The Rise and Fall of the Bretton Woods Fixed Exchange Rate System

The group also planned to balance the world financial system using special drawing rights alone. Dissatisfaction with the political implications of the dollar system was increased by détente between the U.S. and the Soviet Union. The Soviet military threat had been an important force in cementing the U.S.-led monetary system. The U.S. political and security umbrella helped make American economic domination palatable for Europe and Japan, which had been economically exhausted by the war. When common security tensions lessened, this loosened the transatlantic dependence on defence concerns, and allowed latent economic tensions to surface. Members were required to pay back debts within a period of 18 months to five years.

U.S. monetary influence

1. The unpopularity and internal difficulty of such fiscal and monetary prudence led the United States to resort to other options.
2. The August shock was followed by efforts under U.S. leadership to reform the international monetary system.
3. Churchill did not believe that he could surrender that protection after the war, so he watered down the Atlantic Charter’s “free access” clause before agreeing to it.
4. This effect was not welcomed by the nonreserve countries like Britain, France, and Germany.
5. This system required a currency peg to the U.S. dollar which was in turn pegged to the price of gold.
6. The Bretton Woods system effectively came to an end in the early 1970s when President Richard M. Nixon announced that the U.S. would no longer exchange gold for U.S. currency.

Each commission had a number of committees, and some committees had subcommittees. Every country at the conference was entitled to send delegates to all meetings of the commissions and the “standing committees”, but other committees and subcommittees had restricted membership, to allow them to work more efficiently. Except when registering final approval or disapproval of proposals, the work of the conference generally proceeded by negotiation and informal consensus rather than by formal voting. In 1945, Roosevelt and Churchill prepared the postwar era by negotiating with Joseph Stalin at Yalta about respective zones of influence; this same year Germany was divided into four occupation zones (Soviet, American, British, and French).

This culminated with the 1964 tax cut program, designed to maintain the $35 peg. The Bretton Woods arrangements were largely adhered to and ratified by the participating governments. It was expected that national monetary reserves, supplemented with necessary IMF credits, would finance any temporary balance of payments disequilibria. Never before had international monetary cooperation been attempted on a permanent institutional basis.

1. It quickly became apparent that fixed-dollar exchange rates and narrow fluctuation bands were unsuitable for war-torn Europe.
2. Rather than full convertibility, the system provided a fixed price for sales between central banks.
3. Like Woodrow Wilson before him, whose “Fourteen Points” had outlined U.S. aims in the aftermath of the First World War, Roosevelt set forth a range of ambitious goals for the postwar world even before the U.S. had entered the Second World War.
4. Instead, they set up a system of fixed exchange rates managed by a series of newly created international institutions using the U.S. dollar (which was a gold standard currency for central banks) as a reserve currency.
5. In other words, the higher the country’s contribution was, the higher the sum of money it could borrow from the IMF.
6. The other “devaluation” option open to the United States was devaluation with respect to gold.

Bretton Woods Conference

However, as mentioned above, contractionary monetary policies will likely result in higher taxes, lower government spending, a contraction of the economy, and a loss of jobs. For the nonreserve countries, their task was to avoid balance of payments deficits. These deficits would arise if they pursued excessive expansionary monetary policy.

In an increasingly interdependent world, U.S. policy significantly influenced economic conditions in Europe and Japan. In addition, as long as other countries were willing to hold dollars, the U.S. could carry out massive foreign expenditures for political purposes—military activities and foreign aid—without the threat of balance-of-payments constraints. These new forms of monetary interdependence made large capital flows possible. During the Bretton Woods era, countries were reluctant to alter exchange rates formally even in cases of structural disequilibria. Because such changes had a direct impact on certain domestic economic groups, they came to be seen as political risks for leaders. As a result, official exchange rates often became unrealistic in market terms, providing a virtually risk-free temptation for speculators.

In 1971 more and more dollars were being printed in Washington, then being pumped overseas, to pay for government expenditure on the military and social programs. Unusually, this decision was made without consulting members of the international monetary system or even his own State Department and was soon dubbed the “Nixon Shock”. After the end of World War II, the U.S. held $26 billion in gold reserves, of an estimated total of $40 billion (approx 65%).

Formally introduced in December 1945, both institutions have withstood the test of time, globally serving as important pillars for international capital financing and trade activities. The dollar standard was resented by the French in the 1960s and referred to as conferring “the exorbitant privilege” on the US, and the same argument was made in 2010 by the Governor of the Central Bank of China. However, the likelihood that the dollar will be replaced as the dominant international currency in the foreseeable future remains remote.

2008 financial crisis

The IMF sought to provide for occasional discontinuous exchange-rate adjustments (changing a member’s par value) by international agreement. This tended to restore equilibrium in their trade by expanding their exports and contracting imports. A decrease in the value of a country’s money was called a devaluation, while an increase in the value of the country’s money was called a revaluation.

But countries with trade surpluses would also be charged interest at 10% if their surplus was more than half the size of their permitted overdraft, obliging them to increase their currency values and export more capital. If at the year’s end, their credit exceeded the maximum (half the size of the overdraft in surplus), the surplus would be confiscated. Enough consensus existed that the conference was also able to achieve an agreement on the IBRD. Doing so required extending the conference from its original closing date of July 19, 1944 to July 22. Because the United States was the world’s largest economy at the time, and the main prospective source of funds for the IMF and IBRD, the U.S. delegation had the largest influence on the proposals agreed to at Bretton Woods.

Bretton Woods Agreement and the Institutions It Created Explained

In theory, a gold-exchange standard can work to provide exchange rate stability and reduce inflationary tendencies. However, it will only work if the reserve currency country maintains prudent monetary policies and if countries follow the rules of the system. A second effect of the continual balance of payments surpluses was a rising stock of dollar reserves. Treasury bills; thus, increasingly, U.S. government debt was held by foreign countries. John Maynard Keynes first proposed the ICU in 1941, as a way to regulate the balance of trade. His concern was that countries with a trade deficit would be unable to climb out of it, paying ever more interest to service their ever-greater debt, and therefore stifling global growth.

Growth of international currency markets

The collapse of the Bretton Woods system between 1971 and 1973 led to the general adoption by advanced countries of a managed floating exchange rate system, which is still with us. As was argued by Despres et al. (1966) in contradistinction to Triffin, the ongoing US balance of payments deficit was not really a problem. The rest of the world voluntarily held dollar balances because of their valuable service flow – the deficit was demand-determined. This of course was not the case, but although the par value system ended in 1973 the dollar standard without gold is still with us, as McKinnon (1969, 1988, 2014) has long argued.

Meanwhile, to bolster confidence in the dollar, the U.S. agreed separately to link the dollar to gold at the rate of $35 per ounce. At this rate, foreign governments and central banks could exchange dollars for gold. Bretton Woods established a system of payments based on the dollar, which defined all currencies in relation to the dollar, itself convertible into gold, and above all, “as good as gold” for trade. U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. However, if the system had worked properly, foreign central banks would have cashed in their dollar assets for gold reserves long before the dollar overhang problem arose. With diminishing gold reserves, the United States would have what is meant by the bretton woods agreement class 10 been forced (i.e., if it followed the rules of the system) to reverse its expansionary monetary practices.

Between 1962 and 1965, new supplies from South Africa and the Soviet Union were enough to offset the rising demand for gold, any optimism soon deteriorated once demand began outpacing supply from 1966 through 1968. Following France’s decision to leave the Pool in 1967, the Pool collapsed the following year when the market price of gold in London shot up, pulling away from the official price. Further, there was no definitive timeline for implementing the new rules, so it would be close to 15 years before the Bretton Woods system was actually in full operation.