Bretton Woods System - Assignment Example

Question US dollar has relished a hegemonic position in international monetary system after Second World War. This special treatment was the resultof Bretton Woods conference and the system that evolved in turn. This conference established a global financial system in 1944 which primarily determined the international foundation for exchange rates. This conference specified the system under which one currency will be exchanged for another. Bretton Woods system also provided basis for the creation of an international financial institution that came up in the form of International Monetary Fund later on many institutions such World Bank, World Trade Organization and International Trade Organization came to being under this regime (Andrews). Bretton Woods system was introduced to fight the postwar crises and fund reconstruction of economies and international trade. In this regard 44 member states participated and settled to fix exchange rates by pegging their currencies to the US dollar. This instance for pegging currencies to US dollar was in contrast to the postwar crisis of First World War where gold standards for exchange rates led to more crises and ended up with great depression (Stevenson). Pegging currencies to US dollar was to avoid previous experiences. Besides, financial stability of United States of America then was another factor for pegging currency as $1 equated to 35oz. of bullion and this equation was ensured by US government. Harry D. White from United States of America and J.M Keynes: A great economist from Britain were the key player of these negotiations. Bretton Woods system altered the global financial and economic ills and helped controlling blockade of imports and exports by manipulating exchange rates of currencies (Steil). Adjusted peg rates helped overcome depression, devaluation and deflation caused by the warfare. The Bretton Woods system was based upon three pillars. First pillar was expansion of international trade which involved liberalization and openness of economies, second pillar relied upon adjusted peg rates for exchange of currencies. This objective was achieved with the administrative help of IMF. The third pillar targeted recovery and development of economies from depression and destruction. In Bretton Woods negotiations, an institution under name of International Trade Organization was proposed to handle liberalized trade but the motion could not succeed as USA didn’t supported the resolution. In 1947, same institution was established as General Agreement on Tariffs and Trade (GATT) with similar objectives and was ratified by 23 nations which now a days has transformed into World Trade Organization. GATT was established under Bretton Woods regime to enhance economic cooperation between member states and since then has extended its operations not only in trade disciplines but also in riles for employment, mutual and bilateral agreement, international investment scenarios and in business practices etc. After Second World War, what economies needed was a boost which was provided by GATT in the form of tariff cuts (Whalley). Since the great depression many economies were operating under protectionism while Bretton Woods Agreement succeeded to liberalize trade. Since then trade organizations have been actively participating in removal of tariffs and concessions on trade. Second pillar of exchange rate adjustment was derived from the limited expansion of economies under gold standard regime. Gold for exchange rate determination prevented monetary growth and circulation in 1930s which contained money in the market and hence economic activities could not be produced. Keeping in view the limitations, international monetary regime of Bretton Woods agreement decided to peg world currencies to dollar which at that time had promising gold reserves. In this regard central banks were required to maintain fixed exchange rate in contrast to dollar which was only possible with intervention in foreign exchange markets through certain adjustments. Highly appreciated currencies were sold against dollar to maintain fixed exchange rate while devalued currencies were bought out of the market in exchange for dollar. In this struggle for capital controls, IMF played a significant role by financing the balance of payment deficits and by avoiding disequilibrium in economies of member states. Member states were required to keep their reserves at IMF with allocative percentage standing at 20% gold and 80% dollars or the equivalent amount of domestic currency to dollars for global financial stability. In order to ensure consistency, frequent exchange rate adjustments were prohibited whereas IMF provided technical and administrative oversight to this doctrine. Bretton Woods system served the third pillar by marvelous recovery and development of global economies within no time (Eichengreen). Given the circumstances of Second World War, this global financial system helped price stability, capital control and perused development around the globe which was desperately needed. Unfortunately this regime could not keep up the pace of immense growth and tumbled down within two decades. Question 2 The Bretton Woods system provided a platform for growth and development under pegged dollar but in the later part of 1950s, it started to perish. The problem started due to dollar shortage, since all other nations except US could adjust their currencies in case of financial uncertainty. On the other hand US was bound to keep up with the pegged gold while in the face of extending global demand of dollars, it failed to maintain its demand. Apart from global challenges and requirements, American economy itself had expanded enormously, consumers were better off if compared to the postwar scenario, their life style was improved, and their consumption patterns were accelerated. Another most important issue which caused dollar problems was the US military intervention in Vietnam War. It is evident from historical events that intervention in war leads economies to bankruptcy and that is what exactly happened to US dollar. Dollar lost the strength and competitive ground on which this international monetary system was designed in Bretton Woods agreement (Mundell). In 1960s, US dollar up against global powers such Japanese yen and Britain sterling seemed overvalued while exchanging other currencies through pegged dollar put other currencies under crises as sterling crisis is worth mentioning here which worsened the survival of Bretton woods regime. Euro dollar market crisis had shaken the growing economy of Europe which was handled through imposing cuts on sterling usage for international transactions rather dollar was preferred. Though Europe survived the crisis but in turn demand for dollar climbed unexpectedly causing more trouble for America which in the following year caused dollar crisis in America as the relationship ratio between dollar and gold had been disturbed. American government reacted to this crisis instantly and imposed policies for restraining capital movement of dollar. These policies to control circulation proved helpful as people preferred holding dollar in hand than to circulate. Unfortunately such regulatory tools proved short in controlling the crisis which led US economy to taste balance of payment deficit after decades in 1971 (Subacchi, Paola and Driffill). US economy was in deep disaster when President Richard Nixon announced demise of this international monetary regime. Many efforts were made to revive the system by international financial players but US declined to continue the Bretton Woods agreement any further. Somehow, all powers accepted the transition by 1973 but no surprise that the transition of international monetary regime ended up so badly since stock prices went to the ashes, oil prices were handshaking to the sky, inflation and bank failures characterized the dramatic demise. United States of America due to dollar crisis was at the brink of its hegemonic collapse while it decided to maintain its position in the global financial world rather than fulfilling the agreement and wait for its economy to decay. Question 3 Dollar crisis of 1980s was the result of long term commercial borrowing, loans and grants which were given to developing countries under Structural Adjustment Loans and in turn when developing countries failed to repay the loan, crisis went wild. It was not just the debt crisis rather multiple events led to it while debt crisis is one aspect and the second aspect is the tight monetary policy of USA. Numerous syndicated loans were granted to developing countries which mostly had primary resource economy, financial institutions considered it more profitable and safe to reinvest accumulated capital of OPEC countries and were expected to grow rapidly. In contrast to expectations many economies in Europe, North America or even in Asia were facing stagflation which eliminated the rational growth whereas inflation kept growing. Another aspect of this debt crisis was the conditionality imposed by financial institutions which forced developing countries to employ tight monetary and fiscal policies and as a result led to unavailability of developing nations to pay back (Sterling-Folker). In the start of 1980s, America Federal Reserve initiated tight monetary policy to rule out the inflation from the economy. As a result dollar interest rate went sky rocket. Higher interest rates helped US to cope up with inflation but for developing economies under financial loans, it was a nightmare that in weeks their loan payments rose abruptly. Since recession hit the global economy, the exports of developing economies fell and balance of trade went to negative because dollar had appreciated unexpectedly. This irony forced developing countries to declare their unavailability to repay the loan. If we look at the 2010 dollar crisis, it has been caused by the debt crisis of 2008. In order to cope up the liquidity demands of the economy and to earn the interest of investors, US Federal reserve printed more and more money whereas interest rates were kept nearly to zero to boost economic activity (Practising Law Institute). Treasury bills were sold at only 1% interest rate which were once sold at 16% interest rate in 1981. As a result savers around the world have been punished by devalued currency whereas holding US dollar was highly unlikely. Almost all countries around the world have pegged their currencies to dollars for international transactions which by the crisis are forced to face double dip recession caused by debt crisis of 2008. Question 4 International Monetary Fund is an international financial institution established by the Bretton Woods agreement in 1944 and now it has been respected by around 188 countries who seeks services of IMF for global monetary cooperation, international trade, economic growth, poverty reduction, for maintaining financial stability and for deficit financing etc. IMF has survived even after the collapse of Bretton woods regime and has lead global economies through many crises to stability and sustainable growth (Ghosh, Dilip and Edgar). IMF has expanded its operations with the passage of time from economic monitoring and development to lending funds for financial imbalances and also provides technical assistance and training along with financial assistance. IMF proved to be helpful in providing financial assistance to number of developed nations to cope up with their shortfalls. Involvement of IMF has not always been successful as in Structural Adjustment Programs (SAPs) and Structural Adjustment Loans (SALs) failed with serious consequences to world economic stability during 1980s and 1990s (Arestis, Philip and Ferreiro). IMF has also been blamed for its biased policies towards developing countries as compared with developed nations. In many of the evaluation report, IMF has also been charged with incompetence because IMF has failed consistently to identify and assess the upcoming financial crisis and risk rather IMF has led economies to such crisis. During 1980 and 1990s, IMF disbursed and managed funds poorly while incompetent and inaccurate financial models were enforced with conditionality which ended up drastically causing more burden of loan to recipient countries. During its monetary practices, IMF has been characterized by its bullying attitude towards poor countries where as role of IMF is to enhance sustainable growth and develop cooperation. No doubt, IMF has the potential to overlook the risks and manage risks in time but their ability to mount risks has been stalled by the mindset to protect developed nations and advanced economies (Amato, Massimo and Fantacci). Such political constraints have contained effective and transparent governance of IMF which is an early recall for another great depression and needs to be taken objectively otherwise the consequences will be beyond imagination. References Amato, Massimo and Luca Fantacci. The End of Finance. Cambridge: Polity, 2012. Andrews, David M. Orderly Change: International Monetary Relations Since Bretton Woods. Ithaca: Cornell University Press, 2008. Arestis, et al. Financial Developments in National and International Markets. Hampshire: Palgrave Macmillan, 2006. Eichengreen, Barry J. Globalizing Capital: A History of the International Monetary System. Princeton: Princeton University Press, 1996. Ghosh, Dilip K., K. Ghosh Dilip and Ortiz Edgar. The Global Structure of Financial Markets: An Overview. Hoboken: Taylor and Francis, 2013. Mundell, Robert A. "The Future of the Exchange Rate System." Economic Notes (1995): 453-478. Practising Law Institute. Financial Crisis Fallout 2010: Emerging Enforcement Trends. New York: Practising Law Institute, 2010. Steil, Benn. The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order. Princeton: Princeton University Press, 2013. Sterling-Folker, Jennifer A. Theories of International Cooperation and the Primacy of Anarchy: Explaining U.s. International Policy-Making After Bretton Woods. Albany: State University of New York Press, 2002. Stevenson, Jonathan. Preventing Conflict: The Role of the Bretton Woods Institutions. Oxford: Oxford University Press, 2000. Subacchi, Paola and John Driffill. Beyond the Dollar: Rethinking the International Monetary System. London: Chatham House, 2010. Whalley, John. "Assessing the Benefits to Developing Countries of Liberalisation in Services Trade." World Economy (2004): 1223-1253. Read More