Bretton Woods
When war broke out, Keynes once again was asked to return to the Treasury to work on the annual national budget. He began to turn his mind to post-war arrangements. In 1941 Keynes prepared the first of many drafts of a plan for the post-war international financial system.
The “Keynes plan” for an international clearing union became the official British position at the Bretton Woods Conference in 1944. All international payments were to be settled through a Clearing Union in an artificial book-entry currency, which Keynes called bancor. Exchange rates between national currencies and bancor would be fixed but from time to time adjusted to correct payments imbalances. According to the plan, surplus as well as deficit countries were required to take steps to eliminate their foreign imbalances at a feasible pace. The Clearing Union could create loans in bancor to ease adjustment, but penalties were payable on cumulative bancor positions, either debit or credit, above a certain amount. These adjustment mechanisms were an application of liquidity preference theory to international money: their purpose was to prevent the deflationary influence on economic activity of the desire to accumulate foreign reserves. From a world perspective this was sound, but the USA was in a strong creditor position at the end of the war and did not accept enforced adjustment. The Clearing Union was replaced with the USA’s proposed International Monetary Fund, which had more limited credit-creating powers and did not impose adjustment requirements on creditor countries. A separate institution, the World Bank, was founded to deal first with reconstruction and then with lending for development.Keynes was more successful when it came to restrictions on international financial transactions. His arguments were that credit and finance for domestic activities should be left to national institutions, regulated by each country’s central bank. Therefore, member countries were left free to restrict purely financial cross-border transactions. In sum, Keynes was concerned that participating countries should benefit as much as possible from foreign trade, without putting the ability to pursue national full employment monetary and fiscal policies at risk.