Western Europe and the collapse of Bretton Woods

Fearing the implications of the British current account deficit and deteriorating labour relations, speculators rushed to sell sterling on 15 June 1972. By the following week, intervention by central banks across the industrial democracies to support sterling had cost the Bank of England US$2.6 billion, a significant proportion of the US$8.25 billion in reserves that Britain had held at the beginning of the month. After facing a run on sterling for eight days, the British Treasury announced that it would allow the pound to float on the market to relieve the speculative pressure. Prime Minister Edward Heath pointed to the “vast masses of highly mobile funds which can be switched out of one currency into another at very short notice and in enormous volume. What was done to the [Deutsche Mark] in Spring 1971, what happened to sterling last week, can be thrown at any currency however sound, whatever its support, and dislodge it from its accepted parity.” ¹

Heath’s counterparts across the industrial democracies shared his concern about the disruptive potential of transnational capital flows, and the assault on sterling in late June 1972 represented just one of a number of currency crises in the late 1960s and early 1970s that led to the unravelling of the Bretton Woods international monetary system. This article examines the collapse of Bretton Woods, paying particular attention to the impact of financial globalization in Western Europe. Drawing on archival research in Britain, Germany, the Netherlands, and the United States, it contends that Western Europe played a crucial and overlooked role. Most studies focus on the United States, highlighting factors such as the US balance of payments deficits, Washington’s inability to control inflation, and the link between American domestic politics and President Richard M. Nixon’s dramatic decision in August 1971 to decouple the US dollar from gold. ²

The United States undoubtedly played a central role, but this article argues that Nixon was not the only “destroyer of Bretton Woods.” ³ US military and economic hegemony in the postwar international order required participation from followers to ensure that the system functioned. In the case of Bretton Woods, the United States had to coexist within a larger world of currencies and economies. Bretton Woods operated as a system, and financial globalization placed pressure on all currencies that speculators deemed under- or overvalued, not merely the US dollar. ⁴ Real economic concerns about the balance of payments, trade accounts, perceptions of social stability, and other data, underlay monetary wrangling and financial flows. When speculators believed that a country with strong export figures, for example, had an undervalued currency, they rushed to buy it in anticipation of a revaluation. When another country experienced labour unrest that could lead to higher production costs, speculators fled. Financial globalization accelerated interdependence. Because of the “close relationships that exist between the economies of various countries,” the Dutch finance ministry summarized in September 1972, “disruptions in one country affect the economies of other countries.” ⁵

This article is not a comprehensive overview of Western European policymaking at the end of Bretton Woods. It rather highlights three points at which Western Europeans made important interventions that undermined the fixed exchange rate system: the Deutsche Mark crisis in the fall of 1969, the Deutsche Mark and guilder crises in the spring of 1971, and the sterling crisis in the summer of 1972. In each of these cases, Western European policymakers decided to break from fixed parities and float their currencies in order to adapt to market conditions and insulate their domestic economies from the unwelcome effects of financial globalization. They used floating as a tactic to re-establish their currencies at a new parity more in line with market forces. The Western Europeans did not want the Bretton Woods system to fail; they appreciated the certainty that a fixed exchange rate regime offered domestic policy and international trade. The ironic consequence of the decisions to float was that they ultimately served to undermine the very system that the Western Europeans had hoped to protect. The European Community sought to accelerate monetary and economic integration as a means of sheltering themselves from financial globalization, but repeated floats weakened those attempts as well.

The unwillingness of Western Europe to continue playing ball by holding to fixed exchange rates contributed to the collapse of Bretton Woods, forcing the Atlantic community to admit defeat on a primary feature of its postwar monetary system, and compelling policymakers on both sides to grapple with how to build a stable monetary system, a similar challenge that faced them during the Second World War. In his essay on the historiography of international political economy in the 1970s, historian Daniel J. Sargent notes that “a truly international history of the end of Bretton Woods, drawing on multiple national archives and sensitive to the roles of non-state actors still awaits.” ⁶ With the declassification of sources across the United States and Western Europe, such a study is now possible. This article seeks to take a step toward an international history of Bretton Woods’ collapse.

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As the Second World War continued to rage in Europe and the Pacific, representatives from 44 countries came together in Bretton Woods, New Hampshire during the summer of 1944 to design a postwar monetary system. The lessons of the 1930s weighed heavily on their minds. During the Great Depression, the world had dissolved into rival trade blocs, constraining the flow of commerce and capital. Delegates stressed the need to avoid a repeat of these harmful autarkic policies and competitive currency devaluations. They sought to encourage international trade while providing governments with the flexibility to circumscribe the national economy from the larger global context. In the context of the emerging welfare state, it was considered politically unacceptable to re-establish the gold exchange standard that had existed since the end of the nineteenth century, in which the national gold stock determined the domestic money supply and price levels; such a system could not work in an age when governments promised full employment and spent large sums on social programs. The delegations developed a compromise that would allow these international and domestic priorities to coexist. ⁷ At the centre of the system lay the creation of the International Monetary Fund (IMF). The IMF oversaw a system of fixed exchange rates, based on the US dollar, that could fluctuate slightly in either direction. The IMF reserved the right to object to any change larger than 10%. Rather than force countries to deflate and implement austerity measures to correct deficits, the IMF would lend money to governments to finance their debts. This freed governments to engage in deficit spending and provide social services to their people. All currencies were fixed to the US dollar, and the dollar was convertible into gold at the rate of US$35 per ounce, an arrangement that expanded the global supply of reserve assets. ⁸

By the late 1960s, this arrangement became unsustainable. Washington failed to control inflation that stemmed from spending on the Vietnam War and Great Society, and US trade deficits led to a rapid decline of confidence in the US dollar. In the postwar period, US annual current account surpluses nearly balanced US military spending and investment overseas, but this equilibrium began to unravel by the mid 1960s. The chronic deficits in the US balance of payments led to what was called the “dollar overhang.” The dollar overhang referred to the fact that the number of US dollars circulating overseas exceeded the value of gold reserves in Fort Knox. Bretton Woods could only work if countries believed that the “dollar was as good as gold,” and the dollar overhang undermined confidence in the convertibility of the dollar into gold at US$35 per ounce.

US deficits in the balance of payments were just one side of the equation. The other component was the growing economic strength of Western Europe and Japan. Between 1950 and 1973, the French, German, and Italian economies grew twice as quickly as the American on a per-person basis, and Japan’s economy grew almost four times as fast. As the imbalance in economic power between the United States and its allies decreased, the US dollar lost perceived value in the eyes of investors. ⁹ Rather than hold US dollars, speculators began to prefer currencies such as the West German Deutsche Mark or Japanese yen, which were backed by robust export industries, stable governments, and surpluses in the balance of payments.

The rise of the offshore Euromarkets based in London created additional problems. The Euromarkets were created in the 1950s to hold Soviet and Chinese dollar-denominated funds, but soon became the area of choice for multinational companies to “park” their assets. ¹⁰ The John F. Kennedy administration introduced capital controls to defend the US dollar, hoping to discourage the issuance of foreign bonds in the United States. Multinational businesses tended to place their profits into the Euromarkets because they could receive better interest rates than in the United States, and they could also avoid the Kennedy administration’s capital controls. After the explosion of the Euromarkets in the mid 1960s, the US government lost control of a significant percentage of its money supply—the dollars held in the Euromarkets rose as a percentage of the US monetary supply from 9.65% in 1967 to 34.47% in 1972. ¹¹ The problem, the British believed, was there were “too many dollars sloshing round the foreign exchange markets as a result of the substantial US deficit.” ¹² The Euromarkets also provided a place to trade other currencies besides the US dollar outside of the countries of origin, and they permitted speculators to trade currencies in huge quantities quickly. The rise of global financial markets allowed the international economy to integrate, but also posed a threat because such large capital flows could lead to inflation or deplete reserve assets. In 1969, the IMF acknowledged that transnational capital flows made fixed exchange rates vulnerable because of “the greatly increased possibility of sudden pressures on exchange rates, notably when underlying economic developments give reason to suppose that an adjustment may occur.” ¹³ Governments tended to shy away from making quick use of the IMF adjustment process, and speculators saw opportunities to make profits and prevent losses.

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The first major currency crisis that led to a float came in September 1969. It marked the culmination of pressure that had been building for almost 18 months, centring above all on the West German Deutsche Mark and its relationship to the French franc. Speculators anticipated a devaluation of the French franc, believing that increases in wages after French student and worker unrest in the summer and fall of 1968 would weaken exports. They poured money into West Germany, which had strong trade surpluses. At a hastily arranged Group of Ten conference in Bonn in November 1968, the West Germans refused to consider revaluing the Deutsche Mark, despite pressure from the Americans and British. The nominal host of the Bonn summit, Economics Minister Karl Schiller declared at the beginning of the meetings that West Germany would not consider a revaluation, and Finance Minister Franz Josef Strauss added, “Whether there was a majority at this conference of 7 to 3 or 9 to 1 did not impress him. Other countries would not determine what was Germany’s business.” ¹⁴ French president Charles de Gaulle, too, announced that Paris would not touch the franc, choosing instead to go through a period of austerity to improve the balance of payments. The question of who should bear the burden of stabilizing the financial markets, the weaker French or the stronger West Germans, was left unresolved.

De Gaulle’s resignation of the presidency in late April 1969 caused another wave of speculation. While De Gaulle had refused to devalue the French franc as a matter of national prestige, foreign holders of French francs worried that the new government would have a different attitude. Between 28 April and 9 May 1969, about US$4.1 billion flooded into West Germany, including almost US$3 billion between 7 May and 9 May alone. For a country “with an ambitious goal of stability such as the Federal Republic,” an official in the West German Ministry of Economics wrote, capital movements portended instability. ¹⁵ Speculators believed that the revaluation of the Deutsche Mark would happen in “just a matter of time.” ¹⁶

Revaluation became a divisive party issue in West German domestic politics that publicly pitted Schiller against Strauss. On one hand, Schiller of the Social Democratic Party (SPD) had second thoughts about his position at Bonn the previous November, and began to argue in favour of a revaluation of the Deutsche Mark by 6.25%. With the support of the Bundesbank, Schiller stressed the importance of combating inflation, pointing in particular to the increase in the prices of agricultural products and housing. “The continuation of inflation abroad will further exacerbate the situation,” he wrote. “The current parity of the Deutsche Mark must be increased without hesitation. Additional delays weaken the purchasing power of the DM.” ¹⁷

On the other hand, Strauss’ Christian Social Union—whose base of support was Bavarian farmers—opposed revaluation because of its troubling implications for agricultural exports. If the Deutsche Mark increased in value, it would be harder for West German exports to compete on the world market because those goods would be more expensive. Strauss shared Schiller’s fear of inflation; indeed, the experience of hyperinflation still cast a shadow on West German politics. As a young child in the 1920s, Strauss remembered when his father, a butcher, would use the morning’s cash receipts that same afternoon to purchase supplies before prices rose even further. He told British Chancellor of the Exchequer Roy Jenkins that in West German politics, “avoidance of inflation( … )was( … )the first and foremost of the ‘sacred cows’.” ¹⁸ Strauss, however, did not believe in exported inflation. He adopted a firm public persona and cast the concept as a “professorial construct that would never impact the bank accounts of hard-working German savers.” ¹⁹ Chancellor Kurt Georg Kiesinger supported Strauss, seeking to honour repeated public commitments during the previous year that the Deutsche Mark would not be revalued as long as he was in power. Strauss and Kiesinger also had the public on their side; a public opinion survey revealed that 87% of West Germans opposed revaluation because it would hurt exports. ²⁰

After an intense cabinet debate on 9 May 1969, Kiesinger announced that West Germany would not change the value of the Deutsche Mark. Spokesman Conrad Ahlers described Kiesinger’s decision to the media as “final, unequivocal and for eternity.” When reporters pressed Ahlers as to whether West Germany would reconsider in the event that its allies offered to participate in a general realignment of currency parities, Ahlers responded that no external factors would change this decision. ²¹

These public declarations, however, did little to calm the markets, and the pressure on the Deutsche Mark increased as the September federal elections approached. The French had yielded to speculative pressure in August 1969 and devalued the franc by 11%. Speculators anticipated a Social Democrat victory that would empower Schiller, who wanted to revalue the Deutsche Mark, to control West German policy. They rushed to sell US dollars and French francs to profit from the expected SPD victory. In order to stop the hot money, Kiesinger ordered that the West German foreign exchange markets close. ²² The memory of the runaway inflation in 1923 weighed heavily on the minds of West German policymakers, and any inflationary policy was tantamount to political suicide. Bundesbank director Otmar Emminger had told American officials several months earlier that any change in the Deutsche Mark parity would “stem not from the surplus of the balance of payments but from the need to maintain price stability within Germany. It was this factor( … )that was changing the attitude of Germans toward parity.” ²³

The election results of 28 September 1969 were inconclusive, but the SPD made significant gains, and its leader Willy Brandt announced his willingness to form a coalition government with the Free Democratic Party (FDP). The following day, when DM 1 billion [about US$250 million] flooded into West Germany, the caretaker government under Kiesinger directed the Bundesbank to cease intervening in the markets to support the Deutsche Mark. ²⁴ Unwilling to make a definitive decision about revaluation during negotiations between the SPD and FDP, Kiesinger accepted Emminger’s recommendation that the Deutsche Mark should float on the free market. This served as a compromise between the positions of Strauss and Schiller; it left open the possibility that the Deutsche Mark would return to its original exchange rate after floating, while also providing an opportunity for the currency to settle at a higher value. In particular, this suited Schiller, who had come to support the “crawling peg” strategy, in which the government retained some autonomy to gradually change the par value of its currency. ²⁵ Schiller later told US Secretary of the Treasury David M. Kennedy that “Strauss had not realized that once the Deutsche Mark began to float, it would be impossible to return to the old parity. Strauss still feels that he was tricked on this point.” ²⁶ The Deutsche Mark ultimately appreciated by 9.3% (going from DM 4 to 3.66 per US dollar) when the new Brandt government fixed the Deutsche Mark on 27 October 1969. The Agricultural Committee of the Bundestag agreed in April 1970 to provide DM 920 million (about US$250 million) to West German farmers as a means of offsetting their losses from the revaluation. ²⁷

The currency crisis of September 1969 represented the growing power of financial globalization to influence domestic decisions. This had far-reaching consequences for transatlantic relations and European integration. Worried about the instability of the US dollar, the West Germans and French led a renewed push toward economic integration as a means of sheltering themselves from the harmful effects of transnational capital flows. ²⁸ They harboured growing doubts about the reliability of future US economic and political cooperation, and turned inward to find stability. At French president Georges Pompidou’s request, the heads of state in the European Community met in early December 1969 in The Hague to discuss a future direction. Building on Brandt’s initiative at the conference, the European Community decided to chart a path toward a monetary and economic union. Political factors also played a role in this new drive for integration, but the currency crisis of September 1969 created the conditions that allowed cooperation, breaking a stalemate that had hindered progress on integration in the 1960s. The European Council of Ministers came to an agreement to narrow exchange rate margins among the Western European currencies. “Economic imbalances have immediate effects on the overall development of the Community,” the West German Foreign Office observed in January 1970. “Above all, inflationary trends are transmitted more easily and quickly than ever before( … ). These risks can only be averted if decisive progress is made in the harmonization and coordination of economic policies.” ²⁹ Monetary unification was not “an end itself,” the Dutch Ministry of Finance noted in March 1970. The monetary union would facilitate the “disappearance of foreign exchange risks and other obstacles arising from the coexistence of different national monetary policies,” which would give greater certainty about trade within the common market. ³⁰ Debates raged within the Community about what form this cooperation would take, but Western European policymakers agreed about the desirability of closer regional cooperation as confidence in the United States and the dollar diminished.

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Although the Western Europeans sought to create a regional monetary arrangement that would protect against disruptive capital flows, the pressure of financial globalization undermined those plans. Suffering from similar speculative pressure because of its trade surplus, Canada announced in 1970 that henceforth the Canadian dollar would float on the open market, marking the first permanent float of a member country in this period. ³¹ After 18 months without a major currency crisis in Western Europe, speculators wreaked havoc on the exchange market in the spring of 1971. Once more, the Deutsche Mark was the focus of speculative attention—it attracted DM 35.3 billion (US$9.6 billion) from January 1970 to May 1971, mostly from the United States. ³² The cost of living in West Germany rose 4.8% between March 1970 and March 1971, and the Bonn government believed that domestic policies alone could not stop the flow of capital into the country, which accelerated after news spread that the US trade account had fallen into deficit for the first time since 1893. ³³ The West German current account had no fundamental disequilibrium, but the Deutsche Mark had become the “antipole” of the US dollar, Emminger later wrote. ³⁴ At a meeting of the Community finance ministers on 26 April 1971 in Hamburg, Schiller sought to garner support for the revaluation of the Western European currencies collectively or a common Community float in an attempt to forge a multilateral solution to the flow of money into his country. His call did not find support among his Community colleagues, but expectant speculators flowed money into West Germany. Unlike the 1969 crisis, the West German Foreign Office believed that there “was no fundamental imbalance in the balance of payments. The Deutsche Mark at the moment is not undervalued( … ). The sudden capital inflow of about DM 7.5 billion [about US$2 billion] results only from speculative short-term capital movements.” ³⁵ The British observed that “it must now be obvious to speculators and profit seekers generally that the D-mark is a sitting duck.” ³⁶

On 5 May 1971, the West German government announced the closure of the exchange markets after taking in about US$1 billion that day alone. ³⁷ Three days later, Schiller met with his Community colleagues once again in Brussels, pleading with them for 21 hours to develop a multilateral solution. He cast the crisis as an opportunity to use market mechanisms to accelerate economic and monetary integration within the European Community, but with the exception of the Dutch (who also faced heavy speculation), Schiller found no support. The French in particular countered Schiller. French capital controls insulated the franc, and Paris worried that floating would undermine the rough equilibrium in its balance of payments. ³⁸ The French also believed that the root of the problem was “the size of the US deficit and the consequent mass of US dollars which shifted around the world looking for the most profitable home.” ³⁹ Rather than the Europeans bearing the burden of adjustment, the French thought that Washington needed to devalue the US dollar. The volume of US dollars in circulation played a big role in the crisis, but so too did the strength of the West German economy, which led speculators to conclude that the Deutsche Mark was undervalued.

The West German attempt to forge a Community solution failed, and Bonn decided to take unilateral action. Despite opposition from Bundesbank president Karl Klasen, the Brandt government allowed the Deutsche Mark to float when the market reopened on 10 May 1971 (Brandt had distributed instructions several days prior, stipulating that even if Schiller did not facilitate joint European action, the Deutsch Mark would float regardless). With the float, the West Germans sought to achieve two objectives. First, Bonn sought to stop the influx of capital into the country and avoid future speculative inflows. Second, floating would provide stability for the domestic economy by ending the upward pressure on prices. ⁴⁰ The West Germans recognized that this step would irritate their Western European allies and hurt chances for integration, but they also believed that “prices are currently the central problem of the economy” and floating the Deutsche Mark would provide stability—one of the watchwords of the Bonn government—to the domestic economy. ⁴¹

Some scholars have criticized Schiller for making public statements that encouraged speculation, but Bonn’s ultimate decision to float was prudent. ⁴² West Germany received backlash from its fellow members of the Community for stalling progress on European monetary integration, particularly from Paris. But Bonn valued halting inflation more than European integration, and the decision to float did indeed stop the inflow of capital, and provided relief from the upward pressure on prices. The US dollar crisis that would ultimately compel Nixon to decouple the dollar from gold in August 1971 validated the West German move in May 1971. When Nixon announced his decision, money poured into Japan, Switzerland, and the United Kingdom, rather than West Germany. Furthermore, Schiller’s original proposal that the Community float their currencies as a unit against the US dollar would not have had an impact on European trade. In its report to the Bundestag on 13 May 1971, the Brandt government argued that it was committed to moving forward with the economic and monetary union within the Community as well as maintaining stability in the Federal Republic. Schiller’s proposal would have met both objectives, but ultimately they “could not be realized because of French resistance.” ⁴³

Because of the strong Dutch economy, the guilder was also a target for speculative attention. When the Dutch exchange market closed on 5 May 1971, the president of De Nederlandsche Bank Jelle Zijlstra reported that US$250 million had rushed into the country in just the hour before it closed. As the Dutch considered how to respond, the conversation focused on what Bonn would do. Zijlstra said, “The problem that we now face is what to do next. For this, it is necessary to know what West Germany is doing. … The Netherlands faces the same choice as West Germany.” ⁴⁴ On 6 May 1971, the Dutch ambassador J.G. de Beus reported from Bonn that the West Germans would not risk a revaluation; the proper amount would be difficult for Bonn to calculate. A float or the introduction of capital controls seemed more likely. ⁴⁵

When The Hague learned that Bonn would float the Deutsche Mark, it was almost a foregone conclusion that the guilder would do so as well. The Dutch needed to stem the flow of hot money into the country, and they also wanted to ensure that the West German float did not disrupt their close trade relationship. At a cabinet meeting on 9 May 1971, Finance Minister Johan Witteveen said that he expected the value of the Deutsche Mark to rise by about 5%. The guilder did not need to march in lockstep with the Deutsche Mark, but it did need to track it enough so that the Deutsche Mark did not become too powerful. ⁴⁶

The ramifications of the West German float and revaluation in the fall of 1969 weighed on their minds. The Dutch government under Piet de Jong had decided then not to break the guilder from its fixed exchange rate. The Dutch had expected to profit from the West German revaluation because they believed it would increase demand for Dutch exports and would encourage domestic industrial production. West Germany was the “most important competitor for most industrial sectors” in the Netherlands, a Ministry of Economic Affairs study observed in October 1969, and the “position of Dutch industry would be strengthened in the event of a revaluation of the DM.” ⁴⁷ At a meeting of European Community finance ministers, Witteveen added that although the Dutch had a trade surplus, it was nowhere near as large as that of West Germany. Revaluing the guilder to match the Deutsche Mark would have had “a rather large adverse effect.” ⁴⁸

The effects of standing pat in the fall of 1969, however, were less advantageous than the Dutch had predicted. After the West Germans revalued the Deutsche Mark, so much Dutch wheat was exported to West Germany that the Dutch had to buy wheat elsewhere. Minister of Economic Affairs Roelof Nelissen acknowledged that the Netherlands would be “forced to follow” the West German decision, “because otherwise the suction on our exports would be too great.” “The worst thing that can happen,” he continued, “is that our economic position would deteriorate because of the temporary extra suction-power [zuigkracht] from West Germany.” The Council of Ministers concluded that in the agricultural sector, the Dutch could tolerate a variation of no more than 2.5%. This zuigkracht would be smaller when the guilder floated, Witteveen thought, and “probably [could] neutralize the deterioration of our export position somewhat.” ⁴⁹ At a press conference on 9 May 1971, Witteveen announced that the guilder would float when the markets reopened the following day. The Austrians and Swiss also were forced to revalue their currencies.

The unilateral floating of the Deutsche Mark and guilder marked setbacks on two fronts. First, they undermined the fixed exchange regime of Bretton Woods. Rather than weathering the storm and showing resolve in the face of heavy speculation, as the French had advised, the West Germans and Dutch had succumbed to speculative pressure and broken from their exchange rates, encouraging speculators that betting on future parity changes could be profitable. This represented the first prolonged period of freely fluctuating exchange rates for a major currency (the Deutsche Mark was not fixed again to the US dollar until December 1971). The currency crisis confirmed to speculators that the fixed exchange rate system was not sacrosanct, contributing to a run on the dollar in the summer of 1971 that triggered the so-called “Nixon shock,” when Nixon finally decoupled the dollar from gold. Second, the floats disrupted the Community’s efforts to harmonize economic and monetary policies, delaying progress on integration.

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The currency crises in West Germany and the Netherlands illustrated the extent to which strong countries could attract money away from the United States. Currencies that were perceived as weak, however, also faced threats. The crises in 1969 and 1971 and their governments’ reactions to them reinforced speculators’ expectations that adherence to fixed exchange rates was not sacred, and governments would make changes when they came against speculative pressure. This occurred to sterling in June 1972, when speculators anticipated that the British economy would trend downward.

The sterling crisis should be seen in the larger context of the European “Snake in the Smithsonian tunnel.” The Smithsonian Agreement, which had been concluded in December 1971 as a bandage to repair the damage brought about by the Nixon shock in August, established the new parity of US$38 per ounce, and allowed all other currencies to move 2.25% in either direction from its parity. In an effort to narrow the margins between their currencies, the Community agreed in March 1972 to go beyond the 4.5% width that the Smithsonian Agreement allowed, and limited the maximum deviation to 1.125% in either direction. The main argument in support of this project—which became known as the “Snake in the Smithsonian tunnel” after it went into force in April 1972—was that greater monetary coordination within the Community would protect it from capital fleeing the United States. ⁵⁰

Scheduled to join the Community in January 1973, the British watched the creation of the Snake with skepticism. Upon entry into the Community, Britain agreed to adopt whatever monetary decisions had already been concluded. Whitehall doubted, however, whether joining the Snake benefited Britain. In particular, the Treasury came out against the Snake, believing that adhering to the Smithsonian margins served British interests better. The Treasury argued that the Snake encouraged speculation because the rigidity of the 2.25% band on the Snake was less defensible and would require more frequent adjustments. Furthermore, the strength of the Deutsche Mark could push the Snake upward against the US dollar, meaning that sterling would have to revalue to keep pace. The opposite was also a threat: if the weakness of the pound dragged the Snake downward, the exchange rate of the Deutsche Mark would be lower than it should be, and West Germany would doubtless be the target of speculation once again. These were disadvantages, however, “which had to be accepted on political grounds” in order to gain entry into the European common market. ⁵¹

The Community put the Snake into operation in late April 1972, and Britain joined the following week. Ireland, Denmark, and Norway soon followed. Within about six weeks, just as the Treasury had feared, sterling came under attack. Although the British enjoyed a surplus in the balance of payments, speculators worried about the rising volume of imports and decreasing volume of exports. In addition, labour relations soured over the new Industrial Relations Act, and observers worried about how the British economy would perform against European competition when it formally joined the Community in January 1973. Wage and price inflation also scared holders of sterling.

On 15 June 1972, news of an impending dock strike precipitated an assault on sterling. The Bank of England bought West German Deutsche Mark, French and Belgian francs, and Norwegian krone. Central bankers elsewhere purchased sterling in exchange for those currencies, costing the Bank of England US$500 million on the first day. The “shadow” chancellor Denis Healey made a statement to the House of Commons on 19 June 1972 to the effect that sterling would have to be devalued before the end of the summer, which only raised expectations of a devaluation. ⁵² A staffer in the Treasury believed that markets reacted to the likelihood that the British would have a “persistent weakening in the balance of payments,” which would create the “need for intervention on a mounting, and( … )unacceptable scale.” ⁵³

On 22 June 1972, the Bank of England spent more than US$1 billion to defend sterling against speculators, including US$20 million within the first 10 minutes of business. Prime Minister Edward Heath’s advisers noted that the increase in the bank rate from 5–6% the day before had only temporarily slowed the outflow, and “it was clear that the Government had no option but to abandon the present fixed parity.” ⁵⁴ British officials predicted losses of US$1.5 billion the following day, and expected the run on sterling to continue well into the next week. The Treasury believed that a change had to be made, and “it would be better to make it soon while some cushion of reserves remained.” ⁵⁵ Heath convened his cabinet twice on the evening of 22 June 1972 to discuss the course of action. The cabinet had to decide between fixing a new rate and floating the pound. Believing that the economy was fundamentally in a good position with a current account in surplus, they found no justification for a devaluation. The Chancellor of the Exchequer Anthony Barber believed that “floating was the right way to deal with a situation caused wholly by irrational speculation following recent industrial disputes, damaging Press comments and the recent remarks by Mr. Denis Healey.” Floating would also “cause the least trouble for other countries” and would “be less liable to lead to action elsewhere which would increase the pressure” on Britain. The report of the meetings documented the “complete agreement that the decision to float rather than adopt a new fixed rate was the right one.” ⁵⁶ Importantly, adherence to the existing exchange rate was not even an option.

On the BBC news on the morning of 23 June 1972, the Treasury announced that sterling would float, and that as a result, Britain would withdraw from the Snake. The exchange markets would close until 27 June 1972 to allow for a transition to the new arrangements. Heath complained to governor of the Bank of England Leslie O’Brien that the fears that precipitated the run on sterling were “grossly exaggerated.” Inflation ran at 5.5%, and British exports were competitive in Europe. “Nonetheless,” the prime minister sighed, “there had been a constant hammering of the Government’s and the country’s performance in these matters, and a sort of neurosis had developed in the City of London.” ⁵⁷

In contrast to the tortured West German decision in September 1969, the run on sterling did not trigger an intense debate in the British cabinet. Nor did the British decision to float and withdraw from the Snake lead to widespread criticism abroad. On the contrary, the international community sympathized with London’s dilemma. The New York Times reported that “scarcely a voice has been raised at any finance ministry or central bank to denounce Prime Minister Heath for not having defended the pound.” The world had “grown more sophisticated about self-defeated exchange-rate rigidity,” though it still had not yet embraced flexibility. ⁵⁸ O’Brien’s predecessor and then British ambassador to the United States Rowley Cromer wrote from Washington:

The sheer scale of the monetary movement, once again activated by fear of loss, shows how inadequate are the present mechanisms to manage the volume of monetary liquidity deemed necessary to sustain contemporary economic activity. If there is a further serious break in confidence in the system a real holocaust could ensue. … Having had my fill of experience in coping with monetary crises, I have never before sensed a more dangerous state of affairs than now exists. ⁵⁹

The sterling float represented the failure of the Snake as a means of protecting the Western European currencies, only a couple months after the arrangement came into being. The Smithsonian bandage had failed to heal Bretton Woods, and another attempt at Western European unity had been undone by financial globalization.

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The various Western European decisions to float their currencies had far-reaching implications for the collapse of Bretton Woods. In addition to encouraging speculators, they also empowered free market proponents in Washington to advocate the move toward floating exchange rates. The sterling crisis of June 1972 roughly coincided with Nixon’s appointment of economist George P. Shultz to replace John Connally as secretary of the treasury. The first economist with a PhD to serve in the position, Shultz was “very much a ‘free market’ man, with a leaning toward floating exchange rates.” ⁶⁰ The sterling crisis provided further evidence to Shultz that Bretton Woods, as it then existed, was untenable. The British “now have a float,” he told Nixon in early 1973, “which they regard as much more successful, because a float basically insulates you against this kind of speculative rate. The rate just moves rather than … there being an accumulation of dollars going in here, or going out of there.” ⁶¹

The sterling crisis accentuated the need for rapid reform. The day before the British float, Under Secretary of the Treasury for Monetary Affairs Paul A. Volcker had testified before the House Banking and Currency Committee that Bretton Woods needed to adapt to new world conditions, and suggested a two-year timetable to complete this. Pointing to the British surplus in the balance of payments, Volcker did not believe that the Heath government would touch sterling. The decision in Whitehall to float, however, disrupted Volcker’s timetable. “Those SOBs hung me out to dry,” he later said. “I was embarrassed.” ⁶² During the summer of 1972, Volcker worked on an ambitious framework for an overhaul of Bretton Woods, known as “Plan X.” When Shultz unveiled Plan X in September 1972, he presented “an evolutionary roadmap to a radical destination.” The proposal wanted to regularize adjustment by countries with surpluses, and increase exchange rate flexibility. Rather than use capital controls, Shultz sought to use frequent changes in exchange rates to facilitate international trade and capital flows. As Sargent argues, Shultz sought to limit the power of national governments to control their exchange rates, and to empower global financial markets, a scheme that broke sharply from the principles of Bretton Woods. ⁶³ When the death knell for Bretton Woods arrived in early 1973, Shultz attempted to use the currency crises of February and March as opportunities to move toward floating exchange rates. He told the president:

the way in which the system has unfolded since August ’71, in effect, we have been moving toward more flexibility in the exchange rate system, and … there has been a great increase in the … flexibility of the system, and now we have the Japanese floating, the British floating, the Italians floating, the Swiss floating, the Canadians floating, so that I suppose it must be true that one reason for the pressure against those who aren’t floating is that that’s sort of the only pressure point there is, and they become more isolated. ⁶⁴

Responding to a record US trade deficit in 1972, money rushed into West Germany, the Netherlands, France, and Denmark in February and March 1973. The members of the Community responded by floating their currencies as a unit against the US dollar, ending a central feature of Bretton Woods: the fixed relationship of the US dollar to other currencies.

After the collapse of Bretton Woods, the Western Europeans viewed US monetary policy with skepticism for the rest of the decade. They believed that the instability of the US dollar had forced them into difficult decisions about balancing national economic objectives with the desire to adhere to their Bretton Woods commitments. When US oil imports created large trade deficits and the value of the dollar plummeted in 1977 and 1978, many in Western Europe experienced a sense of déjà vu. The weakness of the dollar, Washington’s apparent unwillingness to tackle the US trade deficit, and Western European strength re-created the constellation of forces that had caused the collapse of Bretton Woods. As a means of sheltering themselves from the collapse of the dollar, the Western Europeans committed at the Bremen Summit of July 1978 to establishing a European Monetary System (EMS). The logic of the project was that “the burden of pursuing a policy of holding the EMS down against the dollar would be shared among different countries.” ⁶⁵ Members generally agreed about the necessity to “turn away from the dollar and from US financial policy.” ⁶⁶ The establishment of the EMS closed the door on the possibility of a transatlantic compromise for a durable replacement to Bretton Woods—the Western Europeans instead developed their own regional solution that contributed to the emergence of an increasingly independent European bloc. ⁶⁷ West German Chancellor Helmut Schmidt wrote in his memoirs that “monetary policy is foreign policy.” With the collapse of Bretton Woods, “the United States surrendered the leadership of monetary policy, and thus in practice some of its de facto leadership of the West.” ⁶⁸