and rapidly became the premier villain in Nixon's eyes. Kissinger informed Nixon that Cox, his Harvard colleague, was "a fanatic liberal Democrat and all his associates are fanatics". President Kennedy's former Special Assistant for National Security, William McGeorge Bundy, also of Harvard, apparently claimed that the Kennedy Administration did not undertake any wire-tapping. On June 1, 1973, Nixon told Kissinger that the list of those who had been tapped by Bobby Kennedy would be released "next Thursday ... Monday". In the meantime, Nixon wanted Kissinger to "leak it to someone ... Be sure McGeorge Bundy knows this is coming out". Nixon instructed his Secretary of State to inform his "liberal friends" that "this whole business of tapping, they have, they have opened it up, they have really opened it up, because Bobby Kennedy -". Nixon saw in his opponents a mirror image of himself self-interestedly pursuing Alger Hiss. He hoped that by threatening their self-interest he could persuade Kissinger's "liberal friends" to call off or restrict the Watergate investigation: "remember on this tap business, it's gonna catch some of your friends, incidentally. Cause I know some of the names ... they want a brutal fight, they're gonna get one. And they're gonna get it Goddamned soon" (Kutler 1997, 610, 561-2, 39-40).

On 7 February 1973, as Bretton Woods was undergoing its "last gasp", the US Senate voted 70-0 to establish a select committee to investigate Watergate. Nixon was shocked to hear that the proceedings would be televised (Kutler 1997, 211). In July the existence of Nixon's tapes were revealed (some of which were immediately subpoenaed). Nixon's last months in the White House were spent pouring morosely over these tapes. On the day he was fired (the Saturday Night Massacre) Cox invoked the integrity of Shultz's office to resist Nixon's order to abstain from seeking more tapes: "You remember when Andrew Jackson wanted to take the deposits from the Bank of America and his Secretary of the Treasury wouldn't do it. He fired him and then he appointed a new Secretary of the Treasury, and he wouldn't do it, and he fired him. And finally he got a third who would" (Cox cited by Woodward and Bernstein 1976, 75).

Nixon (1978, 901) realised that the revelation about the existence of the tapes "had changed everything" and that he "should have destroyed the tapes after 30 April 1973". When Nixon discussed the destruction of the tapes with Alexander Haig (1992, 376), his Chief of Staff, advised that "this is not a matter we can let float". Against this background, the floaters achieved their victory over the fixers. In retrospect, the revised Articles of IMF agreement were probably of greater significance for world history than the all-consuming articles of Presidential impeachment. Defensive statements in support of the system of fixed exchange rates became "inoperative" along-side defensive statements about Watergate.

Nixon's threat to fire Shultz was one of the most immediate threats to his Presidency. In April 1974, Nixon selectively released 1,254 pages of transcripts and informed a television audience that he was placing his "trust in the basic fairness of the American people". As part of Nixon's defence, Haig pressured the Cabinet to "go out and proclaim the President's innocence". But "one problem remained: the conversation of September 15 in which the President threatened to fire the chief of the IRS and George Shultz" (Woodward and Bernstein 1976, 153-5, 142). The previous month Nixon (1978, 993) had been ordered by the IRS to pay $400,000 in back taxes, he was accused of spending $17 million of public funds on his private property and several experts concluded that the eighteen and a half minute gap in the tape had been deliberately erased. Shultz told Haig to get a new Treasury Secretary and resigned in May 1974 (1993, 820; Shultz and Dam 1977a, 170). Thus the activities of the plumbers could have inadvertently assisted the fixers in their battle with the floaters.

4.8 Simon

However, Shultz's influence lived on in the system of sometimes-managed floats. The summit meetings between the leading industrial nations at which efforts were occasionally made to influence currency outcomes had its origins in the "Group of Five" or "Shultz's Library Group" which first met in the White House in April 1973, immediately after the abandonment of the fixed exchange rate system. Shultz also acted as the American "sherpa" at the November 1975 Rambouillet summit meeting which was part of the process that provided a legal basis for floating exchange rates (Volcker and Gyohten 1992, 126-7, 141; Shultz and Dam 1977a, 12).

Shultz had prevailed on Nixon to appoint Simon (1978, 8) as his Deputy; now Simon succeeded him as Treasury Secretary. Simon was somewhat anti-intellectual: he had been heavily influenced by Friedman through the popular dissemination of libertarian ideas rather than through academic channels. The official US position as expressed by Secretary Simon was that "We believe strongly that countries must be free to choose their own exchange rate system" (IMF 1975, 269). His two Deputies (Jack Bennett and later Edwin Yeo) were "convinced currency floaters" who were determined to resolve international negotiations in a manner that would "not prejudice the monetary system against floating rates" (Volcker and Gyohten 1992, 141). Simon and Bennett were regarded as "even stronger advocates of free markets" than their predecessors, Shultz and Volcker (de Vries 1985b, 814).

Friedman (1978, xiv) thought that Simon was a "splendid" Treasury Secretary. In return, Simon (1978, 87, 14, 224) reflected that Friedman and his fellow libertarians had "kept the torch of economic liberty burning and are passing it on to younger generations". Simon was "resolved to fight for the free enterprise system … the reason for discussing economic issues is not to inspire a national pastime for bookkeeping, but to inspire a national awareness of the connection between economic and political freedom ... That was my constant thesis as Secretary of the Treasury". Similar sentiments were expressed by the new President, who "wholeheartedly" agreed with Friedman about the need to reassert the power of the market relative to the control exerted by government (Ford 1979, 154). These were the free market sentiments that drove the 1976 Jamaica revision of the IMF Articles which legitimised floating (de Vries 1985b, 761).

The debate over exchange rate regimes had become somewhat "doctrinal". But the French wished to return to fixed rates. At the 1974 IMF annual meeting Simon insisted that "flexible exchange rates … have served us well" (cited by de Vries 1985b, 701). At the 1975 IMF annual meeting he declared that "The right to float must be clear and unencumbered". The French representative described a floating regime as "a dangerous phenomenon that disturbs the world economic order ... the very raison d'etre [of the IMF] is at stake" (IMF 1975, 268-9). d'Estaing described floating rates as "a sort of monetary LSD" (de Vries 1976a, 503). The French insisted that the US were in violation of the Fund's Articles by not adhering to a par value system. Simon's response was that the Fund's Articles be amended accordingly (de Vries 1985b, 738-9, 736).

A French-US deal broke down when the French saw in English the phrase "a stable system of exchange rates" rather than the "system of stable exchange rates" that had been agreed upon verbally. The international policemen felt like Sisyphus "eternally damned to see their efforts undone" (de Vries 1985b, 740-1). Simon then sent Yeo across the Atlantic with "dizzying frequency" to negotiate in secret with the French, whose resistance weakened as a result of a deal struck on gold. As part of this deal, Simon persuaded officials from the five largest IMF countries that there should be no attempts to peg the price of gold. Other compromises were made to appease the French. In the mid-1960s there had been a French-US monetary "cold war" (Triffin 1968, 113). In 1967 de Gaulle insisted that the US remove their military bases from France, and the US demanded $400 million in compensation. In the midst of the negotiations over exchange rates, the French offered $100 million which Ford (1979, 223) and Simon accepted without quibble. In response, the French President appeared to redefine the word "parity" to mean an exchange rate not necessarily attached to a par value. The French were now prepared to accept "limited flexibility of the system".

President d'Estaing after-dinner announcement of the "stunning" news of the French-US agreement was met with "total silence" by the Rambouillet delegates. Such was the "elation" that three of the five Finance Ministers initialled an agreement that they had not even seen. The resulting November 1975 "Declaration of Rambouillet" legitimised floating rates, and proposed frequent consultations to prevent erratic fluctuations. When in December 1975, Polak, the representative of the IMF Managing Director, was allowed to see the agreement about a revision to the IMF Articles he made himself "highly unpopular" by unfavourably comparing the French-US agreement with the draft prepared by the Fund's staff. The deputies of the Group of Ten were prepared to tolerate only minor legalistic redrafting of the Rambouillet agreement without any input from Polak (de Vries 1985b, 746-9).

The agreement was embodied as Article IV section 2(b) of the revised IMF Articles of Agreement which legitimised and legalised floating exchange rates by declaring that "members may choose the exchange arrangements they wish to apply" (de Vries 1985b, 751; 1985c, 326; Solomon 1982, 268, 271-4, 278). James Callaghan (1987, 437, 480) left the Rambouillet meeting with no doubt about the "United States' determination to adhere to floating exchange rates". He also observed that Simon's influence on US economic policy was "paramount" and appeared to exceed that of President Ford's. Simon compared the agreement over the revised Article IV to the original Bretton Woods agreement: "one of the most significant and beneficial international developments of the present decade" (cited by Emminger 1976, 21).

John Williamson (1977, 67, 70-1, 75) reflected that "One country, at least, seemed happy enough with a non-system". Shultz recalled that the agreement was deliberately designed so that the US could "defeat" any attempt to return to a regime of fixed exchange rates by requiring an 85% vote in the IMF, thus giving the US an effective veto (Shultz and Dam 1977a, 131; Scammell 1983, 208). The French were offered "vague allusions to a return to a general par value system" and so were able to represent the agreement as a step in that direction (Volcker and Gyohten 1992, 141; Solomon 1982, 273). To one observer at least, the linguistic compromises embodied in the final agreement were "worthy of a slapstick comedy" (Triffin 1976, 47). As Friedman's Chicago colleague Arnold Harberger pointed out the terminology "non-system" was coined by those whose systems had been rejected (Williamson 1987, 32). In reality, the victory of Friedman's case for flexible exchange rates was complete.

5. Conclusion

Since the death of Keynes, no economist has exerted a comparable influence to that of Friedman. Giscard d'Estaing (1969, 13) described international monetary reform as "a race that is being run on three tracks at once". Adapting this analogy, Friedman's influence can be attributed to his determination to influence three marketplaces simultaneously: the academic, the political and the popular. He influenced economists' methodology before he influenced their policy prescriptions: positive economics was the antidote to the use of "arbitrary" principles such as Occam's razor which sought to discriminate between "formal models of imaginary worlds" (Friedman 1953, 283). Friedman's razor-sharp advocacy was inserted at every point of tangency between academics, policy makers and the general public. It is a classic illustration of the process by which academic ideas become fertile.

Friedman influenced public opinion through Capitalism and Freedom (1962), Free to Choose (1980) and his Newsweek column. He influenced American presidents through his brilliant and unrelenting advocacy. President Reagan "just could not resist Friedman's infectious enthusiasm and Reagan's eyes sparkled with delight every time he engaged in a dialogue with him". Friedman was "a ball of controlled energy" with an "extraordinary personality" (Anderson 1990, 172). Nixon informed a television audience that he had "great respect" for Friedman (Friedman and Friedman 1998, 370, 375-6, 382). In turn, Friedman reflected that "My principles were Nixon's prejudices" (cited by Reichley 1981, 206).

Even when he lost the immediate argument, Friedman left an indelible impression on those he was seeking to influence. According to Evans and Novak (1971, 371), Nixon's initial resistance to wage and price controls was "reinforced by George Shultz's doctrinaire opposition". Shultz recalled that "In the end, the only people opposed to controls were Richard Nixon, Milton Friedman and myself" (cited by Reichley 1981, 222). Nixon (1980, 238-9, 245) reflected that the controls went against his "every instinct about what is good for the American economy ... The economy is not just the realm of accountants. It is also the realm of the spirit". Citing Friedman, he concluded that "Most important, there is a direct relationship between human liberties and a free economy ... The best economic advice I can give to my successors in office is to resist firmly political pressures to impose wage and price controls". To those "chafing under controls" and to policy makers "resistant to the constraints that the balance of payments seemed to place on their domestic economic goals", Friedman's "magic" solution of floating exchange rates "offered an appealing escape".

With the benefit of hindsight it is clear that neither adversarial position with respect to exchange rate regimes was fully vindicated by subsequent events. Behind the public analysis offered by the international policemen lay the fear that Friedman and his academic associates were attempting to open a Pandora's box which it would be best to leave closed. For example, Roosa in 1964 "emphatically" and privately informed the recently appointed British Chancellor that it would be impossible to maintain the post-war system if a currency realignment was even attempted. Therefore, if the idea was merely "floated the subsequent failure would be disastrous for the stability of the international monetary system" (Callaghan 1987, 171). Not surprisingly, after Pandora's box was opened, the policemen looked at the world "with an unusual mixture of hope and uneasiness" (de Vries 1985a, 85).

But contrary to Roosa's public assertion, a market for foreign exchange did emerge. Friedman, Shultz and Simon played pivotal parts in this process also. After the NEP, the Chicago Mercantile Exchange commissioned Friedman to prepare a Report on 'The Need for Futures Markets in Currencies'. Friedman's (1971, 2-4) Report proclaimed that Bretton Woods is now "dead", and the moment of death was dated to the initiation of the two tier gold market in March 1968. Friedman's Report which predicted a "great expansion in the demand for foreign cover" was sent to Shultz who "offered immediate and warm support ... and embraced Friedman's philosophical rationale". Burns and Herbert Stein were also courted: in both cases, Friedman's paper paved the way for a "receptive encounter". The International Monetary Market (IMM) was opened on May 16, 1972. But consent to institute Treasury futures did not occur until Friedman intervened with Secretary Simon who "readily agreed". In all of this Friedman "provided us with the intellectual courage to proceed undaunted" (Melamed 1988b, 421-2).

The par value system may or may not have withstood the strains associated with the oil price rises of the mid-1970s. Either way, the world had learned to live with floating and the IMF rapidly adjusted to the loss of its defining role and focused instead on policing other areas of the international economy. It also became clear that floating did not deliver the hoped for "escape". During the last 13 years of fixed exchange rates (1960-1972), the seven leading industrial countries experienced real growth rates at double the rate of the 1973-1990 period, and as growth rates were cut in half, inflation and unemployment more than doubled (Bordo and Jonung 1996, 177-188; Salvatore 1993, 614; Volcker and Gyohten 1992, 293, 304). The post-1973 period also exhibited larger and more persistent inflation differentials than under the Bretton Woods system (Alogoskoufis 1992; Aldcroft and Oliver 1998, 174). Country-by-country changes in real behaviour are not easily traced to individual post-1973 decisions to float or fix (although fixing in a generally floating world is different from fixing in a fixed world); and some evidence suggests that the exchange rate regime has little significance in explaining pre- and post-1973 economic performance (Baxter and Stockman 1989). But the volatility of exports, imports and the real exchange rate increased in the post-1973 period (Baxter and Stockman 1989).

But after the collapse of fixed exchange rates there was no return to unemployment-exporting efforts of the competitive devaluations of the 1930s. Instead, the adoption of domestic monetarism led to soaring interest rates and, in effect, to competitive appreciations (Solomon 1982, 360). It had been argued that flexible exchange rates would assist the free movement of capital which Friedman (1967) sought to "welcome and encourage" and facilitate the associated domestic adjustment: "the exchange rate will then move and this will tend to create the balance-of-trade difference required to accommodate the capital movement". But anti-inflationary monetary targeting in the UK forced the real exchange rate to rise from 106.3 in March 1978 to over 140 in 1980 (March 1973 = 100): "by far the most excessive overvaluation which any major currency has experienced in recent monetary history" (Emminger cited by Keegan 1984, 171). Between 1977 and the first half of 1982, the volume of world trade rose by 18% while UK exports of manufactured goods was unchanged. Domestically over the same period, import volumes rose by 40% and output of the UK manufacturing sector fell by 14%. Between 1979 and January 1983, UK unemployment increased from 5.5% to 13.3% (Keegan 1984, 179-80, 131).

Friedman's advocacy was informed by the weaknesses he perceived in his opponents' arguments and psychological make up. In the 1960s, he was "appalled" at the "intellectual homogeneity" and "smug self-satisfaction" of the East Coast Friedman (1968a, 181-2) also detected behind the central bankers' benevolent veneer a contempt for democracy combined with "dictatorial and totalitarian" sentiments. These "small number of public officials" who were like "modern King Canutes ... commanding the tide not to rise – and are apparently determined to continue until we are engulfed by it" (Friedman 1972b, 99; 1968a, 241). Friedman (1968a, 238) recommended that they needed to "examine their clichés". What Schweitzer (1976, 209) described as the "loyalty to the institution they are serving" may, in this instance, have been a source of intellectual weakness for the IMF rather than a source of strength.

Emminger (1977, 29) concluded that the Smithsonian realignment "collapsed like a house of cards" because, after December 1971, "the various difficulties which could threaten and break down any system of fixed parities succeeded one another in textbook fashion". Within the IMF, when the final currency crisis came it was "as if a trapdoor had opened" (de Vries 1996, 133-4). With the benefit of hindsight it is reasonable to conclude that influential agents within the White House had been determined from the outset to allow the par value system to swing in the breeze. The policy of "benign neglect" was indistinguishable from the policy of waiting for the final collapse, which, in the absence of US intervention, was the likely consequence of the next currency crisis.

The US negotiating position may have appeared to contain a commitment to a return to the par value. But throughout this period the lack of US Treasury commitment was clearly visible, as was the lack of US-German policy coordination (Emminger 1977, 31-2). Those whose system had been vanquished had misread the straws in the wind. Their faith in some modified version of the status quo had persuaded them that the alternative to their own writ was quite literally unthinkable.

In the process two sacred symbols of the post-war order, the macroeconomic pursuit of Full Employment and the regime of fixed exchange rates, were jettisoned and replaced by monetary targeting. Friedman's methodology of positive economics nominated predictive success as the criterion of reliable science. Using that methodology, Friedman (1968c) successfully predicted that microeconomic forces would increase unemployment as inflation rose. Since his policy opponents were perceived to have predicted that inflation would accompany, not undermine the macroeconomic pursuit of Full Employment this prediction increased the attractiveness of Friedman's framework of analysis and greatly enhanced the status of the natural-rate of unemployment model. With respect to the subject matter of this essay, Friedman (1965, 179) also predicted that "the Emperor is naked". In reply, Edward Bernstein (1965, 182) "predict[ed] that Mr Friedman is going to be pleasantly surprised by the survival power of the present international monetary system". Again, it was Friedman who appeared entitled to don the mantle of predictive accuracy.

Shultz reflected on the "gamesmanship" inherent in price fixing arrangements: "It is a continual process of interplay and interrelation through which those controlled develop ways of doing whatever it is they really want to do" (Shultz and Dam 1977b, 143). With respect to the international monetary system, Shultz recalled that "from the outset we envisaged the road to reform as consisting of two lanes: the one of negotiations and the other of reality" (Shultz and Dam 1977a, 127). The defenders of the par value system relished travelling along the lane of negotiation largely oblivious to the realities of the lane that was being travelled by their flexible rate opponents. When those travelling along the negotiation lane realised that their destination all along had been a "flexible market system" that was "a bitter pill for some to swallow" (Shultz and Dam 1977a, 128).

Friedman (1965, 181) concluded that the "political aspect of the monetary arrangements is the ghost that haunts the discussion. It needs to be brought out into the open". Friedman (1968a, 3) modestly described himself as "an amateur political scientist" and his interest in flexible exchange rates was "a minor avocation rather than a vocation" (correspondence to the author 24 September 1999). This essay has described the process by which this self-proclaimed amateur constructed and disseminated an argument which over the course of a quarter of a century, became the effective organising principle for the international monetary system and provided the necessary precondition for the domestic monetary revolution that followed.


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  1. I am grateful (without implication) to Bob Coats, Graeme Dorrance, Stanley Fischer, Milton Friedman, Dan Hammond, Robert Hetzel, David Laidler, Michael Parkin, Mark Perlman, James Powell, Pierre Rinfret, Don Walker, Richard Watson and John Williamson.

  2. Haberler (1961, 67) concluded that "Needless to say, this [deflation] solution to the balance-of-payments problem is totally unacceptable nowadays".

  3. Hansen’s (1948, 379) doubts "related to serious questioning that, in many if not most cases, a deficit in the balance of payments can be cured by a change in the exchange rate. I do not deny, however, that along with other measures a change in the exchange rate may, in certain specific cases, help".

  4. Indeed, the Joint Economic Committee was informed that it was "not up to academic economists to strike a balance between the pros and cons of exchange rate adjustment" (Houthakker 1962, 304).

  5. These threats may have partially succeeded. Nixon’s speechwriter was convinced that for Volcker the Bretton Woods Agreement was "sacrosanct" (Safire 1975, 518). Certainly, Volcker decided that when he needed a precise calculation of the extent of the "fundamental disequilibrium" of the dollar in 1970, it was unsafe to discuss the matter with anyone except a socially gauche economist who would remain "quiet". He was persuaded of the overriding importance of maintaining an international "framework for cooperation, both institutional and personal" (Volcker and Gyohten 1992, 72, 78).

  6. Friedman initially accepted membership of the Study Group but regretted "exceedingly" that he was unable to eventually attend (Friedman 1965, 178; Machlup, Malkeil et al. 1964, 11).

  7. The CEA report was "not a scientific discussion. It was ... a political discussion" (Friedman 1967, 135).

  8. Loose leaf attached to Friedman and Roosa (1967).

  9. Roosa also recalled that the "frustrated" Kennedy economists were "continually being reminded that the balance-of-payments position prevented all-out efforts for their own programs". The external constraint was regarded not as "warts on the economic body, quite unrelated to it’s own functioning" but as "a kind of mirror, reflecting whether or not the home economy itself was functioning in a sustainable way within the limits of its own resources".

  10. The threat of competitive depreciation was "a false issue ... a herring". In the 1930s, the floating countries "got out of the depression first". But the analogy with the Depression was misplaced: "There is no mileage to be gained from competitive depreciation by anyone in a world of reasonably full employment (Friedman 1967, 90-1).

  11. Friedman (1967, 185): "Do you deny that the market will set a price?" Roosa: "I deny that an actual market will exist". Friedman: "You deny that a market will exist in exchange?" Roosa: "I do, yes".

  12. He thought that most economists would still not favour completely floating rates.

  13. In January 1969 a "confrontation between academic economists and practitioners" resulted in Friedman and Roosa drawing up two alternative agendas for a further conference. Roosa (1970, 56, 53) acknowledged that the choice now lay between "one or more of the new approaches". In the first decade of convertibility there had been a "bias" towards fixity; the second decade required "a presumption" in favour of greater flexibility "with the objective of dissolving political stalemates" associated with the resistance to adjust rates.

  14. At the March 1970 Madrid conference fixed rate advocates were so much on the intellectual defensive that they were obliged to produce a positive 'case' as Friedman had done when in a minority in 1953 (Johnson and Swoboda 1973, 18).

  15. Halm thought that the IMF Executive Directors were offering only "a rather feeble excuse" for the preservation of the existing system.

  16. The "sorry Bush-Clinton period would never have occurred" had Reagan chosen Donald Rumsfeld, rather than George Bush as his running mate (Friedman and Friedman 1998, 391).

  17. Since 1959, Friedman had been campaigning for the "Dutch auction" method of auctioning government securities, and with Shultz as Secretary of the Treasury, Friedman was "able to persuade them to experiment with Dutch auctions" until Simon became Secretary: "Personalities do matter. If George Shultz had remained treasury secretary, I am persuaded that the method of auctioning securities would long ago have been drastically reformed" (Friedman and Friedman 1998, 376, 386).

  18. The non-dissenting members were Fellner, Haberler, Hendrik Houthakker, Herbert Prochnow, William Schmidt, Henry Wallich and Thomas Willett.

  19. Powell declared that "Like the Romans, I seem to see the river Tiber foaming with much blood ... those whom the gods wish to destroy they first make mad. We must be mad, literally mad" (cited by Wilson 1974, 663). In 1972, Powell "with the appearance of a madman" horrified Mont Pelerin members by opposing a mark of respect for the Israeli athletes who had just been massacred at the Munich Olympics (Friedman and Friedman 1998, 335).

  20. In 1980, Heath repaid the compliment by using a radio broadcast to launch "a vitriolic and libelous attack" on the Thatcher advisers including Friedman (Friedman and Friedman 1998, 390-1).

  21. He was referring to his wartime experiences in the Treasury.

  22. Neither advocate agrees with Safire’s recollection. Friedman scribbled "Nonsense" in the margin alongside this sentence in an earlier draft. Rinfret (correspondence 16 September 1999) denies that he would have exchanged unpleasantries in front of the President, but indicates that in private he would have been felt no such inhibition in combating Friedman. Either Safire has exaggerated the heat or time has cooled the memory for both Friedman and Rinfret.

  23. "How wrong can you be!!" was Friedman’s scribbled comment on this passage.

  24. Nixon’s staff pondered about the rhetorical impact of the NEP. The idea that the 90-day freeze should be extended by 10 days simply to mimic FDR’s 100 days was rejected on historical analogy grounds: the phrase "hundred days" originally measured the time between Napoleon’s escape from exile in Elba to his ultimate defeat at Waterloo. But with respect to the associations attached to "NEP". Safire (1975, 523, 525) recalled that he "had a nagging feeling it was not original, but I could not pinpoint my objection. It turned out to be Lenin’s slogan".

  25. In 1971, the Japanese persuaded Connally (who had been hit by one of the bullets aimed at President Kennedy in 1963) to accept a 16.88% revaluation of the yen rather than 17% because the Finance Minister who agreed to a 17% devaluation in 1930 had been assassinated (Volcker and Gyohten 1992, 97).

  26. In this instance, a conflict between the Executive Office of the President and the Treasury over the introduction of a value added tax.

  27. Shultz (1995, 15) was involved with the proposal which became the tax reform act of 1986. He recalled that "As secretary of state, after talking it over with Milton Friedman – a source of wise and practical counsel over many years – I suggested the idea ... to Ronald Reagan in December 1982".

  28. Shultz appeared "groggy" after watching on television the National Guard kill four students at Kent State University (Safire 1975, 191). In contrast, Nixon expressed no sympathy for to the families of the dead students (Ambrose 1989, 351).

  29. Nixon was also apprehensive about George Wallace splitting the right wing vote by running as a third party candidate. On 13 January 1972, the Wallace threat was neutralised when announced he was entering the Democrat primaries. The day before, the IRS announced that it was dropping its investigation into his brother (Ambrose 1989, 455, 542, 500).

  30. In 1964-5, Friedman while a visiting Professor at Columbia University was recruited as economic adviser to Presidential-candidate Goldwater. There were apparently very few New York intellectuals who would speak on Goldwater’s behalf and Friedman was in great demand to speak to academics, the media and the financial community. The six weeks prior to the election were a "blur of one meeting or interview or talk after another". But Friedman was "appalled" at what he found: "There was an unbelievable degree of intellectual homogeneity, of acceptance of a standard set of views complete with cliché answers to every objection, of smug self-satisfaction at belonging to an in-group ... To exaggerate only slightly, they had never talked to anyone who really believed, and had thought deeply about, views drastically different from their own" (Friedman and Friedman 1998, 370-1).

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