Bretton Woodss Agreement - Essay Example

Bretton Woods’s agreement Name University Affiliation Introduction Bretton Woods agreement was an international monetary system agreement reached on after representatives from industrialized nations met in Bretton Woods in New Hampshire in the USA. Over 700 delegates from 44 nations attended this conference and signed the agreement. This monetary system established several rules that that could be used for commercial and financial relations among the world’s industrialized states during the twentieth century. This was the first monetary system of a fully negotiated monetary agreement that aimed to monitor the monetary interrelationship among countries (Hall, Hondroyiannis, Swamy, &Tavlas, 2010). This occurred just after World War II in the year1944. This agreement was one of the efforts put forward by the international leaders to rebuild international economic system which had been devastated by World War II. The leaders saw that it was wise for them to salvage the world economic system through collaboration. The main activities that went on during this conference were setting up rules that would be followed by each member country on monetary issues. Secondly, the conference saw the setting up of institutions that would initiate international monetary exchange. Some of the institutions that were established were; international monetary fund (IMF) and IBRD which is a world’s bank responsible for development (Hall, Hondroyiannis, Swamy, &Tavlas, 2010). These institutions started functioning in 1945 after all the member countries had ratified the agreement. Then the last activity in this conference was setting up the procedures to regulate the world’s monetary system. This was just meant to bring some orderliness and harmony in international exchange rates. This paper fuses on the main features of Bretton Woods system, what actually was contained in this agreement. It discusses the reasons why this system failed after just a few decades and what system replaced it after its collapse. The origin of the Bretton Wood agreement came due to some two main factors. First, we had the shared experiences of the great depression that occurred at around 1930. This great depression left many nations helpless; nations had great unfavorable balance of payments, budget deficit, high inflation and deteriorating economic growth (Eichengreen, 1994). Thus, every nation around the world felt this depression that is why they decided to come together to rebuild the condition through collaboration. Actually it was impossible for a country to have self sustenance during and after the depression. Therefore, the problem called for collective action to attain stability. Thus, the industrialized nations such as Japan, Germany, France, Belgium Britain, USA and many more decided to come up with this agreement. The second reason that prompted the development of the Bretton agreement was the concentration of power within just a few numbers of states. This excluded a number of important nations that could contribute a lot to the world’s economic growth. This exclusion was due to the on going war that created enmity among nations (Eichengreen, 1994). Therefore, other nations thought that it was good to create a system that is inclusive so that it can bring many nations together to enhance harmony to boost economic growth. This implies that one of the reasons for this agreement was to enhance peace among the nations. Reports reveal that the main reason why this conference was held in Bretton New Hampshire in USA was because the USA currency i.e. the dollar was the most stable currency among other world currencies. Therefore, they agreed to adopt the US dollar to be the standard measure by which other currencies would be measured against. The United States of America had a post war vision of having an international economic management so that to avoid the economic problems that had been experienced in 1930s. To ensure political, economic stability and peace, many countries complied with the USA‘s vision. This enhanced the creation and maintenance of efficient international monetary system to foster the reduction of trade barriers and capital flow among nations (Eichengreen, 1994). They agreed the vision to regulate the production of their home currencies to maintain stable exchange rates amongst themselves hence, facilitating a healthy international trade. The base of the US’s vision of the post-war was to create global free trade, maintenance of the balance of trade and maintaining fixed exchange rates that would be favorable to the capitalist system. Features of the Bretton Wood system As we have seen, the Bretton agreement had several features that were different from those of the systems before and after its collapse. One of the main features of this system is that central banks of the member countries were given the mandate of maintaining the exchange rates between their currencies and the dollar. The central banks facilitated this by intervening in he foreign exchange markets. For example, in case the country’s currency was too high as compared to the dollar, the central banks would come in and sell its currency in the exchange with the US dollar. This helped in driving down the value of its currency (Hall, Hondroyiannis, Swamy, &Tavlas, 2010). This facilitated health balance between the exchange rates between the currencies. At the same time when the value of the country’s currency was too low relative to the US dollar, the central banks would intervene by buying its own currency in exchange with the dollar. This helped in driving up the prices hence maintaining health exchange. This feature actually helped many nations to gauge its economic performance with that of the US so that it could rectify by putting necessary measures that would stabilize its economy. The second feature of the Bretton Woods system which is closely related to the first one is that all the nations around the world accepted a US dollar to be a medium of exchange. This is because it acted as a standard measure for other currencies hence it was widely accepted as a valid currency by many people (Eichengreen, 1994). As mentioned earlier, the dollar was a standard measure where other currencies were compared to unlike in the period before and during the great depression where there was a gold standard. Here, all currencies were compared relative to the gold but this standard collapsed during the great depression in 1930. Views from economists suggested the collapse of the gold standard was due to the adherence to it and this prevented the monetary authority from expanding the supply of money fast enough revitalize the economic activities especially after World War I. The third feature of Bretton system it involved in establishment of international institutions that would oversee the international exchange rates. Some of these institutions include the international bank for reconstruction and development (IBRD), International monetary fund, international finance corporation and the World Bank itself (Cesarano, 2006). All this finance institutions were established to foster the economic growth around the world. Most of their functions are to give finance aid to the nations to initiate developmental projects. Actually, the establishment of these world institutions was a great step in reviving the world economy. It was something that had not occurred in the past; therefore, these institutions were the first international institutions to be established. The fourth feature of the Bretton system is the obligation of each member state to adopt a monetary policy that would maintain the exchange rate of its own currency at a fixed value. This rate was plus or minus 1% in terms of gold exchange and the capability of the international monetary fund to cover the temporary imbalances of payments. (Cesarano, 2006). Maintenance of the fixed exchange rate was of great value to the country’s economy since it ensured that the economy grew at a stead rate like those of other countries. Moreover, the Bretton system aim was to prevent currency competition and boosting monetary co-operation amongst the member states. Under this system, the states agreed on a system of exchange rate that could be adjusted within defined levels with the dollar (Stephey, 2008). They agreed that the IMF would change the fundamental disequilibrium in the balance of payments until equilibrium is found. This was done by setting the par value system which functioned until 1971 when the system collapsed. Reasons behind the collapse of the Bretton Woods system As we have seen, the famous Bretton system collapsed after twenty five years. Since its initiation in 1944, the system functioned well but it started to encounter problems in 1960s thereafter failing in 1971 (Stephey, 2008). There are several reasons put forward by the economists that explain why this system collapsed despite its many successes in its earlier ears. One of the factors that was behind the collapse of the Bretton system was that in the late 1960s, the inflation and trade deficits in the United States were growing steadily undermining the value of the dollar. The US approached the nations whose balances of payments were favorable like Japan and Germany to appreciate their currencies. However, these nations were reluctant to do so because when they could raise the value of their currencies, they prices of their exports would rise hence reducing the exports (Stephey, 2008). The United States gave up and decided to abandon the fixed value of dollar system and allowed the dollar to float. Floating of the currency here means allowing it to fluctuate against other currencies. The value of the dollar drastically fell leading to the collapse of the Bretton system of fixed exchange rate against the US dollar to allow floating. Another reason that led to the collapse of the Bretton system was that there was the formation of gold pool which led officially to gold sales. This permitted an internal drain on gold and terminated the speculative run on gold in 1968. The private market for this gold was separated from with the official market set by the system and there was an establishment of the private floating market price and restricted that official bearers of the gold would just transact only with each other (Bordo, 2007). Historians say that in 1960s, there was the emergency of the Eurocurrency which mainly consisted of Eurodollars which were free floating dollars. These currencies were traded in uncontrollable global market. This made the task of maintaining the stable exchange rates to be quite difficult. Therefore these emerged Eurocurrency are the ones that helped in killing of the Bretton Woods system. Therefore, the establishment of private exchange of gold among the private holders contributed a lot to the collapse of the fixed system of exchange since most people preferred to use the private system which was a bit profitable than the set system(Bordo, 2007). Moreover, the foreign central banks increased the selling attacks on their currencies hence participating on the final attack on the gold; this forced the end of access to the US gold and in turn generating around of revaluations against the dollar. Years before the collapse of this system, there was huge unsustainable expansion in the US dollar which had denominated the global liquidity. There were several foreign exchange crises and some ad hoc arrangements that aimed sustaining the system (Palgrave.com). Actually these conditions could not sustain an efficient global exchange rate system. These were just some of the signs that showed that the system was already overwhelmed with obstacles and it was bound to fail. Another possible reason that led to the collapse of the Bretton system was the struggling US economy. The US had recently increased the government pending on the Vietnam War. There was rampant inflation in US a situation which worsened the balance of trade in the US (Bordo, 2007). The United States was at the same time facing a stiff competition from export oriented economies such as Germany, Japan, Taiwan and Korea. Generally, there was a relative decline of the US economy in late 1960s; bearing in mind that the US was responsible for almost 50% of the global industrial output during the establishment of the Bretton agreement. This means that it held the world’s economy and since this economy was struggling, its currency which is the dollar could easily loose value against other world currency. Hence, the fixed exchange rate failed to function. What replaced the Bretton Woods System? After the failure of the Bretton Woods system, there was an attempt to revive it through Smithsonian agreement. There was an international negotiation undertaking in the framework of group f 10. Te negotiation was held in Smithsonian institution in Washington DC in late 1971 (Cesarano, 2006). This agreement was later on formalized by the IMF. This agreement was a temporary monetary negotiation where the member state was allowed to vary the exchange rate within the margin of 2.25% on either side of the central rates of their currency alignment. Currencies appreciate where the US accepted to raise the price of gold from $35 to $38 per ounce. This was the same as devaluing the dollar by 8% (Cesarano, 2006). The second devaluation was done in 1973 by 11%. In spite of tall this effort to safeguard the system, things could not work. Therefore, the Smithsonian also failed hence leaving the currency to float against the dollar. Conclusion Bretton Woods system was an international agreement established just after World War II with the main aim of reviving the ailing world economy. History reveals that is the first international agreement of its kind that mainly concerned the economy of the world. The war and the great economic depression had actually harmed the world economy and it really begged for revival. As seen, its initiation indeed helped the world economy to stabilize where important international financial institutions were established. However, the system lasted for only two decades and collapsed again due to lack of coordination among nations. Many factors such inflationary rates, interests rates, balance of payments, and many more contributed for the collapse of the system in 1971. A lot of efforts was done to return salvage this situation but all was in vain since there are multiple intertwined factors that hindered ye process. References Bordo, M. (1993). Bretton Woods international monetary system: A historical overview. Retrieved from http://www.nber.org/chapters/c6867.pdf Bordo, M. (2007). A retrospective on the Bretton Woods System: Lessons for international Monetary reform. University of Chicago press. Chicago. USA. Cesarano, F. (2006). Monetary theory and Bretton Woods. Cambridge University press. UK. Dellas, H. (1989). International reserve currencies. International monetary fund, research department. Indiana University. USA. Eichengreen, B. (1994). The Bretton Woods System: Paradise Lost? University of California. California. USA. Eichengreen, B. (1994). History of reform of the international Monetary System. University of California. Berkeley. USA. Hall, S. G, Hondroyiannis, G, Swamy, &Tavlas, G. (2010). Bretton Woods system and old new and rotation of exchange rate regimes. Retrieved from http://www.bankofgreece.gr/BogEkdoseis/Paper2010112.pdf Iastate.edu. Bretton Woods system. Retrieved from http://www2.econ.iastate.edu/classes/econ355/choi/bre.htm Palgrave.com . The collapse of Bretton Woods. Retrieved from http://www.palgrave.com/politics/global/students/casestudies/14039_89826_Ch19_GPI_ BrettonWoods.pdf Stephey, M. J. (2008). A brief history of Bretton Woods System. Time business nd money. Retrieved from http://www.time.com/time/business/article/0,8599,1852254,00.html Read More