The Bretton Woods Agreement - Thesis Example

The Bretton Woods agreement Insert Name Course, Class, Semester Institution Instructor Date The Bretton Woods agreement What were the foundations of the 1944 Bretton Woods Agreements? This query has fascinated many economists because of the influence these Agreements consequently had, and continue to have, on the development of the post-war global economic system. The Agreements were particularly significant in outlining a novel ‘embedded liberal’ idea that sought a central way between classical global liberalism and the new more domineering economic ideas that had become powerful across the world during the 1930s (Shamah, 2003). While embracing a many-sided financial order of steady currencies and current account convertibility, the Bretton Woods planners supplemented market mechanisms by putting up publicly-controlled global financial institutions to offer short-term balance of payments sustain and long-term investment capital (Andrews, 2008). Their approval of capital controls and exchange rate alteration also provided greater policy sovereignty for governments to follow more interventionist domestic policies. For a period of three weeks, between 1 and 22nd of July 1944, 730 delegates from the 44 allied nations gathered at the Mount Washington hotel in Bretton Woods to establish a system that could bring about reconstruction to the international monetary system. The agreement that was to be made was a comprehensive agreement referred to as the Bretton Woods agreement, a system that would peg the currencies of the states to the US dollar (McEachern, 2009). The agreement was centered on the financial relations among the key industrial states in the mid-20th century. The results of the conference saw the institution of the international bank for reconstruction and development and the international monetary fund. The international bank for reconstruction is currently part of the World Bank group, but IMF still remains. The agreement gave the IMF power to intervene in the event that two states differed on current account transactions. The most prominent feature of the Bretton woods agreement was an obligation for all countries to adopt a monetary policy that fixed the foreign exchange rate in relation to the United States dollar. Apparently, in 1944, the United States had control of well over 50% of the worlds manufacturing capacity (Kim, 2011). Additionally, the country had the most of the country’s gold. It is important to note that gold has been set as the economic standard after the World War I, but had failed as the central factor of the international monetary system. The US dollar was deemed the most effective currency against which all other currencies could be pegged as it was relatively stable at the time. Many economists have tied the use of the US currency to the fact that the United States was not actively involved in the second armed conflict of the world. For most of the time, the United States remained neutral. The second most important feature of the agreement was the formation of the international monetary fund, commonly referred to as just the IMF, and the international bank for reconstruction and development. The international bank for reconstruction and development, now part of the World Bank group was instituted for the sole purpose of ensuring the countries that had been destroyed by the war get back on their feet and start over again by fixing the faults that the war had caused in their economies. It is particularly important to mention that the economies of most nations were hurt by the war as most funds were dedicated to the war and even the human resources committed to the conflict diverting the countries’ reconstruction energies away. The international bank for reconstruction was aimed at offering loans to the devastated nations, so that they could afford to strengthen their currencies and economies without much hassle. The third feature of the Bretton Woods agreement was that it lay down the infrastructure for international trade especially in the capitalist west. The Bretton Woods agreement focused on the capitalistic economies since these were the countries that were allied to the biggest capitalists – the United States of America (Carbaugh, 2011). The international relations and trade were made possible through the ultimate liberalization of both trade and capital account. Such liberalization efforts saw that countries go beyond their borders to engage in export and import trade. It is particularly important to note that the Bretton Woods agreement was signed at the world war was at its peak. The countries had been wasted in the war and since no country is self sufficient, most of them were in dire need of imports. Essentially, the countries in the capitalist west were allies in the war, and reconstructing trade among them was not a hassle. The Bretton woods agreement established the convertibility of the currencies. The otherwise fixed currencies were subjected to what is referred to as the pegged exchange rate. The convertibility was done, with the US dollar being the central point of reference. The currencies were converted according to how many dollars they were worth. This meant that no currency was supposed to appreciate so much as to surpass the United States Dollar. In the event that that happened, the central bank of the country concerned had to buy back its currency to the extent that it had to fall below the US dollar (Lien & Lien, 2009). This was essential for the countries as they had to maintain their export and import trade. A country that let its currency surpass the United States dollar only worked to hurt its imports and consequently creating a balance of trade deficit. The Bretton woods agreement pegged the international monetary system to the gold standard. The gold standard centered the gold as the reserve currency. The agreement fixed the exchangeability of the United States dollar to the gold standard at 35 dollars per ounce (Eichengreen, 2007). Gold was selected because in the post first world war period, all nations had agreed on using gold as a reserve currency following its intrinsic value and lack of possibility to fluctuate against other currencies. The gold standard was the reason why the US dollar was selected. Fundamentally, the US dollar was the most stable currency considering that the country’s resources had not gone to significant waste as had the currencies of other countries. Liberalization of the capital account and international trade relations saw the foreign exchange rate liberalized with the international monetary system giving prominence to the central banks of the countries concerned. Article IV is another prominent feature of the Bretton woods agreement. The Bretton woods argument, according to this article, required that a member country could only change the par value of its currency so as rectify a fundamental disequilibrium. At the time of joining the Bretton woods agreement, the countries submitted the par values of their currencies. Submitting such par values could enable the fund make a follow-up of the currency so as to determine when to allow a change in the value. There could be no objection to a change in the par value, if the supposed change was below 10%. Article VI is another notable feature of the Bretton woods agreement. The article allows the member countries to exercise control over their capital accounts. Such control extended to capital accounts held in foreign countries. These articles related to most common changes that could be made to affect the value of the currency. The currencies’ fluctuation and adjustments were determined by these two articles. According to article VII, the fund may declare a currency scarce. Such powers of the fund further enabled the fund to authorize the member countries associated with the scare currency to impose exchange control on the scarce currency. According to many economists, there is a big weakness in this article. The primary weakness lies in the fact that those countries with favorable balance of payments do not adjust their currencies (Helleiner, 2010). In the 1920s for instance, the Great Britain did devaluate its currency, but the favorable balance countries such as the United States and France did not fluctuate or duly adjust their currencies. Article VIII forbids all member countries to exercise restriction on current account balances. In furtherance of the requirements of this article, all member states are obligated to keep the convertibility of foreign held balances on current account. The Bretton woods agreement was to be made effective by the central banks of the various countries represented. The countries represented recognized the need to have a stable export import trade. The exports could be at risk, if the currency of the country appreciated to go beyond the United States dollar (Bordo, 1993). On the contrary, the countries could expand their export capacity by simple devaluation of the currency. Such measures as well kept a check on inflation in the concerned economies. The countries concerned had to look up to the central bank to devaluate the currency in such a manner that the US dollar remained superior( Hammes & Wills, 2003). Inflationary effects were being felt in most western countries including the United States because of the war. This hurt the United States whose currency was fixed. The United States struggled to have its currency perform better but it was impossible considering that the Bretton agreement required it to remain fixed so as to create the much needed stability in the international monetary system. Attempts to work with Japan and Germany so as to improve he currency did not succeed, and this led to the Nixon Shock. The Nixon shock came when the United States floated its currency, making it a fiat currency. The end of the Bretton Woods agreement The Nixon shock marked the end of the Bretton woods agreement. The decision by President Nixon to have the United States currency operate as a floating currency saw the United States dollar fluctuate with changes in the changes in other currencies (Dooley et al, 2003). Apparently, the united states dollar was in dire need of adjustments that would seethe United States compete and trade freely with such countries as the great Britain whose currency had remained floating for the whole period. The GBP had gained so much prominence as the most valued currency. The decision by the United States to make the US dollar a floating currency made the US economy operate with what economists refer to as a fiat currency. A fiat currency is one that is basically determined by the government (Eichengreen, 2004). Fiat currencies have a face value but no intrinsic value. The United States dollar became fiat as the central bank took to control the rate at which the currency exchanged with changes in other currencies. Efforts to revive the agreement, such as the Smithsonian agreement failed because the United States was too indebted following involvement of the war, especially during the final days of the war. The main reason why the United States had to opt for the floating currency state is essentially because the country had failed to come to an agreement over various capital account transactions and the trade agreements (Ajami, 2006). The fall of the Bretton Woods agreement saw the coming in of the managed float regime. As a matter of common knowledge, a float regime is one in which the currencies freely fluctuate against others according to changes in such conditions as inflation. Inflation makes a currency lose value and exchange at poor rates in relation to other currencies. Speaking of an absolute float regime would mean that the system could allow for free changes, without checks and balances (Hägele, 2010). The checks and balances can be introduced to bring what economists refer to as the controlled or managed float regime. A managed float regime is one in which there is a body governing the exchange rates among the currencies. In the post Bretton Wood agreement period, the central banks took over the full control of the various currencies. The liberalization of trade across the world saw the central banks assume the role of controlling their domestic currencies as a measure to reduce changes of a hurt international economy (Roubini & Setser, 2005). The banks in the post Bretton wood agreement period took it upon themselves to oversee the controlling of the inflation rate. Ultimately, the central banks sought to protect a countries export trade while mitigating chances of importing inflation along with the many goods that came from countries experiencing the same. What the central banks were required to do in order to maintain the stability of the currencies is to buy and sell their own currencies depending on the fluctuations (Northrup, 2003). When the currency appreciated too much, the central bank could buy the domestic currency because essentially, when a currency appreciates too much, there are chances that the exports will appear too expensive to other countries, and hence will not be bought. This will bring a situation of unfavorable balance of payments. The collapse of the Bretton Woods agreement marked the beginning of the system that is in place to this day. Currently, with liberalism being a wide spread concept central banks are prominently controlling the rate at which the currency trades in relation to other currencies (Dooley et al, 2004). A fixed system cannot effectively serve the nature of foreign trade. This upholds the decision to replace the Bretton Woods system with the controlled or the managed float regime. References Ajami, R. A. (2006). International business: Theory and practice. Armonk, N.Y: M.E. Sharpe. Andrews, D. M. (2008). Orderly change: International monetary relations since Bretton Woods. Ithaca: Cornell University Press. Arnold, R. A. (2010). Microeconomics. Mason, OH: South-Western Cengage Learning. Bordo, M. D., Eichengreen, B. J., & National Bureau of Economic Research. (1993). A Retrospective on the Bretton Woods system: Lessons for international monetary reform. Chicago: University of Chicago Press. Brigham, E. F., & Houston, J. F. (2009). Fundamentals of financial management. Mason, OH: South-Western Cengage Learning. Carbaugh, R. J. (2011). International economics. Mason, OH: South-Western Cengage Learning. Dooley, M. P., Folkerts-Landau, D., & Garber, P. (2003). An essay on the revived Bretton Woods system (No. w9971). National Bureau of Economic Research Dooley, M. P., Folkerts‐Landau, D., & Garber, P. (2004). The revived bretton woods system. International Journal of Finance & Economics, 9(4), 307-313. Eichengreen, B. (2004). Global imbalances and the lessons of Bretton Woods.Economie internationale, (4), 39-50. Eichengreen, B. J. (2007). Global imbalances and the lessons of Bretton Woods. The MIT Press Hägele, K. C. (2010). The Bretton Woods System of Fixed Exchange Rates - Theoretical Background and its Development. München: GRIN Verlag. Hammes, D., & Wills, D. (2003). Black gold: the end of bretton woods and the oil price shocks of the 1970s. Available at SSRN 388283 Havrylyshyn, O., Nsouli, S. M., & International Monetary Fund. (2001). A decade of transition: Achievements and challenges. Washington, DC: IMF Inst. Helleiner, E. (2010). A Bretton Woods moment? The 2007–2008 crisis and the future of global finance. International Affairs, 86(3), 619-636. Kim, K. A. (2011). Global corporate finance: A focused approach. Singapore: World Scientific. Lien, K., & Lien, K. (2009). Day trading and swing trading the currency market: Technical and fundamental strategies to profit from market moves. Hoboken, N.J: John Wiley & Sons, Inc. McEachern, W. A. (2009). Macroeconomics: A contemporary introduction. Mason [Ohio: Thomson/South-Western. Northrup, C. C. (2003). The American economy: A historical encyclopedia. Santa Barbara, Calif: ABC-CLIO. Roubini, N., & Setser, B. (2005). Will the Bretton Woods 2 regime unravel soon? The risk of a hard landing in 2005-2006. Unpublished manuscript, New York University and Oxford University, 6. Shamah, S. B. (2003). A Foreign Exchange Primer. Chichester: John Wiley & Sons. Read More