Creation of the Bretton Woods System

One of the primary features of the Bretton Woods System was a set conversion between currencies and the U.S. dollar and the U.S. dollar and gold. Those who held other currencies covered by the agreement always knew how many dollars they could receive for their British pounds or French francs. But despite these revaluations, another run on the dollar occurred in 1973, creating inflationary flows of capital from the U.S. to the Group of Ten.

The U.S. was running balance-of-payments deficits in the 1950s and had a current account deficit in 1959. In 1958, the Bretton Woods system became fully functional as currencies became convertible. Countries settled international balances in dollars, and US dollars were convertible to gold at a fixed exchange rate of $35 an ounce.

  1. Australia and New Zealand were likewise absent from formal participation at Savannah (Australia sent observers), though they joined the IMF and IBRD later.
  2. 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.
  3. 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.
  4. However, with a mounting recession that began in 1958, this response alone was not sustainable.

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. Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus, the deficit would be rectified. Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend.

As with the benefits of all currency pegging regimes, currency pegs are expected to provide currency stabilization for trade of goods and services as well as financing. When the Bretton Woods system collapsed, countries became free to set the value of their currencies as they wished. Most countries remain members of the IMF, which forbids nations from returning to the gold standard. As the oversupply of the dollar increased, people who held dollars worried that the government would have to cut the value of the dollar in comparison to gold.

Replacing the Gold Standard

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. Flows of speculative international finance were curtailed by shunting them through and limiting them via central banks.

Bretton Woods System and 1944 Agreement

Countries pegged their currencies to the US dollar and the US dollar was pegged to gold to help stabilize the global economy. Another goal was to prevent governments from devaluing their currencies to compete with other countries in the import and export markets. The new system aimed to establish fixed exchange rates between the monies involved. These new forms of monetary interdependence made large capital flows possible.

The onus is on the host country to make a summit a success and Johnson has not made life any easier for himself by cutting the UK’s aid budget from 0.7% to 0.5%. It is not too late to rectify this error and the prime minister should make it clear that Britain will rescind the cut and use the money to pay its share of a G7 fund designed to ensure blanket vaccine coverage. A report prepared for Boris Johnson for the G7 meeting by the economist Nick Stern makes this point clearly. The world is confronting an interwoven set of challenges spanning health, growth, jobs, climate change and biodiversity, and failure to act on any of the various dimensions of the challenge will weaken progress on the others. But while member nations had individual incentives to take advantage of such an arbitrage opportunity, they also had a collective interest in preserving the system.

What is the Bretton Woods Agreement?

The agreement also established the International Monetary Fund, which is tasked with tracking exchange rates, maintaining international reserves currencies, and lending money to countries that require extra funds to maintain their exchange rates. It also created the World Bank, which aimed to help rebuild the global economy after World War II and assist underdeveloped countries with growing their productivity. The Marshall Plan and more competitively-aligned exchange rates relieved much of the pressure on European nations trying to revive their war-torn economies, allowing them to experience rapid growth and restore their competitiveness vis-à-vis the U.S. Exchange controls were gradually lifted, with full current account convertibility finally achieved at the end of 1958. However, during this time the U.S. expansionary monetary policy that increased the supply of dollars, along with increased competitiveness from other member nations, soon reversed the balance of payments situation.

Increasing Instability in the High Bretton Woods Era

The agreement was criticized for being too rigid, not having enough power to control inflation, favoring developed countries over developing countries, and favoring creditors over debtors. Nevertheless, the agreement helped stabilize the global economy after World War II. The agreement eventually broke down due to unsustainable US deficits and other economic factors. With dollar claims on gold exceeding the actual supply of gold, there were concerns that the official gold parity rate of $35 an ounce now overvalued the dollar.

For example, they wouldn’t lower their currencies strictly to increase trade. For example, they could take action if foreign direct investment began to destabilize their economies. Agreements were signed that, after legislative ratification by member governments, established the International Bank for Reconstruction and Development (IBRD, later part of the World Bank group) and the International Monetary Fund (IMF). This led to what was called the Bretton Woods system for international commercial and financial relations.

IMF loans were not comparable to loans issued by a conventional credit institution. Instead, they were effectively a chance to purchase a foreign currency with gold or the member’s national currency. 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. Some economists have argued that the agreement led to the eventual collapse of the Bretton Woods system in 1971. Nevertheless, the agreement was a significant step in the international regulation of currency and trade. The agreement has been criticized for being too rigid, not having enough power to control inflation, favoring developed countries over developing countries, and favoring creditors over debtors.

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. They could move from a weak to a strong currency hoping to reap profits when a revaluation occurred.

In other words, the higher the country’s contribution was, the higher the sum of money it could borrow from the IMF. Thus, the new system would be devoid (initially) of governments meddling with their currency supply as they had during the years of economic turmoil preceding WWII. Instead, governments would closely police the production of their currencies what is meant by the bretton woods agreement and ensure that they would not artificially manipulate their price levels. If anything, Bretton Woods was a return to a time devoid of increased governmental intervention in economies and currency systems. On a larger scale, however, the agreement unified 44 nations from around the world, bringing them together to solve a growing global financial crisis.

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