Features of the Bretton Woods Agreement - Coursework Example

Student Name: Student Number: Unit: International Business Unit Coordinator: Dr Assignment: 02 Topic: Due Date: Word Count: 2,291 Topic 2: Describe the most important features of the Bretton Woods Agreement. Why did the Bretton Woods ‘system’ break down and what has replaced it? Introduction Background Information Bretton Woods system, which seized operations in 1971, was the very last standard which used gold as a means of exchange (Eichengreen, 1996). It was established after World War two (WWII). The agreement to come up with a new international monetary system was discussed among allied powers even before WWII came to an end (Bloch, 1977). The negotiation in 1944 resulted to the creation of Bretton Woods Agreement. Bretton Woods is the name of a small tourist spot that is located in New Hampshire, America. It is at Bretton Woods where delegates gathered to come up with a novel global economic system (James, 1996). Their most vital goal was to prevent every country from following self centred policies for instance forming trade blocks, protectionism and competitive devaluation. It is noted that in 1930s trade blocks damaged the world economy (Coblentz, 2002, p.12). John M. Keynes was in charge of the British delegation while the US side was headed by Harry D. White who worked for the American treasury Department (Calleo & Rowland, 1973). The new system's contents were negotiated by the US and Britain. As an economic power and a dominant military the Americans took the leadership of the system away from Britain. At the time Britain was losing overseas influence and was war torn (Moggeridge, 1980, p.101). The British proposal was not accepted and the US idea was the foundation of the newly founded IMF (International Monetary Fund). The British proposal that was disallowed was to come up with a mighty settlement union for each and every country. Every country was to have an official account at the proposed mechanism and all the balance of payments (BOP) deficits and surpluses would be jotted down and settled through the aforementioned accounts. This would imply that both the shortfall and surplus countries bear the responsibility for making sure that the imbalance is corrected (Bordo & Eichengreen, 1993). However, the revolving fund which was feebler was taken up. It was coined by America. In this system, every country would contribute a given quantity (labeled "quota") to the fund and member countries which had BOP problems would borrow (or "buy" hard moneys) from this fund. This implied that only countries with deficits would be vested with the responsibility for rectifying the imbalance (Gavin, 2003). (Britain was anticipated to be a country with a shortfall at the culmination of WWII while America was anticipated to be a country with a surplus.) In the 1950s, the borrowing countries were anticipated to implement macroeconomic policies so as to trim down the shortfall. This strategy was termed as conditionality (Coblentz, 2002). The World Bank (International Bank for Development in conjunction with Reconstruction) was also established by Bretton Woods Agreement (Cordell, 1948, p. 81). The preliminary purpose of the World Bank was to aid in the reclamation of war ravaged Japan and Europe. But in real sense, the reclamation of Europe was helped by the Marshall Plan which was a large American aid program and that of Japan was helped by the American bilateral aid. The World Bank is now an organization that assists developing countries. The World Bank and IMF were denoted to as Bretton Woods sister establishments (Copeland, 2000, p. 10-35). Body Important features of the Bretton Woods Agreement The Bretton Woods Agreement features were as follows; gold based system, adjustable peg system, tight capital control and good macroeconomic performance (Gavin, 2003). The Bretton Woods Agreement was a system pegged on the American dollar. Officially, Bretton Woods System was a gold based system. All countries were run symmetrically. The IMF (International Monetary Fund) was responsible for its management. However, in reality Bretton Woods was a system dominated by America with the American dollar as the major currency (Hudson, 2003). The relationship that was there between other countries and America was highly asymmetric. The US being the center country, it provided domestic price stability which other countries were able to "import". However, it did not engage in currency intervention (this phenomenon is referred to as benign neglect; America did not care about the exchange rates, which was deemed desirable). By contrast, every other country in the system had the obligation to intervene in the currency market so as to fix their exchange rates against the American dollar (Gavin, 2003). It was an adjustable peg system. (The phrase adjustable peg system implies that exchange rates were usually fixed but allowed to be amended infrequently under various conditions. As a result, exchange rates moved in a manner that was stepwise in fashion. This was as such an arrangement to mix exchange rate flexibility and stability, while in the same breath avoiding mutually destructive devaluation) (Hudson, 2003). Countries which were members were permitted to rectify exchange rates ("parities") when "fundamental disequilibrium" was experienced. Fundamental disequilibrium however, was not clearly outlined anywhere. In the real sense, exchange rate adjustments happened to be implemented less often than imagined by the builders of Bretton Woods system. France lessened twice, UK lessened once and Germany lessened twice. On the other hand, Italy and Japan were not able to revise their exchange rates (Gavin, 2003). Bretton Woods' capital control was deemed to be tight. This was a very big difference from Classical Gold Standard that existed in 1879-1914. During the aforementioned period there existed free capital mobility (Ronald, 1996). Although Germany and the US had in place relatively less capital-account regulations, the other countries had in place severe exchange controls (Gavin, 2003). Bretton Woods' macroeconomic performance was splendid. In particular, high growth and global price stability were simultaneously reached under the deepening trade liberalization. There was stability in prices that were tradable from mid 1950s to late 1960s which was internationally common and almost perfect (Eichengreen, 1996). The macroeconomic achievement was deemed as archeologically unprecedented. Bretton Woods 'system' break down A number of reasons have been floated to explain the demise of the Bretton Woods' system. The first reason would be the nominal anchor problem (William, 2001, p. 295-323). The American monetary order played the role of Bretton Woods system's nominal anchor. But during the period when the United States' economy started to experience inflation, it followed that the international monetary system based on the dollar started to disintegrate (William, 2001, p. 295-323). A step by step explanation of the US inflation is given in the paragraphs that follow. 1950s was a time of dollar shortage (Copeland, 2000, p. 10-35). Japan and Europe had the desire to increase imports. This was due to their bid to recover from war damage. But the American dollar was the only internationally acceptable currency. Due to this their import capacity was greatly limited by the presence of foreign reserves that denominated in American dollar (Gowa, 1983). However, there existed a dollar over supply (dollar overhang) in the world economy by the 1960s. This turnaround was as a result of the American balance of payments shortfall. The shortfall was caused by an expansionary fiscal policy (William, 2001, p. 295-323). The US's spending increased for the following reasons; welfare expenditure, war in Vietnam and space race with USSR (send humans by 1960 to the moon). In the years 1950s, the need to come up with a new international currency was felt by the IMF (International Monetary Fund). This was to supplement the dollar. The international conciliation took a very long time. Also the artificial currency (Special Drawing Rights ) was crafted in 1969 (Ronald, 1996). It goes by the acronym SDR. By 1969 there was no dollar scarcity. Today SDR is used as the IMF's accounting unit. The American domestic inflation started to accelerate in the mid 1960s (Geir, 1986, p.263-277). The inflation lay a strain on it. During the period in which the US was providing price stability, the other countries were open to giving up monetary policy independence and as such peg their currencies to the dollar (Ronald, 1996). Through the aforementioned operation, their price levels were stabilized. But when the United States started to have inflation, the other countries slowly refused to import the dollar. As such the dollar experienced a downward pressure (Edward & Robert, 1973, p. 105-107, 124-135). The fixed connection between gold and dollar was thrown out in 1968. There was the introduction of two-tier pricing of gold. This was where the official gold dollar exchange rate was de-linked from that of the gold's market price. The dollar's market price depreciated immediately. This was the same as the situation of several exchange rates; an overvalued official rate against a depreciated market rate (Cohen, 2000). At last, in 1971, the fixed connection between the dollar and other currencies and was discarded. The then president of the United States declared that the US would not sell gold to foreign central banks against the dollar anymore (Elliott & Atkinson, 2008, p. 6-15, 72-81). The move by America completely terminated it. As a result key currencies started to hover. Another explanation (the second explanation) of its decline was given by Professor Triffin. He argued that the system was bound to collapse since there was a fundamental liquidity dilemma in which some country's national currency was utilized as international currency (William, 2001, p. 295-323). He argued that as the world economy became larger, more global money (dollar) was needed. To provide that, America had to run a BOP (Balance of payments) shortfall. But if the US continued to run a deficit then it would lose its credibility as a sound currency country (Odell, 1982). The quantity of gold that it had would soon be way less than the amount of dollars that would be held by various countries. This implied that the United States could not guarantee conversion of dollars (available internationally) into gold, if each and every foreign central banks cashed in (Pollard, 1985, p.8). For there to be global liquidity, America had to run a shortfall. But to ensure credibility, America is not supposed to run a shortfall. The aforementioned was the fundamental problem. The dilemma was not solved as the United States chose to run a balance of payments deficit, which led to the loss of credibility and the eventual disintegration of Bretton Woods system (William, 2001, p. 295-323). Replacement of Bretton Woods System Floating exchange rates replaced it (William, 2001, p. 295-323). Since its collapse, the members of IMF have been open to choose any exchange arrangement they deemed appropriate (with the exception of pegging their currency to gold); they permitted the currency to float freely. They pegged the currency to a basket of currencies or to another currency, they then adopted the currency of another country, which participated in a given currency bloc and as such formed part of a given monetary union (Gavin, 2003). Many were scared that the disintegration of the initially utilized Bretton Woods system would result in the end of the rapid growth period. This was far from the truth since the transition to floating exchange rates went smoothly and it was noted to be a timely occurrence due to the demise of the System. The flexible exchange rates led to easy adjustment for economies to the more expensive oil (Clyde, 2003), during the period when there was an increase in its price (October 1973). Floating rates have such facilitated adjustments to any occurring external shocks (Clyde, 2003). The IMF also picked up after the disintegration of the System. It did this by reacting to the oil shock of the 1970s by adjusting its lending instruments (Ronald, 1996). IMF set up the very first of the two oil facilities to aid oil importers deal with anticipated current account shortfalls in conjunction with inflation in sight of higher oil prices (Ronald, 1996). Also from the mid-1970s, the International Monetary Fund sought to react to the difficulties of balance of payments that faced a number of the world's poorest countries through concessional financing via what was named the Trust Fund (Cohen, 2000). Later on in March of 1986, International Monetary Fund also started a novel concessional loan program that was named Structural Adjustment Facility (SAF) (Cohen, 2000). In December of 1987 the SAF was succeeded by another concessional program; Enhanced Structural Adjustment Facility (Pollard, 1985, p.8). Conclusion International trade led to the formation of the Bretton Woods system (Eichengreen, 1996). The system was to ensure that world trade was standardized through a uniformly accepted currency which was the American dollar. Bretton Woods system which was started in 1944 (New Hampshire America) was the final gold exchange standard (Eichengreen, 1996). It started being used at the end of World War II and was led by America. Apart from ensuring the standardization of international trade its other vital goal was to prevent every country from pursuing self centred policies for instance protectionism, competitive devaluation and forming trade blocks (Coblentz, 2002, p.12). The agreement also saw the creation of the International Monetary Fund which managed the Bretton Woods system. It had the following main features; gold based system, adjustable peg system, tight capital control and good macroeconomic performance (Gavin, 2003). A gold based system means that gold was used in exchange of the dollar. An adjustable peg system implies that exchange rates were usually fixed but allowed to be amended infrequently under various conditions. A tight capital control implies that there was stringent exchange controls in place. Good macroeconomic performance implies that there was stability in in prices that were tradable from mid 1950s to late 1960s which was globally common and almost perfect (Cohen, 2000). The system later collapsed due to a balance of payment deficit experienced by the US and a nominal anchor problem (Pollard, 1985, p.8). Bretton Woods system was succeeded in the 1970s by a floating exchange rate system (William, 2001, p. 295-323). Reference List 1. Bloch, F.L. (1977). The Origins of International Economic Disorder. Berkeley and Los Angeles: University of California Press. 2. Bordo, M.D. & Eichengreen, B. (1993). A Retrospect on the Bretton Woods System: Lessons for International Monetary Reform. University of Chicago Press 3. Calleo, D.P. & Rowland, B.M. (1973). America and the World Political Economy. Bloomington, IN: Indiana University Press 4. Clyde, P. (2003). Rogue Nation. Oxford University Press 5. Coblentz, B. (2002). America, Russia and the Cold War. New York, p.12 6. Cohen, B.J. (2000). Bretton Woods System. Retrieved April 17th 2013 from www.polsci.ucsb.edu 7. Copeland, L. (2000). Exchange Rates and International Finance. Prentice Hall, p. 10-35 8. Cordell, H. (1948). The Memoirs of Cordell Hull. New York: Macmillan Press, vol.1, p.81. 9.Edward, M.S. & Robert, A.E. (1973). The World Bank Since Bretton Woods. Washington D.C The Brookings Institution, p. 105-107, 124-1357. Eichengreen, B. (1996). Globalizing Capital. Princeton University Press 10. Elliott, L. & Atkinson, D. (2008). The Gods that Failed: How Blind Faith in Markets Has Cost Us Our Future. The Bodley Head Ltd, p.6-15, 72-81 11. Gavin, F.J. (2003). Gold, Dollars and Power-The Politics of International Monetary Relations, 1958-1971.The University of North Carolina Press 12. Geir, L. (1986). Empire by invitation? The United States and Western Europe, 1945-1952. Journal of Peace Research. vol.23, No.3, p.263-27710. 13. Gowa, J. (1983). Closing the Gold Window: Domestic Politics and the End of Bretton Woods. Ithaca, NY: Cornell University Press 14. Hudson, M. (2003). Super Imperialism: The Origin and Fundamentals of US World Dominance. London & Sterling: Pluto Press 15. James, H. (1996). International Monetary Cooperation Since Bretton Woods. Oxford University Press, USA 16. Moggeridge, D. (1980). The Collected Writings of John Maynard Keynes. London: Cambridge University Press,vol.26, p.101 17.Odell, J.S. (1982). U.S. International Monetary Policy: Markets, Power and Ideas as Sources of Change. Princeton, NJ: Princeton University Press 18. Pollard, R.A (1985). Economic Security and the Origins of the Cold War, 1945-1950. New York: Columbia 19. Ronald, M.I. (1996). The Rules of the Game: International Money and Exchange Rates. MIT Press , p.8 20. William, G. (2001). Floating the System: Germany, the United States and the Breakdown of Bretton Woods, 1969-1973. Prentice Hall, p.295-323 Read More