This paper studies the mechanisms of international payments adjustment at work under the Bretton Woods system of fixed exchange rates between 1945 and 1971. I argue that two market failures - imperfect international capital mobility and imperfect wage-price flexibility - are central to understanding the adjustment problems of that period. Imperfect capital mobility implied that even intertemporally solvent governments could face international liquidity constraints. Wage-price inflexibility implied that countries suffering from simultaneous reserve loss and unemployment might need to undergo lengthy transitions before returning to balance. By the 1960s, when trade had been substantially liberalized and partial convertibility restored, the main remaining adjustment weapon was currency realignment: devaluation could eliminate an unemployment-cum-deficit dilemma in a stroke, while revaluation could relieve the inflationary pressures in surplus countries. The currency realignment option proved incompatible, however, with the growing efficiency of the international capital market. Under the classical gold standard, high capital mobility had supported the credibility of fixed exchange rates. Under Bretton Woods, fixed gold parities did not have primacy among other economic objectives; and increasing capital mobility undermined the regime as governments proved unwilling to stand by key systemic commitments.
