How Bretton Woods Reshaped the World - Case Study Example

? Economic events Task: Economic events The end of the Second World War marked the beginning of many negotiations to reconstruct the economy of the world. One landmark forum to discuss the reconstruction of the world economy after the war was the meeting that created the IMF and World Bank, in 1944. The contribution of oil towards the performance of the global economy is inevitable, and any disruption in its supply can cause substantial instability in the global economy. Since 1944, the world has experienced several instances of disruptions of the supply of oil mainly supplied from the OPEC countries, in the Middle East. Such historical instances of oil shocks had subsequent implications on the world’s economy in diverse ways. From observations of oil supply disruptions for over almost six decades now, from 1944, it is incontrovertible that high oil prices have been the significant cause of world’s major economic recessions. Introduction of Bretton Woods system was one of the post-war reconstruction initiatives undertaken by world leaders from over one hundred states. It is remarkable that the U.S dollar dominated during the world war for being very powerful against other currencies. The Bretton Woods system, a decision made in 1944, allowed for the exchange of different currencies. The conference also resolved to form the IMF. The World Bank was among the institutions formed during the conference. The IMF was created for the function of monitoring the different countries’ rates of exchange. It also served as an institution mandated to lend reserve currencies. The decision was to help countries with deficits to evade any circumstances that would cause devaluation of the country's currency and cause instability. The World Bank’s mandate was to issue capital needed to the underdeveloped countries as part of post-war reconstruction of the global economy. There was a common decision by the leaders of countries represented in the conference to have a fixed rate of exchange. The U.S dollar was the chosen currency; the value of gold was pegged to ensure a constant fixed rate of exchange of the currencies of all the countries. This was the pegging of dollar to gold. The choice of the dollar was because of the extent to which the dollar was considerably reliable from its long-time stability over the period of the world war. By the end of the second war, the U. S still experienced a relatively stable economic state compared to other countries. All the nations, therefore, decided to trade in dollar which was pegged to gold. The United States expressed its dedication to redeeming the international holdings of the dollar. The rate set was thirty-five dollars per ounce. This was the greatest reason for the stability in the financial system experienced after 1944. The gold standard set in 1944 ensured stability in the rates of exchange. Under the Bretton Woods system, there were exclusively limited conditions that would call for a reform of the value of gold in relation to the currency of any country. It led to the ceiling of the domestic money supply of every country. The 1970s, however, presented several challenges to the U.S currency following several economic conditions, which brought in many challenges to the stability of the dollar. There were the economic effects of the Vietnam War, for instance. The U.S, in 1971, made the decision that was later to have an effect on the entire world economy and cause a collapse of the stability that prevailed since 1944. Without consultations, the U.S disregarded the gold standard set in 1944. Floating rates started to function as compared to fixed rates after the uplifting of the pegging. Market trading remained the determinant of the currency value of all currencies. The effects of uplifting of the pegging on the oil price had extensive implications and were a cause of instability. Since the dollar is the global currency used in the crude oil market, a weak dollar would attract a high price of oil. An example is the high price of gasoline that emanates from a weak dollar. There was a notable failure of any attempt to reach a consensus and agree to revert the situation in the 1970s (Schifferes, 2008). According to the IMF (2013), the decline of the fixed value of the dollar against gold was because of the country’s high economic spending. The various programs set by the administration of President Lyndon Johnson contributed to high spending in the country. The Vietnam War also escalated the country’s spending rate through military spending. These lowered the value of the country’s currency on which the value of gold was pegged. The system became ineffective from 1968 to 1973, according to the IMF (2013) with the turning point coming оn August 15, 1971. The declaration of the uplift of the pegging of the dollar to gold, by President Richard Nixon, while referring to it as temporary caused a great challenge to the fixed exchange rate under the former system. This marked the end of the Bretton Woods system. The collapse initiated a number of economic implications in the global status of the economy. Formerly, before the collapse of the 1944 agreement and uplift of the pegging, the fixed exchange rates of currencies ensured stability. Under the new system, IMF members have the authority to select their most preferred exchange rates. IMF members no longer pegged their currencies on gold as in the Bretton Woods system. The choice of the most preferred exchange arrangement by every member of the IMF allows a free float of the currencies. IMF members gained the freedom to peg their currencies on those of other countries; free participation of members in currency blocs was also allowed. The effects of the oil shocks were experienced in many parts of the countries. With the uplift of the dollar pegging and subsequent devaluation of the dollar, crude oil prices rose. Countries experienced challenges in coping with the high prices of oil experienced after the shock. Flexible rates of exchange enabled many of the courtiers to adjust to the external shocks was a major cause of the high price of oil. The IMF introduced programs to address implications the oil shock experienced after the collapse on the economic performance of its member countries. It introduced the oil facilities in the mid 1970s. The decision was to cushion IMF members from the possibilities of inflation that would result from the oil shock. There was the need to avoid any occurrence of current account deficit that IMF members would incur resulting from the oil shock. The IMF resorted to helping underdeveloped countries through diverse initiatives. Concessional financing was among the initiatives launched by the IMF to cushion developing countries from the effects of the oil shock. The October 17, 1973 marked a defining moment in the history of the world economy. Oil Diplomacy, a term coined by the OPEC countries, came into effect following the OPEC countries’ boycott of oil supply. They decided to stop their supply of oil to the U.S and other countries that offered full support to Israel following the occurrence of the Yom Kippur war. Before 1973, OPEC countries supplied crude oil at an affordable price and reliably. Another notable cause of the move by OPEC to impose the embargo was the 1971 devaluation of the dollar. The devaluation caused a vast loss incurred by OPEC and prompted negotiation of the price of oil. The situation, therefore, presented the OPEC members with a forum to negotiate the price of oil with the U.S and other western countries. With Arab producers of the valuable product imposing an embargo, there was a high increase in the price of oil by a considerable percentage. The embargo posed a serious challenge to the global economy since it initiated a great recession effect. The extent of influence of the embargo on the end of the Bretton Woods system was massive. The boycott of supply of oil that started in 1973, October lasted until March 1974. Throughout the period, the U. S had a serious challenge to its economy following the exceedingly high cost of gasoline. The cost of world oil prices rose by a fourfold figure, from three to twelve dollars. This was after serious negotiations between western oil companies and the OPEC. There were several effects of the embargo, on the U.S and other western countries, as well. After the negotiations and agreement to supply the oils, the members of OPEC received serious surplus from the inflated oil price that they set. Most of the surplus of these current accounts ended up in the banks in the U.S, which had more capacity to accommodate the surplus than those in the OPEC countries. This caused the effects of the petrodollar recycling. Western countries also faced the challenge of inflation. Food prices were high, and the citizens incurred high cost of living. Most of the countries had to ration the use of gasoline, for instance. This turned out as a serious cause of slow economic growth in the western countries. The action by oil-exporting countries to cut their supply of oil prompted the western countries to draft the new agreements of trade. Trade policies among countries improved by a great extent following the embargo. Most western countries sought to improve their relationship with countries that could supply oil at a lower price than the OPEC countries. The oil crisis, which started in 2007, remains one of the oil shocks that had a serious impact on the world economy. According to the United Nations (2009), the crisis that extended to 2008 resulted from economic causes mainly after the fall of the shadow banking system. Shadow banking refers to a scheme of financial intermediaries in the banking sector that operate mostly in the property markets. The rise and success of shadow banking occur when the property markets perform well. An example of shadow banking is the operation of equity companies that perform well and have extensive implications on the economy of a country. The U.S has a record high performance of the shadow banking sector compared to other world countries with great economies. Improper regulation of the sector was the major economic escalator of the crisis experienced in 2008. With inadequate oversight, the sector most likely experienced instability. It is estimated that there was a high performance in shadow banking, during the time before 2007, a factor that initiated the crisis. The economic condition experienced from 2007 to 2008 had a considerable effect on the world oil markets. The demand for oil escalated very significantly in most countries including China. China’s consumption of oil increased in 2007 (Hamilton, 2009). Despite the increase in demand in China, there was a notable reduction in the supply of oil from OPEC countries. The high demand against a stagnating supply of oil experienced during that time created the effect of escalated oil prices. According to Tong and Wei (2008), the subprime crisis appeared as one of the greatest crises ever experienced in history since the end of the Great Depression. The effects of the crisis were varied and covered a considerable population and parts of the world. It affected the level of domestic spending with the automobiles sector experiencing the most impact of the crisis from reduced purchasing. Besides affecting the level of consumer demand, the crisis also caused serious challenges on the supply side. Non-financial firms, for instance, had to contend with firm liquidity regulations. The real economy was not spared the effects of the crisis. Before the beginning of the crisis, non-financial firms kept a considerable amount of cash. A comprehensive analysis of the path to achieving post-war reconstruction of the global economy that began in 1944 reveals instances when there have been serious global economic recessions. A succinct evaluation of these periods in the world’s history of reconstruction since the end of the second war starts with the introduction of the Bretton Woods system. This acted as a key step towards having a strong global economy. The resultant agreement to peg the dollar to gold managed to attain a fixed exchange rate for the currencies of all the world countries. However, the decision to uplift the pegging that came in 1971 marked the beginning of instability. The 1973 oil embargo also affected the world economy to a considerable extent. The 2008 oil crisis also was a great challenge. In all the instances, the role of supply and cost of oil made a considerable contribution to determining the global economic situations. References Hamilton, J. (2009). Causes and Consequences of the Oil Shock of 2007-08 (No. w15002). National Bureau of Economic Research. Schifferes, S. (2008, November 14). How Bretton Woods reshaped the world. BBC News. Retrieved from: http://news.bbc.co.uk/2/hi/7725157.stm The International Monetary Fund (IMF). (2013). The end of the Bretton Woods System (1972–81). The International Monetary Fund. Retrieved from: http://www.imf.org/external/about/histend.htm Tong, H., & Wei, S. (2008). Real effects of the subprime mortgage crisis: Is it a demand or a finance shock? (No. w14205). National Bureau of Economic Research. United Nations. (2009). Trade and Development Report 2009: Responding to the Global Crisis - Climate Change Mitigation and Development. United Nations Publications, New York, NY. Read More