The Bretton Woods Agreement and Its Failure - Essay Example

Running Head: Bretton Woods System The Bretton Woods Agreement and its Failure Name Institution Date Bretton Woods System To begin with, the Bretton Woods Agreement is an economic pact that was established by representatives of worlds' leading nations following the great depression of the 1930's. This was in Bretton Woods, New Hampshire, the year 1944. The aim of the Bretton woods agreement was to establish a new monetary system through which central banks of other countries would maintain stable exchange rates. In this meeting, it was agreed that the standard currency of exchange is the United States Dollar. The reason for adopting the United States Dollar as the standard for currency exchange was that at that time, the United States of America had most of the world’s gold and industrial manufacturing industries. Before the Bretton Woods Agreement, gold was the standard measure of currency exchange. (Musgrave, 1981) Under the Bretton woods agreement, countries with a very high value currency in view of the dollar were supposed to sell it out in exchange for the dollar something that would ensure stability of the international currency market. Conversely, countries whose currencies were too low would buy it in exchange of the dollar something that would as well uplift it. The idea behind the Bretton Woods Agreement therefore was purposely to stabilize the distribution of the world currencies and therefore ensure stability in the world economies. In this case therefore, central banks were to play a critical role in the implementation of the Bretton Woods agreement since they are the ones who deal with the control of currency supply within an economy. The Bretton woods agreement was characterized by a number of features. First and foremost, it introduced a new concept of which countries were required to adopt a monetary system of exchange. This would provide a leeway through which nations would test their currency strength against the US dollar. Secondly, the Bretton Woods Agreement led to the creation of the International Monetary Fund whose functions were to check and balance monetary transactions across countries. Until today, the International Monetary fund ensures stability of the monetary exchanges between countries. Moreover, the Bretton Woods Agreement brought into existence a system that aimed to end the unstable exchange rates that had been there before (Hall, 2009). Another feature of the Bretton Woods Agreement was that it gave countries the autonomy to make and implement domestic regulations that would facilitate the full realization of their economic aspirations. In this case, therefore, countries could develop economic frameworks that would ensure the prioritization of their domestic economic produce over that of outsiders. Even though countries were allowed autonomy by the Bretton Woods agreement, they would always consider good relations with other countries especially those that they trade with most (Garber, 1993). According to Astrow (2012), the Britton Woods established a framework that allowed more flexibility in the current exchange rate regime. This enabled countries with strong economic problems to devalue their currencies to the United States dollar. Countries were allowed access to the short term loans from the International Monetary Fund so as not to experience the deflation effects, which was so much prominent during the era of Gold Standard. Looking back, the Bretton Woods System collapse was influenced by the decision of the United States of America to adopt a free currency exchange market but also the increasingly uncontrolled gold market. At this time the dollar was no longer fixed. Instead, it fluctuated depending on the currency against which was to be exchanged. From another perspective, the collapse of the Bretton Woods System followed from the fact that there was an unbalanced flow of the dollar to other countries especially in Europe through the gold trade (Radmir, 1987). In order to correct the situation, nations adopted the so-called Smithsonian Agreement as a replacement of the collapsed Bretton Woods System. This was in the year 1971. However, this realignment did not entirely end the problem of massive dollar acquisition in the European continent, which meant therefore that the problem was far from over. Hence, the struggle to stabilize the situation continued until 1973 when a generalized floating of currency began. Of course even with the generalized floating of currency there was also the problem of inflation which needed to be dealt with (Gilpin, 1987). In an effort to achieve a stable dollar, the United States of America created policies that would regulate the financial market. They therefore turned to running current accounts in bank institutions. The bank systems would help to balance transactions and deficit payments of gold sales. But more importantly, the banks systems would serve a great deal in controlling flow of dollars from within and outside of the United States. By extension, given that the dollar remained the standard for currency exchange, this would also control laundering in other economies. With the coming into place of the Smithsonian Agreement, the major achievement was that the dollar was no longer convertible to gold and this made it stronger as it could be traded with more accuracy vis a vis other currencies. The Smithsonian Agreement effectively replaced the fixed- exchange rate that had been established under the Bretton Woods system (Economic and Social Committee of the European Communities, 1978). Nonetheless, the Smithsonian system has its own peculiar challenges too. To that end, different scholars and economists hold different views regarding the agreement. The international monetary management collapsed because of structural changes. It was after formation of bilateral arrangement, that the world monetary system became gradually unstable until it collapsed closing its golden window in 1971 (D'Arista 2009). This was generated by an acceleration of inflation that led to collapse of system tormented by serious errors of the gold exchange standard and the modifiable hook in the US. The rise of inflation in the world was closely linked to rise in money growth thus comparative to the growth of real output. In 1971, the US president hurled a New Economic Policy that adjourned convertibility of gold from dollar at establishment level. Spero and Hart, (2009) says that, this caused major currencies float rather than remain fixed. In addition, there was stiffer competition from export-oriented countries like Germany, japan and newly industrialized economic countries like Korea and Taiwan. It was therefore seen that, relative decline of the US economy was because of shortage in industrial output that had fallen to 20 per cent as compared in the 1945. Therefore, the breakdown of Bretton Woods system was contributed by US declining gold stocks thus inability to maintain the value of the dollar. Furthermore, the rise of Western Europe and Japan, payments of debits made US choose to give its national interest the first priority rather than the large word economy. This saw collapse of the system of Bretton. This led to dismantling system of global power to serve the interest of US nation. For this reason, it contributed to collapse of Bretton Woods due to economic conflicts (Eichengree & Kenen 1994). Bretton Woods system, supervised world economy largely through the maintenance of stable exchange rates. However, the system broke down in early 1970s as floating exchange replaced fixed exchange rates thus conversion of economic abundance. It was after the break of the system that different member countries agreed on allowing different methods to assess the exchange value of a nation’s money. This enhanced most developed countries to float freely. This meant currency value was to be determined by demand and supply at the market. Furthermore, there were changes in the East-bloc as well as breakdown of Soviet Union. Before then, these communities had feared joining World Bank and IMF because of economic superiority but after adjustment in their economies, they benefited as they solved their problems (Dammasch, 2001). According to Allen (1961), the International Monetary Fund was proven and given the responsibility of providing financial assistance to members with debits, provision of multilateral payments system and cancellation of restrictions on exchange, maintaining stable exchange rates, and facilitating the maintenance of full employment. During the Briton woods agreement, gold did not have a major role to play. Countries that took part in the agreement decided to use a system of adjustable exchange rate, which allowed the international currencies to be hooked directly to the dollar at a gold price of $ 35/oz. At that particular time, central banks were given the right to change the dollar holdings into bullion, and the opening of the London gold market in 1954 was still to be endorsement by the of exchange controls. In respect to this, all the foreign currencies hooked to the US dollar did have a fixed gold value, which facilitated the establishment of the greenback as the major international currency (Astrow, 2012). States then opted to use the national recovery programmes to maintain sovereignty over the monetary policy, which did not permit exchange rate flexibility. This prevented the smooth flow of capital by use of elaborate controls measures. It is the strict control of capital that protected the pegging of the exchange rate and guarded countries from the problems of capital flight. After the post-war boom that occurred in the 1950s and later 1960s, the function of the United States dollar pegged to gold brought about pressure to the international monetary system. It is the period when the US started operating persistently huge external deficits, and at the same time required to supply the global liquidity to facilitate international transactions. The amount of dollars maintained as reserves for the foreign exchange by the various officials and private entities became more than the volume of gold held in the Federal Reserve by a big magnitude. This financial trend greatly weakened the credibility the price for gold which was on demand by all the individuals or nations in possession on the US dollars (Astrow, 2012). In an effort to maintain credibility in the price of gold, the great ten states decided to develop a Gold Pool to intervene in the unpredictable market. The central banks in the ten states took over the selling of gold with the intention to control the price of gold from going up (Lucarelli, 2011). This led to a decline in the volume of bullion maintained in the reserve assets. In November 1967, when the sterling pound experienced devaluation, it was still used as the secondary reserve asset across the globe. Despite this, there was increase in speculation about the gold price of the US dollar, which resulted to the suspension of the operations of the Gold Pool in 1968 (Astrow, 2012). It was the first step in the regime of Bretton Woods, which focused on eliminating gold as the international monetary system and introduce demonetization of bullion. Even when the central banks maintained the official price of gold, the private market price remained unstable. The introduction of the private market made the price of gold to soar much above the price set by the central banks, a situation that led to more speculation (Lucarelli, 2011). The pressure could not allow the central banks to maintain a fixed price for the holders of the US dollars. As a result, in 1971 President Richard Nixon suspended the conversion of gold to the dollar, which led to devaluation of the dollar. In December the same year, attempts were made to prop up the pegged exchange rate system with different parities in the Smithsonian Agreement. This never succeeded since the private market hindered the ability to enforce the new proposed rates. The sterling pound continued to float against the dollar by 1972 and in March 1973 the other currencies had followed the trend. This led to the collapse of the Bretton Woods (Astrow, 2012). It was after the breakdown that large accumulation of global investments took place. Global investments rose between 2002 and 2007 mostly by the Asians emerging economies. This was influenced by unilateral self-insurance after an exchange crisis that struck these economies in between 1997 and 1998, additional savings from domestic investment and growth through export especially in Asian market economies reinforced by undervalued control on capital flows and exchange rates (Posen 2008). After the collapse of the Bretton Woods agreement between 1971 and 1973, countries eliminated capital controls and resorted to deregulation of their domestic financial markets. The US continued to enjoy the advantages of dollar seigniorage, given that it was the issuer of the reserve currency globally. What this means is that the US not restricted to the dollar/gold convertibility. The United States policy makers implemented the unfettered strategy which helped to restore their competitiveness globally through the dollar devaluations (Lucarelli, 2011). The collapse of the Bretton Woods agreement made countries to use strict deflationary policies to control their markets. In conclusion, the Bretton Woods agreement marked the beginning of global monetary system that enabled states to exchange the currencies against the US dollar. It is an agreement that gave countries the autonomy to regulate their domestic monetary markets. However, decline in the gold stocks, unbalanced flow of dollar together with the structural changes among other factors as discussed above led to the collapse of agreement. References Allen, W. R. (1961). The International Monetary Fund and Balance of Payments Adjustment. Oxford Economic Papers, 13(2), 149-165. Astrow, A. (2012). Gold and the International Monetary Systems. A Report by the Chatham House Gold Taskforce Dammasch,S. (2001).The system of Bretton Woods.A lesson from History. D'Arista, J. (2009). The evolving international monetary system. Cambridge Journal of Economics, 33(4), 633-652. Economic and Social committee of the European Union , E. a. (1978). Monetary Disorder. . Garber, P. M. (1993). A Restrospective on the Bretton Woods System: A Lesson for International Monetary Reform. The Collapse of the Bretton Woods Fixed-Rate Exchange System, 2-5. Gilpin, R., & Gilpin, J. M. (1987). The political economy of international relations, Princeton: Princeton University Press. Hall, S. G. (2009). Bretton-Woods Systems, Old and New, and the Rotation of ExchangeRates Regimes. Bretton-Woods Systems, Old and New., 3-7. Lucarelli, B. (2011). A new international Bretton Woods System?. Real-world Economics Review, (58), 83-88. Musgrave, A. (1981). Unreal Assumptions in Economic Theory, Vol. 34 Iss.3, Pg.33-37. Posen, A. S. (2008). Why the Euro will Not Rival the Dollar*. International Finance, 11(1), 75-100. Radmir, G. (1987). The Political Economy of International Relations. Princeton: Princeton University Press. Spero, J. E., & Hart, J. A. (2009). The politics of international economic relations. Wadsworth Publishing Company. Read More