VoxEU Column Economic history International Finance

TARGET balances, Bretton Woods, and the Great Depression

Since 2007, there has been a buildup of TARGET imbalances within the Eurosystem – growing liabilities of national central banks in the periphery matched by growing claims of central banks in the core. This column argues that, rather than signalling the collapse of the monetary system – as was the case for Bretton Woods between 1968 and 1971 – these TARGET imbalances represent a successful institutional innovation that prevented a repeat of the US payments crisis of 1933.

During the Eurozone crisis, an analogy was made between the events in Europe between 2007 and 2012 and the collapse of the Bretton Woods System between 1968 and 1971. There has been a build-up of TARGET liabilities since 2007 by some central banks (notably Greece, Ireland, Portugal, and Spain, or the ‘GIPS’), and of TARGET assets by Germany and others. This is compared to the historical accumulation of big US current-account deficits under Bretton Woods’s gold-dollar standard that were matched by the large surpluses of Germany and others (see Sinn and Wollmershaeuser 2011 and Kohler 2012).

The events of 1968–1971 did not end well. Back then, the US did not have to adjust its payments deficit – other countries accepted US dollars as international reserves. In the face of rising US inflation after 1965, growing payments imbalances, and inflationary pressure on the surplus European countries, the whole Bretton Woods system collapsed between 1971 and 1973.

Another Bretton Woods analogy relevant to today’s Eurozone problems is that of the UK, which ran persistent current-account deficits and faced deflationary pressure that eventually led it to devalue in 1967. Germany, by contrast, ran persistent surpluses and faced ongoing inflationary pressure. On two occasions, it was forced to revalue.

Which analogy is more apt? And are there other analogies which may be even more relevant?

Analogy 1: The Eurozone crisis and the collapse of Bretton Woods

In the Economic and Monetary Union (EMU), the ECB and the Eurosystem of national central banks operates a real-time gross payments settlement account called TARGET (Trans-European Automated Real-Time Settlement Express Transfer). TARGET has many similarities to the US Federal Reserve System’s Interdistrict Settlement Accounts, which operate in the US monetary union. In both systems, in normal times, net claims between different countries’ central banks (Fed districts) tend to cancel out. However during major crises like 2007–2012, when shocks hit unevenly across the monetary union, settlement imbalances between countries (districts) tend to build up as the central banks finance the demands for liquidity.

Beginning in 2007, with the reversal of capital inflows and the global seizing-up of interbank markets, TARGET liabilities in the peripheral countries of Europe (Greece, Ireland, Portugal, and Spain) grew. (See Figure 1.) At the same time, TARGET claims of Germany (and the Netherlands) increased. This process was worsened by the Greek sovereign debt crisis in 2010 and similar (less dramatic) events in Portugal, Ireland, Spain, and Italy. Sinn and Wollmershaeuser (2011) also show that TARGET balances are highly correlated with current-account imbalances between the GIIPS countries (with deficits) and Germany (with surpluses). (See Figure 2.)

These authors express concern that the growing TARGET imbalances pose a risk to Germany in the event of a sovereign default and exit from the Eurozone. They are also concerned that the provision of TARGET liquidity would prevent the peripheral deficit countries from making the necessary structural adjustments to reduce their imbalances.

Figure 1. Net claims of the national central banks resulting from transactions within the Eurosystem

Source: Sinn and Wollmershaeuser (2011).

Figure 2. Annual current-account balances

Source: Sinn and Wollmershaeuser (2011).

Under the Bretton Woods System, members would declare a par value in terms of US dollars (peg their currencies). The US would peg its currency to gold at the fixed price of $35 per ounce. The rest of the world would use dollars (and until 1968 pounds) as international reserves. The US maintained extensive gold reserves as backing for the dollar. The Bretton Woods system also incorporated an adjustable peg whereby members could change their parities in the event of a ‘fundamental disequilibrium’ (a.k.a. persistent structural imbalance). The Bretton Woods system also prescribed capital controls.

The Bretton Woods system became fully operative in December 1958, when many European countries declared current-account convertibility. As time elapsed, it evolved into a gold-dollar fixed exchange-rate system embodying an asymmetric adjustment mechanism, under which the US did not need to adjust to a balance of payments deficit by contracting aggregate demand. The deficit would be financed by dollar outflows to be absorbed as international reserves by surplus countries.

The balance of payments deficit was perceived as a problem by the US monetary authorities because of the effect on confidence. As official dollar liabilities held abroad increased with successive deficits, the likelihood would increase that dollars would be converted into gold and the US monetary gold stock would reach a point low enough to trigger a run. By 1959, the US monetary gold stock equaled total external dollar liabilities, and the monetary gold stock in the rest of the world exceeded the US monetary gold stock. By 1964, official dollar liabilities held by foreign monetary authorities exceeded the US monetary gold stock. (See Figure 3.)

Figure 3. Monetary gold and dollar holdings, the US and the rest of the world, 1945–1971

Source: Bordo (1993).

For the Europeans, the US balance of payments deficit was a problem because, as the reserve centre country, the US did not have to adjust its domestic economy to the balance of payments. As a matter of routine, the Fed automatically sterilised its dollar outflows. The Europeans resented the asymmetric adjustment. The Germans viewed the US as exporting inflation to the surplus countries through its deficits. They wanted the US to pursue contractionary monetary and fiscal policies. The French (Charles DeGaulle) resented US financial dominance and the seigniorage earned on outstanding liabilities. In 1965, acting on this perception, France began systematically converting its outstanding dollar liabilities into gold (Bordo et al. 1996).

The Bretton Woods system collapsed after 1968 in the face of rising US inflation driven by expansionary monetary and fiscal policies (financing the war in Vietnam and the Great Society). US inflation was transmitted abroad by the classical price–specie flow mechanism augmented by capital flows (Bordo 1993: 77). As dollar reserves accumulated in Germany, other continental countries, and Japan, they were sterilised to prevent the domestic money supply rising, which would lead to inflation. As the process continued, it became increasingly difficult to sterilise the reserve inflows, leading to a dramatic increase in money and inflation. The only alternative to importing US inflation for Germany and the other surplus countries was to float, which they did in 1971. The collapse of the system began in August 1971 when France and the UK signalled their intention to convert their dollar assets into gold, leading President Nixon to close the gold window on 15 August.

Analogy 2: Persistent imbalances within the Bretton Woods system

In addition to the imbalance between the US and the rest of the world emphasised by Sinn and Wollmershaeuser (2011) and Kohler (2012), another Bretton Woods imbalance has important relevance to the ongoing problems of the Eurozone. It was between major European countries prone to persistent deficits (e.g. the UK) and countries prone to surpluses (e.g. Germany). This reflected significant fundamental structural and policy differences between countries. The UK had a lower underlying productivity and real growth rate, and tended to follow expansionary monetary and fiscal policies to maintain full employment. Its exchange rate was persistently overvalued. Germany had faster productivity and real growth and a ‘stability culture’ which deplored excessive monetary growth and inflation. The Deutschmark was persistently undervalued.

The UK, 1959–1967

Between 1959 and 1967, the UK alternated between expansionary monetary and fiscal policy designed to maintain full employment and encourage growth, and austerity programs when a balance of payments crisis threatened – a policy referred to as stop-go. The stop-go pattern continued until a massive deterioration in the balance of payments in the summer of 1967 led to a $3 billion rescue package. It was insufficient to stop the pressure on sterling until a devaluation of 14.3% was announced in November 1967. That action was the beginning of the end of sterling’s role as a reserve currency.

Germany, 1959–1968

West Germany ran persistent balance of payment surpluses. It had opposite problems to the UK – rapid growth in real output and exports, and a lower underlying rate of inflation. This led to a series of current-account surpluses and reserve inflows throughout the 1950s. Concern over the inflationary consequences of balance of payments surpluses led the German monetary authorities to tighten monetary policy and institute measures to prevent capital inflows – a prohibition of interest payments on foreign deposits, and discriminatory reserve requirements on foreign deposits (Bordo 1993: 54).

Tight monetary policy led to recession and further reserve inflows in 1960. In 1961 the Deutschmark was revalued by 5%. With the exception of two years –1962 and 1965 – the current account was in surplus until the end of 1965. The package of tight money and capital controls was repeated in 1964, 1966, and 1968. Opposition to further revaluation – largely from exporters – increased throughout the 1960s. Thus Germany resisted adjustment during Bretton Woods.

Some lessons

The historical comparison between the UK and Germany is an important analogy for the Eurozone’s ongoing problems.

Like the UK in the 1960s, the periphery Eurozone countries have had lower productivity and real growth, higher inflation, and low overall competitiveness compared to the core countries of Western Europe. This has led to a buildup of imbalances in the Eurozone – current-account deficits in the periphery and surpluses in the core. This is a classic case of maladjustment. But, unlike under Bretton Woods, the Eurozone countries with imbalances cannot adjust their exchange rates, and nominal and structural rigidities have impeded real adjustment. Nor can a one-size-fits-all monetary policy be very effective in a monetary union with such large real imbalances and rigidities. Hence, in the absence of a fiscal union, the periphery has needed to adjust by internal devaluation. The global financial crisis of 2007–2008 exacerbated the dilemma. Ongoing recession and expansionary fiscal policy (and a housing bust in Ireland and Spain) created a debt crisis and a banking crisis in the periphery.

Which Bretton Woods analogy is more relevant?

The Bretton Woods system was an adjustable-peg international monetary system with member countries having independent monetary and fiscal policies. It also had restrictions on capital flows. By contrast, the Eurozone is a monetary union with perfectly fixed exchange rates with no option for adjustment. Members do not have access to monetary policy as a palliative, and capital is freely mobile.

Under Bretton Woods, the adjustable peg allowed some adjustment between deficit and surplus countries; and independent monetary and fiscal policies, the IMF, and capital controls gave members with imbalances some temporary respite. For the US as reserve centre country, devaluation would require raising the price of gold (as advocated by France). This was strongly resisted by the US on the grounds that it would be time-inconsistent and would benefit the pariah states – the USSR and South Africa. As it turned out, ending the system was the only way out.

The Eurozone is not a pegged exchange-rate system, nor is one member’s currency used as a reserve currency. The Maastricht Treaty abolished members’ currencies and created a new currency, the euro, and a new common central bank, the ECB. The escape valve of the Bretton Woods adjustable peg is not present. Moreover, unlike national monetary unions like the US, the Eurozone does not have a fiscal union or a Eurobond to facilitate adjustment.

But a more important difference between the Bretton Woods breakdown analogy and the crisis in the Eurozone is the existence of a payments clearing mechanism – the TARGET system and the Eurosystem of national central banks and the ECB. In the Eurosystem, a key mandate is a uniform currency across the Eurozone – that a euro always be worth the same in every member country (Cour-Thimann 2012). Thus under TARGET, country imbalances are financed by access to the liquidity facilities of the Eurosystem of national central banks using the ECB as a clearing platform.

What happened in the Eurozone after 2007 is that the TARGET liabilities in the periphery (and the TARGET claims in the core) built up because the ECB acted to prevent the breakdown of the payments system after the interbank market collapsed and private capital flows disappeared (Cour-Thimann 2012). Indeed, before 2008, most flows between countries in the Eurozone were intermediated by banks. After that the interbank market dried up, and national regulators started treating banks as legally separate entities even when they were part of a euro-wide banking group. So what was previously a euro-wide banking system became fragmented. TARGET substituted for the euro banking system. The Federal Reserve performed the same function in the 2007–2008 crisis in the US, but unlike Europe the big banks still transferred money across the country.

Bretton Woods did not have an international central bank to act as a clearing mechanism as Keynes wanted with his International Clearing Union. If it did, perhaps the outcome would have been different. Clearly the ‘Bretton Woods breakdown’ analogy (1) is less relevant than the ‘persistent imbalances between countries’ analogy (2).

An alternative to the Bretton Woods analogy – the payments crisis in the US in the Great Depression

An alternative and perhaps more appealing analogy to the TARGET imbalances in the Eurozone than Bretton Woods is the breakdown of the payments mechanism in the US during the Great Depression. The Federal Reserve System established in 1914 had a clearing mechanism between the member Reserve banks called the Gold Settlement Fund. The Fund recorded the flow of funds among Federal Reserve districts. There was also considerable inter-district borrowing (James 2013). During the Great Contraction of 1929–1933 there were massive gold flows between regions (see Figure 4). This reflected a substantial drain of gold from the interior Southern and Western regions hardest hit by the successive banking panics which closed thousands of small unit banks, to the safety of the Eastern money centres – especially New York (Rockoff 2004).

Figure 4. The flow of gold to Eastern financial centres on private accounts, 1926–1933

Source: Rockoff (2004).

Unlike in the recent financial crisis in Europe and the US, the Fed did much less to accommodate the demands for liquidity. By the fall of 1932, the breakdown of the payments system was so widespread that many of the US states declared banking holidays to prevent depositors from making withdrawals from their bank accounts. Banking holidays spread from state to state as the authorities in neighbouring states tried to prevent depositors who could not get cash in one state turned to banks in neighbouring states. The contagion culminated with Franklin Delano Roosevelt – right after he was inaugurated as President in March 1933 – declaring a nationwide banking holiday which effectively ended the panic (Friedman and Schwartz 1963). Thus, the buildup of TARGET imbalances in the Eurozone since 2007, rather than being a signal for the collapse of EMU – as was the case for Bretton Woods between 1968 and 1971 – was a successful institutional innovation that prevented a repeat of 1933. The TARGET experience reflects learning the correct lessons from the past.


Bordo, Michael D (1993), “The Bretton Woods International Monetary System: A Historical Overview”, in Michael D Bordo and Barry Eichengreen, eds., A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, Chicago: University of Chicago Press for the NBER.

Bordo, Michael D, Dominique Simard, and Eugene White (1996), “France and the Bretton Woods International Monetary System; 1960–1968”, NBER Working Paper 4642.

Cour-Thimann, Philippine (2013), “Target Balances and the Crisis in the Euro Area”, CESifo Forum, 14.

Friedman, Milton and Anna Schwartz (1963), A Monetary History of the US 1867 to 1960, Princeton: Princeton University Press.

James, Harold (2012), “US Precedents for Europe”, paper presented at the “Current Policy Under the Lens of Economic History” conference, Federal Reserve Bank of Cleveland, December.

Kohler, Wilhelm (2012), “The Eurosystem in Times of Crises: Greece in the Role of a Reserve Currency”, CESifo Forum.

Rockoff, Hugh (2004), “Deflation, Silent Runs, and Bank Holidays in the Great Contraction”, in Pierre C K Burdekin and Pierre Siklos (eds.), Deflation: Current and Historical Perspectives, New York: Cambridge University Press.

Sinn, Hans-Werner and Timo Wollmershaeuser (2011), “Target Loans, Current Account Balances and Capital Flows”, NBER Working Paper 17626.

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