Originally posted Saturday, June 30, 2012


“Experience is the name we give to our past mistakes, reform that which we give to future ones.” — Henry Wallich, used as the epigram to The Rules of the Game, by Kenneth W. Dam.

As noted in the Wikipedia, “Kenneth W. Dam  served as Deputy Secretary of the Treasury (the second highest official in the United States Department of the Treasury) from 2001 to 2003, where he specialized in international economic development. He is currently a senior fellow of the Brookings Institution and a professor emeritus and senior lecturer at the University of Chicago Law School.

Dam held a number of government positions during various Republican administrations while on leave from the University of Chicago:

  • Program Assistant Director for national security and international affairs at the Office of Management and Budget (1971-1973)
  • Executive Director of the White House Council on Economic Policy (1973)
  • Deputy Secretary of State (1982-1985)

Kenneth Dam, in his 1982 classic of monetary policy The Rules of the Game: Reform and Evolution in the International Monetary System, University of Chicago Press, 1982, , writes (p.64),

The Vulnerability of the Gold Exchange Standard:  An Unlearned Lesson

Not all of the lessons that might have been drawn from the interwar experience were learned by the Bretton Woods planners.  Problems leading to its eventual demise were overlooked in the construction of the Bretton Woods system.   These problems involved the fundamental vulnerability of any gold exchange standard.

The essence of the gold exchange standard as actually practiced was that central banks might hold their international reserves in two forms–gold and foreign exchange–in whatever proportion they chose.  Indeed, central banks might change that proportion as they saw fit.  Moreover, they were not required to maintain the foreign exchange component in any one currency but might switch from one “reserve currency” to another.  The vulnerability of the gold exchange standard may thus be discussed under two headings.  The first, involving the weakness arising out of the ability of a central bank to vary the proportion of foreign exchange and gold, materialized as soon as France began to convert some of its claims on London into gold in 1927.  The second, involving the ability of a central bank to shift its foreign exchange assets held in the form of claims on one reserve center to claims on another foreign exchange center, became a steadily increasing factor as New York became a rival of London as a financial center.

Dam recognizes that “it is justifiable to think of a gold exchange standard as inherently vulnerable for these two reasons” but goes on to argue that such “it is not true that the gold exchange standard need be unstable at any particular time.”  Yet he goes on to examine and conclude that “a review of Britain’s position as a reserve currency country between 1925 and 1931 helps to reveal the dimensions of the vulnerability of a gold exchange standard.”  Whatever theoretical arguments can be made about the theoretical justifiability of a gold exchange standard, it repeatedly has led to catastrophic failure in what Lewis E. Lehrman refers to as the “laboratory of history.”