[MUSIC] In our last module, we learned that the world relied on a fixed exchange rate system based on a gold standard for many decades, leading up to the start of World War I. In fact, that gold standard worked reasonably well at stabilizing the currency markets for more than 50 years. And maintaining the balance in trade across many nations right up until the start of World War I in 1914. However, with the advent of World War I, many nations had to temporarily abandon the gold standard to finance their war efforts. And the way these nations did so was often by printing new money, a surefire way to create inflation. The problem was not inflation per se, however, but rather with the fact that they were differing rates of inflation observed in different countries. Of course, that would not have been a problem in a floating exchange rate system, as we learned in our discussion of why exchange rates move. Each country's exchange rate would simply have adjusted to the inflation differences. However, in this case, when peace returned at the end of World War I, and nations then returned to the gold standard. The old exchange rates between countries no longer reflected the true value of the different currencies. For example, the French franc was significantly undervalued because it had experienced relatively higher levels inflation during the war. In contrast, Britain had sustained relatively lower inflation rates than many of its trading partners, so its currency was overvalued. The result under the reestablished fixed exchange rate gold standard after World War I was the rapid emergence of large trading balances between countries, and a system where some countries boomed while others went bust. For example, the French economy enjoyed the export-led boom because of it's undervalued currency, and France began to accumulate large surpluses of foreign currencies. In contrast, Britain found it very difficult to sell its exports, and found itself overwhelmed by cheap imports. In fact, by 1930, Britain was so drained of its gold reserves that it had to abandon the gold standard altogether. At that point, the US dollar came under similar attack, and France, in particular, began to unload large amounts of its surplus dollars for US gold. While the presidential administration of Herbert Hoover first stemmed this gold flow by raising domestic interest rates. This active contractionary monetary policy also helped push, indeed some would say it helped shove, the US economy further into what was emerging as the Great Depression. Eventually in 1933, President Roosevelt followed the British in abandoning the gold standard, and that's where the international financial system and global economy really got chaotic indeed. With the collapse of the gold standard in the 1930s, countries, desperate to create jobs in a depressionary global economy, engaged in so-called competitive devaluations. In particular, these struggling countries began to manipulate and devalue their currencies in order to boost exports and reduce imports, as a means of boosting both job creation and GDP growth. And in the parlance of economics, these competitive devaluations are referred to as, Beggar Thy Neighbor policies, because the clear intent was for one country to benefit at the expense of another. The problem, of course, was that with each new competitive devaluation, and each new tariff a country adopted. Other countries retaliated and it turned into a race to the bottom of the Great Depression. These economic pressures, in turn, led to political pressures that gave rise to warmongering, fascist leaders like Adolf Hitler in Germany, Benito Mussolini in Italy, and Ferdinand Franco in Spain. And here, it may be accurately said, that one of the most important causes of World War II was the collapse of the international monetary system. Here, it may also be accurately said, that this collapse also gave rise to the next stage in the evolution of the international monetary system with the emergence of the US dollar standard. Indeed, it was the harsh lessons of the 1930s that brought the allied powers to America's Bretton Woods, New Hampshire in 1944. As representatives from 44 countries met for 22 days to design an international monetary system, that was brand new, based on a US dollar standard. So let's look at the rise, and unfortunate fall, of that dollar standard in our next module. [MUSIC]
