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

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In the long run it was expected that such European and Japanese recovery would benefit the United States by widening markets for U.S. exports and providing locations for U.S. capital expansion. The U.S.-backed IMF plan sought to end restrictions on the transfer of goods and services from one country to another, eliminate currency blocs, and lift currency exchange controls. As a result of the establishment of agreed upon structures and rules of international economic interaction, conflict over economic issues was minimized, and the significance of the economic aspect of international relations seemed to recede.

The hope was to create a system to facilitate international trade while protecting the autonomous policy goals of individual nations. It was meant to be a superior alternative to the interwar monetary order that arguably led to both the Great Depression and World War II. Because of its success in founding two international organizations that have had long and influential lives, the Bretton Woods Conference is sometimes cited as an example worthy of imitation.by whom? In particular, since the collapse in the early 1970s of the system of pegged exchange rates agreed to at Bretton Woods there have been a number of Calls for a “New Bretton Woods”.

Rather than issue a new currency, it would be funded with a finite pool of national currencies and gold of $5 million that would effectively limit the supply of reserve credit. By 1968, the attempt to defend the dollar at a fixed peg of $35/ounce, the policy of the Eisenhower, Kennedy and Johnson administrations, had become increasingly untenable. Gold outflows from the U.S. accelerated, and despite gaining assurances from Germany and other nations to hold gold, the unbalanced spending of the Johnson administration had transformed the dollar shortage of the 1940s and 1950s into a dollar glut by the 1960s. In 1967, the IMF agreed in Rio de Janeiro to replace the tranche division set up in 1946.

As world trade increased rapidly through the 1950s, the size of the gold base increased by only a few percentage points. The first U.S. response to the crisis was in the late 1950s when the Eisenhower administration placed import quotas on oil and other restrictions on trade outflows. However, with a mounting recession that began in 1958, this response alone was not sustainable.

Dollar shortages and the Marshall Plan

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The seminal idea behind the Bretton Woods Conference was the notion of open markets. Treasury Secretary Henry Morgenthau, stated that the establishment of the IMF and the IBRD marked the end of economic nationalism. This meant countries would maintain their national interest, but trade blocs and economic spheres of influence would no longer be their means. The second idea behind the Bretton Woods Conference was joint management of the Western political-economic order, meaning that the foremost industrial democratic nations must lower barriers to trade and the movement of capital, in addition to their responsibility to govern the system.

Design of the financial system

Led by the British economist John Maynard Keynes and Harry Dexter White from the U.S. Treasury, they hammered out an agreement they hoped would form the basis of a new financial world order. The “Bretton Woods” system of internationally fixed exchange rates was born out of the conference, as was the International Monetary Fund (IMF) and the World Bank. The Bretton Woods system was an international exchange rate system established in 1944. It dictated that major international currencies would be “pegged” – or fixed – to the U.S. dollar, while the U.S. dollar would be convertible to gold at a fixed rate of $35 per ounce.

Thus, the U.S. dollar was strongly appreciated in the rest of the world and therefore became the key currency of the Bretton Woods system. Before the war, the French and the British realized that they could no longer compete with U.S. industries in an open marketplace. During the 1930s, the British created their own economic bloc to shut out U.S. goods. Churchill did not what is meant by the bretton woods agreement class 10 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.

International Trade Organization

The new economic system required an accepted vehicle for investment, trade, and payments. Unlike national economies, however, the international economy lacks a central government that can issue currency and manage its use. In the past this problem had been solved through the gold standard, but the architects of Bretton Woods did not consider this option feasible for the postwar political economy. 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.

  1. The Versailles treaty imposed reparations on the country for the damages it caused in World War I, and hyperinflation greatly affected the German economy.
  2. Subsequently, both institutions have continued to maintain their founding goals while also transitioning to serve global government interests in the modern-day.
  3. This led to what was called the Bretton Woods system for international commercial and financial relations.
  4. In response, the U.S. resorted to capital controls, creating an international dollar shortage.
  5. 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.

Bretton Woods Agreement and the Institutions It Created Explained

In 1947, Washington, concerned that European countries might resort to protectionism, devised the Marshall plan to provide aid to the devastated European economies. The dollar’s value in gold was fixed at 1/35th of an ounce, or $35 per ounce of gold. The major currencies were to be fully convertible to dollars at a fixed exchange rate, though with fluctuation permitted within a 1% band. Countries participating in the scheme would settle their international obligations in dollars, but the U.S. would settle its own international obligations in gold. They sought to create a system that would not only avoid the rigidity of previous international monetary systems, but would also address the lack of cooperation among the countries on those systems. The classic gold standard had been abandoned after World War I. In the interwar period, governments not only undertook competitive devaluations but also set up restrictive trade policies that worsened the Great Depression.

  1. During the Second World War, it helped the Germans transfer assets from occupied countries.
  2. As host of the conference, the records held by the United States are particularly comprehensive.
  3. Dollar overhang occurred in the system by 1960 and continued to worsen throughout the decade of the 1960s.
  4. The group also planned to balance the world financial system using special drawing rights alone.
  5. Alternatively, when there was excess supply of the home currency, in exchange for dollars, the nonreserve central bank would supply dollars and buy its own currency on the Forex, resulting in a balance of payments deficit.

Few countries desired a return to the pre-war standard, but the group designed a system anchored to gold. The IMF is provided with a fund composed of contributions from member countries in gold and their own currencies. When joining the IMF, members are assigned “quotas” that reflect their relative economic power—and, as a sort of credit deposit, are obliged to pay a “subscription” of an amount commensurate with the quota. They pay the subscription as 25% in gold or currency convertible into gold (effectively the dollar, which at the founding, was the only currency then still directly gold convertible for central banks) and 75% in their own currency. The other option open to the United States was a change in domestic monetary policy to reduce the excess supply of dollars on the Forex.

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The other “devaluation” option open to the United States was devaluation with respect to gold. In other words, the United States could raise the price of gold to $40 or $50 per ounce or more. However, this change would not change the fundamental conditions that led to the excess supply of dollars. At most, this devaluation would only reduce the rate at which gold flowed out to foreign central banks. Also, since U.S. gold holdings had fallen to very low levels by the early 1970s and since the dollar overhang was substantial, the devaluation would have had to be extremely large to prevent the depletion of U.S. gold reserves. The discipline of a gold standard and fixed exchange rates proved to be too much for rapidly-growing economies at varying levels of competitiveness.

The conference, formally known as the United Nations Monetary and Financial Conference, convened on July 1, 1944, and was attended by 730 delegates. Delegation led Commission II that dealt with the proposal for a bank for reconstruction and development. The commission’s committees were tasked with studying the preliminary draft presented to the conference and gathering additional suggestions and proposals.

Instead, White proposed an International Stabilization Fund, which would place the burden of maintaining the balance of trade on the deficit nations, and impose no limit on the surplus that rich countries could accumulate. White also proposed the creation of the IBRD (now part of the World Bank) which would provide capital for economic reconstruction after the war. The IMF as agreed to at Bretton Woods was much closer to White’s proposal than to Keynes’s. White’s plan for a new institution was one of more limited powers and resources. It reflected the concerns that much of the financial resources of the Clearing Union envisioned by Keynes would be used to buy American goods, resulting in the United States holding the majority of bancor.