What explains the demise of the Bretton Woods system - Essay Example

? The demise of Bretton Woods System: One of the major reasons for the global economy to progress in such a high scale is because of the Bretton Woods Agreement of 1944 which was announced jointly with Marshall Plan (1947-1950). The joint venture brought about a system wherein countries having problems in balance of payments can solve it because of one of the feature of fixed exchange rates in the agreement. This has laid to an economic reconstruction in Europe for a very long decade which in turn gave rise to capitalist expansion, which has not been seen till date. This gave an added boost to the global economy where mostly in the capitalist countries, the standard of living of the working class has improved to a very high extent. (Bordo & Eichengreen, 1993). In the period of post World War 1, majority of the countries had a tendency to go back to the previous situation of financial stability and security as it prevailed before such wars were held. The old gold standard were again preferred and every country tried to incline towards it and by 1926 all the leading economies again established the system and accordingly the circulating money of every nation had to be geared by gold reserves and foreign currencies to a huge extent. But while implementing the gold several steps were undertaken mistakenly as a result of which the economic and financial relations collapsed leading to the Great Depression in 1929. In order to reduce the deficit in payment balance by deflating its currency every single country gave a boost to its export product to increase its competitiveness in productivity. This idea fell in place and was running successfully till the countries continued deflating their currencies. This over laid phenomenon marked an international deflation competition which led to unemployment among masses, enterprises were rubbed out of bankruptcy, many credit institutions failed and also hyper inflation was noted to occur in various countries concerned. (Kenen, 1994; Moggridge, 1980). Due to this phenomenon of Great Depression, several conferences who were dealing with the world monetary problems ended up in failure in the decade of 1930s. But every country tended for a stabilizing system that rectified mistakes which became one of the evident phenomenons. After this, several plans were made in order to build an innovative monetary system and an institution that will supervise all sorts of actions and financial hazards. During the war time conditions, all of the initial negotiations happened. (Kenen, 1994; Moggridge, 1980). In Bretton Woods, New Hampshire (USA), an international conference took place in 1944. This conference was attended by 44 countries so as to restructure the international finance and currency relationships. The International Monetary Fund (IMF) and The International Bank For Reconstruction And Development (IBRD/ World Bank) was created by the participants of this conference . In addition, they also accepted the fact of implementing a system of fixed exchange rate with the U.S dollar as the leading currency. Harry Dexter White, the American Minister of State in the U.S treasury and the British Economist John Mayard Keynes were responsible to develop the plans for the Bretton Woods system. They also stated that they want to establish a system which would be acceptable by all the nations. The ideas of Harry Dexter and Keynes always happened to be very similar to each other. The White Plan supplements that a Bank for Reconstruction and an International Stabilization Fund should be put up. This was similar to what Keynes has described in his plan. But there was a little difference which got reflected in Keynes plan was he wanted to vest the IMF ideas with possibilities to create money and with the authority to take actions on a very large scale. Whenever there will be imbalances in the balance of payments both the sides, that is, both the debtors and creditors must change their policies. Countries that have their payments in excess should increase their scale of imports from the countries running out of deficit and thereby establishing an equilibrium in foreign trade. On the other hand, Harry Dexter White saw the problem of imbalances in balance of payments only in countries which ran out of deficit. Nowadays, the modern economists has accepted the fact which Keynes have delivered thus providing Keynes to be very strong in prediction while White was proven wrong in delivering his stock of ideas. (Keynes, 1971). However it was sad that the ideas of Keynes were never discussed seriously in the Bretton Woods while the participants agreed on the ideas which White delivered. The United States defined dollar value in terms of gold so that the value of one ounce of gold be equal to thirty five dollars. Then every member had to define the value of money according to the system of par-value in terms of U.S dollar or gold. (Giovannini, 1993). The Bretton Wood system is still being dominated by USA. USA was the only country which showed huge economic potential after the Second World War. The Dollar Of United States had a huge purchasing power and it was the only currency that was supported by gold. In addition to this, all the European nations who were involved in the Second World War were suffering from debt and transferred large amounts of gold in the United States, and this laid to the supremacy of USA. Therefore, in the rest of the world, the US dollar were highly accepted and appreciated as a result the US dollar became the key currency in the Bretton Woods System. The headquarters of IMF and World Bank was situated in Washington D.C. The dominant role of USA was very much highlighted when the American ideas of the Bretton Woods System gained more credibility and acceptance than those of Great Britain. (Giovannini, 1993). But the Bretton Woods Agreement had its loophole at the same time. The agreement did not reflect its attention onto the essential contradictions of the capitalist economy. Moreover, the regulated post war order was not given to them and has brought them to the surface because of this expansion in the global economy. (Marston, 1993; Giovannini, 1993). This was very necessary for proponents of Keynesian regulation to put focus on this point in the face of claims so that the stability of the post war period can be regained and also the social reformist policies which accompanied it, so that a solution point can be reached on the Bretton Woods Agreement. However, the advocates of this program never tried to find out the clue behind the collapse of the original system. (Marston, 1993; Giovannini, 1993). There were two processes responsible for such a breakdown. One is the decline of the US relatively within the Bretton Woods order and its inclination towards a new regime which was based on free capital movement in order to maintain position in the global hegemony. Another is the increasing trend of advancement in production and finance of the global system. (Solomon, 1976; Obstfeld and Rogoff, 2001). The emergence of the Euro dollar market at the end of the 1950s was one of the first crack in the economic order whose impact was not so big. Initially the agreement on currency values had provided free convertibility which proved to be impossible in 1958. This has caused a deadline sterling in 1957 to which the response of the British Government was to put restrictions on the capital movement. This made a huge impact on the operations of the British banks. The banks were forced to circumvent the restrictions as they feared of being eclipsed by their trans-Atlantic rivals. They tried to continue their international operations by depositing the dollars instead. (Gilbert, 1968; Ashworth, 1987). For this emergence of the new financial market, the British government had a very positive attitude. On one hand, they ensured London to be the highlight of international finance while on the other hand, the national policy dictated the need for financial controls.( Irwin, 1995). Within this time, another problem tried to root up again, in this structure of the system. Under the Bretton Woods agreement, the American dollar played the role of a virtual world currency, giving Us a great advantage along with the capitalist powers. But these advantages were very limited as the provision of the US dollar can be redeemed against gold at thirty five dollar per ounce. (Scammell, 1975). The gold backing system as the case with financial arrangements performed very well as it was not tested actually but was founded on contradiction. The system continued to operate as the US dollars circulating in the rest of the world was supported by the gold backing system. This expansion in international trade in turn increased the need of international liquidity in the form of dollars. This means the relation between gold and dollar became more fragile as the global economy expanded more and more. (Krugman and Obstfeld, 2000). Due to an increase in US investment abroad and in military spending, the difference between dollar in international circulation and value of gold backing held in Fort Knox, began to grow. As a result, the administration in US imposed policies which had its basic on capital movement restrictions while their British counterparts found the Euro dollar market very interesting in making it a useful means for circumventing the actions of their own government. The US currency did not felt much currency as the administration in US had an ambivalent attitude to the Euro dollar market. In order to counter the balance of payments deficit, they tried to restrict the capital outflow so that the foreigners feel satisfied with the existence of the Euro dollar market. (Krugman and Obstfeld, 2000). Keynes and Hary Dexter White foreshadowed the growth in the Euro dollar market had a major impact as a result of which the growing amounts of finance capital was able to move around the world, beyond the control of the governments. The fixed exchange rates did not prove to be sustainable. In 1967 the pound came under pressure which was followed by dollar in 1968. A qualitative change was noted in 1971, for the first time before the First World War, which experienced a balance of trade deficit leading to the announcement by Nixon in 15 August.(Keynes, 1971) It is through the exercise of capital controls, Japan and other countries tried to resurrect the Bretton Woods system. The US opposed to all such measures as it tried to restricted its freedom of operation both domestically as well as internationally. (Krugman and Obstfeld, 2000). Under Bretton Woods Agreement, US have always tried to cover up the imbalances in its international position. One way to do that was during the Vietnam war, they tried to restrict the military spending. But this has weakened the power of US along with the other major powers. Paul Volker concluded the financing of US deficits has allowed United States to carry out heavy military expenditure and to undertake other foreign commitments. The most important goal is to free the foreign policy from the constraint imposed upon them by the weaknesses in the financial system, upon which during 1990s Volker commented that Nixon and Johnson were not ready to accept the fact that their options have been limited as dollar lost its value and importance in the market. (Linder, 1961). Another way to put a limit in the deficit of balance of payments is to lighten the pressure on the dollar so as to maintain system of regulation in order to put a limit in US spending. The aim was to induce a severe recession out of the consequences. In the working class there was a rising tide of militancy noted, but they did not consider the rebellion of black youth in the cities and also the student radicalization produces by the Vietnam war. (Solomon, 1976) The US ruling circles had a considerable support as the system of control on capital movement were scrapped ad in order to maintain its position and weight, US would be able to maintain its hegemonic position. Other nations would opt for dollars as it played a vital role in the international market. Dollar has helped the financial economy to rise to heights of success as it focused to play a vital role in the global economy. One of the personnel in the higher authority of the administration department in Nixon said that dollar will remain to be their currency and if it creates any problem then it is their concern and not them He also said that before the foreigners screw them for this, they will screw them before. References: 1. Bordo, M. D. & Eichengreen, B. (1993). A Retrospective on the Bretton Wood System. Chicago and London: The University of Chicago Press 2. Kenen, P. B. (1994). Managing the world economy: fifty years after Bretton Woods. Washington DC.: Institute for International Economics. 3. Keynes, J. M. (1971). The collected writings of John Maynard Keynes. London: Macmillan. 4. Moggridge, D. (1980). Activities 1941 - 1946 : shaping the post-war world, Bretton Woods and reparations. London: Macmillan. 5. Onkvisit, S. & Shaw, J. J. (1997). International Marketing: Analysis and Strategy. New Jersey: Prentice Hall 6. Giovannini, A. (1993). “Bretton Woods and Its Precursors: Rules versus Discretion in the History of International Monetary Regimes,” in Michael D. Bordo and Barry Eichengreen (eds.), A Retrospective on the Bretton Woods System, Chicago: University of Chicago Press. 7. Gilbert, M. (1968). The Gold-Dollar System: Conditions of Equilibrium and the Price of Gold. Princeton Essays in International Economics. Princeton University, International Finance Section. 8. Ashworth, W. A. (1987). A Short History of the International Economy Since 1850. London: Longman. 9. Irwin, D. (1995). “The GATT’s Contribution to Economic Recovery in Post-War Western Europe,” in Barry Eichengreen (ed.), Europe’s Postwar Recovery. Cambridge: Cambridge University Press. 10. Krugman, P. and Obstfeld, M. (2000). International Economics: Theory and Policy. 6th Ed. Harlow: Addison-Wesley. 11. Marston, R. (1993). “Interest Differentials under Bretton Woods and the Post-Bretton Woods Float: The Effects of Capital Controls and Exchange Risk,” in Michael D. Bordo and Barry Eichengreen (eds.), A Retrospective on the Bretton Woods System, Chicago: University of Chicago Press. 12. Obstfeld, M., and Rogoff, K. (2001). “The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?” NBER Working Paper 7777. 13. Solomon, Robert (1976). The International Monetary System, 1945-1976: An Insider’s View. New York: Harper & Row. 14. Scammell, W. M. (1975). International Monetary Policy: Bretton Woods and After. London: Macmillan. 15. Linder, Staffan (1961). An Essay on Trade and Transformation. New York: Wiley. Read More