NEWS ANALYSIS : Best-Laid Money Plans May Go Astray, History Shows : Currencies: Politics and realities tend to overthrow management programs of people and nations.

Almost 50 years ago at a resort hotel in a New England village far removed from the smoke and fire of World War II, specialists from around the globe gathered on an unprecedented mission: to link all the world’s currencies in a single monetary system that would serve a lasting, U.S.-led era of peace and prosperity.

Yet by the early 1970s, the Bretton Woods agreement--named for the New Hampshire village where officials sweated for three weeks in July, 1944--had collapsed. The world had changed, unleashing new political and economic pressures that could no longer be contained by the system’s rigid framework.

Once the old financial setup no longer reflected reality, not all the gold in Ft. Knox could save it: “Essentially,” said Keith D. Savard, a senior economist at the Institute of International Finance in Washington, in a situation like that, “you’re leaning against a hurricane.”

For almost half a century, since World War II left the economies of Europe and Asia a shambles, Western leaders have been groping for a way to manage the world’s money, trying to create a viable system for deciding such things as how many French francs or Japanese yen will be equal to a dollar.

From Bretton Woods of the Franklin Roosevelt era to the Plaza Accord of Ronald Reagan’s presidency, a succession of schemes has been tried. Each has been hailed. Yet each has eventually collapsed, amid crisis and near-panic.

The current financial chaos in Western Europe, in which individual countries have scrambled wildly to try to protect the value of their currencies against the more powerful German mark, is only the latest example.

And while political leaders argue about who’s to blame, the underlying problem is as simple to state as it is difficult to solve: A workable monetary system must accurately reflect the real economic conditions of the countries involved and produce results that are politically acceptable to all concerned.

“If the fundamentals in each economy and the basic performance of each economy do not conflict, there is no reason for the turbulence to appear,” said Manuel Guitian, a senior official with the International Monetary Fund in Washington.

Unfortunately, experience suggests that may be impossible to manage--especially over long periods of time.

Abstract and esoteric as they may seem, monetary systems have an all-too-real impact on the everyday lives of people everywhere. They may saddle some nations with high interest rates and joblessness, for instance, while neighboring states prosper. Speculators may dump or hoard currencies, sending painful shock waves through some countries but not others.

Adding to the difficulty, economic conditions change over time, and power may shift among the participating countries. What was acceptable, even beneficial, at one point may become intolerable under different circumstances. When that happens, some of the nations may rebel.

Also, such arrangements challenge the very heart of national sovereignty. They require an extraordinary willingness by participants to coordinate interest rates, spending and other economic policies.

“They’re trying to tie themselves together like California and New York are tied together,” said Robert Solomon, a Brookings Institution expert on international finance, commenting on Western Europe’s present effort to create an economic union. But in contrast to California and New York, he noted, independent countries may have vastly different economic policies--the very economic policies that must be coordinated for such efforts to succeed.

“It has been because of the difficulty of keeping to constraints that history shows these attempts fail,” said the IMF’s Guitian.

At the same time, in a global economy the need for a smooth method of exchanging national currencies is fundamental; by one study, the daily market in currencies exceeds $600 billion.

Business executives in Long Beach may need Japanese yen for a purchase in Osaka. Banks with far-flung branches have a voracious appetite for different currencies.

If there is not a reasonably stable and predictable basis for exchange, the resulting chaos can disrupt economic activity everywhere.

The history of the 20th Century is littered with examples of currency exchange rates becoming divorced from reality. Often it happens because national leaders, for political reasons, refuse to recognize that the balance of power has changed--before their eyes.

After World War I, for example, Britain attempted to link the pound to the gold standard at the same values that had existed before 1914. But with its treasury depleted by four years of war, London could sustain the pound at those levels only through punishing domestic economic policies, which led to postwar recession.

In the mid-1940s, as the world economy lay in tatters, officials gathered in the hotel in Bretton Woods to set the framework for a smoother, more prosperous era after the war.

In a symbol of American supremacy, all currencies were effectively pegged to the U.S. dollar, by far the preeminent currency of the era. The financial experts of the day recognized that conditions could change and that the levels might have to be re-pegged. They even came up with a term for it--a “fundamental disequalibrium.”

But adjustments, particularly for the British pound, proved painful. As Britain’s diminished role in the postwar world became obvious, investors tried to get rid of their pound holdings, forcing Britain to keep interest rates painfully high in order to attract foreign cash. This led to unemployment and further distress for the once-great power until adjustments were made.

“It was hardly a smooth operation,” noted Solomon, author of “The International Monetary System, 1945--1981.” “It was a crisis.”

By the 1960s, new historical forces were eating away at Bretton Woods--and the dollar. America was waging a war in Vietnam and spending on domestic programs as never before. President Lyndon B. Johnson preferred not to raise taxes to pay for all of it, however, even as new inflation was eroding the dollar.

The U.S.-dominated system of fixed exchange rates finally broke down in 1971, under the weight of Richard Nixon’s attempts to deal with surging prices. On the day in August of that year when Nixon imposed wage and price controls, he also took the dollar off the gold standard, allowing it to float.

Hoping to ensure his reelection in 1972, Nixon pressured Federal Reserve Board Chairman Arthur Burns to rapidly liberalize U.S. monetary policy, fueling domestic growth but taking the dollar further out of balance with other major currencies. By early 1973, Bretton Woods was dead.

As some see it, the collapse of the Bretton Woods system is largely traceable to the failure of the United States to continue to provide international leadership--and especially its domestic failure to confront its worsening problems with inflation and slowed economic growth.

“Bretton Woods worked only as long as U.S. policies were responsible,” argues William Niskanen, a conservative economist at the Cato Institute in Washington.

But floating rates, which were highly touted by economists at the time, proved no panacea either. By the mid-1980s officials of the United States and other leading industrial nations were increasingly worried about the dollar, which had rocketed in value during Ronald Reagan’s first term in office.

As Japanese imports flooded into the United States and American workers lost their jobs, manufacturers increasingly grumbled about the fact that the U.S. dollar was overvalued against the Japanese yen. In fact, the strong dollar was terrible news for the U.S. trade deficit, a growing political embarrassment to the White House.

But as the problem worsened, Reagan refused to act. The dollar’s strength, as he put it, was just a sign of the free market at work.

What the Reagan Administration did not recognize, however, was that the currency market was sending a signal to Washington: the United States had to reckon with the vast new power of Japan. Finally, in 1985, the dollar’s effect on the U.S. trade deficit grew unbearable.

In crisis-atmosphere meetings culminating in an agreement at the Plaza Hotel in New York, Treasury Secretary James A. Baker III orchestrated a broad realignment in the relationship between the dollar and the yen. “The Plaza strategy was the political manifestation of the Reagan Administration’s decision to succumb to reality,” wrote Yoichi Funabashi, a Japanese economist who wrote a history of the crisis.

By 1987 the dollar began to plummet once more against the yen. In fact, the plunge was so sharp that a second agreement, the so-called Louvre Accord, was needed to stabilize exchange rates once more.

Meanwhile, Western Europe was enjoying an unusual period of prosperity. Germany, historically skittish about inflation, had been imposing economic discipline on the rest of Europe ever since 1977, when the current monetary system was created as a regional replacement for Bretton Woods.

By tying themselves to the German mark, other European nations saw monetary union as a way to force discipline on themselves, and the effect was dramatic: Consumer prices, which had been rising by as much as 20% a year in some European nations, fell dramatically.

Exchange rates, while regularly realigned, remained remarkably stable, helping to provide a basis for Europe’s broad economic boom in the 1980s.

The system worked well as long as the German economy functioned smoothly. Yet under the surface, pressures have been building ever since the Berlin Wall crumbled.

Germany, suddenly confronted with the $100 billion annual cost of modernizing a decrepit East Germany, could no longer keep its well-oiled economic machine in perfect running order. It either had to raise taxes or raise interest rates to finance the huge new budget deficits stemming from reunification. Because of widespread domestic political opposition to the kind of massive tax increase that would have been required, Germany decided to raise interest rates instead.

But that decision had a cascading effect throughout Europe as higher German interest rates led to a Continent-wide economic slowdown. Meanwhile, the German policies began to place unbearable stresses on Europe’s fixed-exchange rate system, because the high German interest rates strengthened the value of the mark against all other currencies.

But despite mounting political pressures, both from the Bush Administration and European capitals, Germany’s independent central bank refused for months to cut its high rates. The gap in economic performance between Germany and such weaker nations as Britain and Italy was becoming too great to sustain the rigid exchange rate system.

Finally, the exchange rate system began to crack. This week it appeared to break.

“You’ve had imbalances building up since German unification, but the Europeans tried to keep exchange rates fixed in the face of changing realities,” said Fred Bergsten, an economist at the Institute for International Economics in Washington.

When the German central bank stubbornly refused to offer more than a token cut in its interest rates earlier this week, the crisis was on, raising a new question: If Europe cannot jointly manage its money, can it handle a broader economic union?

“In the simplest terms, this crisis shows Europe splitting into two camps--a fast-track Europe and a slow-track Europe,” said David Roche, global strategist for Morgan Stanley based in London. “This volatility shows a clear lack of consensus over European unification.”