Aid to Europe and Japan was designed to rebuild productivity and export capacity. 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. In addition, the IMF was based in Washington, D.C., and staffed mainly by U.S. economists.
Its current account balance was low; thus, the government decided to call off this system. The US Dollar was pegged against the price of gold—fixed at $35 per ounce of gold. As mentioned above, 44 allied nations met in Bretton Woods, NH in 1944 for the United Nations Monetary and Financial Conference. At that time, the world economy was very shaky, and the allied nations sought what is meant by the bretton woods agreement to meet to discuss and find a solution for the prevailing issues that plagued currency exchange. These countries were brought together to help regulate and promote international trade across borders. 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.
After Bretton Woods, each member agreed to redeem its currency for U.S. dollars, not gold. In turn, the dollar was pegged to the price of gold, and the U.S. became dominant in the world economy. It standardized international monetary payments—by facilitating currency conversion. Exchange rate stability and regulation of global payment and settlement post-World War II were the objectives of the Bretton Woods agreement.
A negative balance of payments, growing public debt incurred by the Vietnam War and Great Society programs, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued. The drain on U.S. gold reserves culminated with the London Gold Pool collapse in March 1968. By 1970, the U.S. had seen its gold coverage deteriorate from 55% to 22%. This, in the view of neoclassical economists, represented the point where holders of the dollar had lost faith in the ability of the U.S. to cut budget and trade deficits.
It was a collective strategy to recover from the impact of World War II. A super currency would replace the U.S. dollar as the world’s reserve currency and form the basis for a new global monetary system. A floating exchange rate is a regime where a nation’s currency is set by the forex market through supply and demand. The currency rises or falls freely, and is not significantly manipulated by the nation’s government. It was envisioned that these changes in exchange rates would be quite rare. However, the concept of fundamental disequilibrium, though key to the operation of the par value system, was never defined in detail.
In a sense, the new international monetary system was a return to a system similar to the pre-war gold standard, only using U.S. dollars as the world’s new reserve currency until international trade reallocated the world’s gold supply. The international monetary system is the system linking national currencies and monetary system. In this system, national currencies, for example the Indian rupee, were pegged to the dollar at a fixed exchange rate. The dollar itself was anchored to gold at a fixed price of $35 per ounce of gold.
All of the countries in the Bretton Woods System agreed to a fixed peg against the U.S. dollar with diversions of only 1% allowed. Countries were required to monitor and maintain their currency pegs which they achieved primarily by using their currency to buy or sell U.S. dollars as needed. The Bretton Woods System, therefore, minimized international currency exchange rate volatility which helped international trade relations.
It would be the unit for accounting between nations, so their trade deficits or surpluses could be measured by it. The shift toward a more pluralistic distribution of economic power led to increasing dissatisfaction with the privileged role of the U.S. dollar as the international currency. Acting effectively as the world’s central banker, the U.S., through its deficit, determined the level of international liquidity.
They could move from a weak to a strong currency hoping to reap profits when a revaluation occurred. If, however, monetary authorities managed to avoid revaluation, they could return to other currencies with no loss. The combination of risk-free speculation with the availability of large sums was highly destabilizing. 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.
Gold reserves remained depleted due to the actions of some nations, notably France, which continued to build up their own gold reserves. The architects of Bretton Woods had conceived of a system wherein exchange rate stability was a prime goal. Yet, in an era of more activist economic policy, governments did not seriously consider permanently fixed rates on the model of the classical gold standard of the 19th century. Gold production was not even sufficient to meet the demands of growing international trade and investment.
In this lesson, we will review the key elements and its eventual collapse. 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. This led to a run on gold, which was part of President Nixon’s reasoning for suspending the dollar’s convertibility.
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. IMF approval was necessary for any change in exchange rates in excess of 10%.
These moves helped alleviate the shortage of dollars and restored competitive balance by reducing the U.S. trade surplus. Further provisions of the Articles stipulated that current account restrictions would be lifted while capital controlswere allowed, in order to avoid destabilizing capital flows. In these depression years, India became an exporter of precious metals, notably gold.
By so doing, it established America as the dominant power in the world economy. After the agreement was signed, America was the only country with the ability to print dollars. The representatives wanted to revitalize international trade by standardizing exchange rates across the globe. Canada, Mexico, Russia, Brazil, China, India, Netherlands, Poland, Belgium, Chile, and Czechoslovakia were the active member nations. The purpose of the IMF was to monitorexchange ratesand identify nations that needed global monetary support. The World Bank, initially called the International Bank for Reconstruction and Development, was established to manage funds available for providing assistance to countries that had been physically and financially devastated by World War II.
But incurring such payment deficits also meant that, over time, the deficits would erode confidence in the dollar as the reserve currency created instability. 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. The ICU would effectively be a bank with its own currency (the “bancor”), exchangeable with national currencies at a fixed rate.
Currencies belonging to allied nations were ascertained against the value of the US dollar. On a larger scale, however, the agreement unified 44 nations from around the world, bringing them together to solve a growing global financial crisis. It helped to strengthen the overall world economy and maximize international trade profit.
In 1971, concerned that the U.S. gold supply was no longer adequate to cover the number of dollars in circulation, President Richard M. Nixon devalued the U.S. dollar relative to gold. After a run on gold reserve, he declared a temporary suspension of the dollar’s convertibility into gold. The Bretton Woods System required a currency peg to the U.S. dollar which was in turn pegged to the price of gold. To encourage long-term adjustment, the United States promoted European and Japanese trade competitiveness. Policies for economic controls on the defeated former Axis countries were scrapped.