Important Features of the Bretton Woods Agreement - Case Study Example

Bretton Woods Agreement [Name] [Professor Name] [Course] [Date] Abstract: The Bretton Woods system refers to an international monetary structure of fixed exchange rates that was initiated by Britain and the United States in 1944. It is widely understood to denote the global monetary system that existed from the Second World War to 1970s (Eichengreen, 1995). The arrangement represented the world’s first ever wholly negotiated monetary system whose design was intended to regulate currency relations of independent states. It integrated bilateral decision making with binding legal obligations enabled through IMF, which had supernatural authority. In principle, the subsequent effectiveness and the ultimate disintegration of the Bretton Woods Agreement directly relied on the policies and influences of its most powerful member state, the United States (Calleo and Rowland, 1973). This paper describes the most influential features of the Bretton Woods Agreement and the reasons underlying its eventual disintegration. Bretton Woods Agreement: Features The Bretton Woods system refers to a global monetary structure of fixed exchange rates that was initiated by Britain and the United States after the World War II. It came about when nations sought to revitalize the gold standard after World War I, although it collapsed completely in the course of the Great Depression of the 1930s (Cohen, n.d.). In 1944, delegates of the leading industrial nations later met in Bretton Woods in New Hampshire to formulate a global monetary system (Bloch, 1977). Bretton Woods system established the financial and commercial regulations among the top industrialized nations in the mid-20th century. As a landmark monetary management system, it was the foremost example of a fully-fledged negotiated monetary order that was designed to regulate monetary relations amongst the world’s sovereign states. Indeed, a number of regulatory systems, procedures and institutions aimed at regulating the global monetary system were borne out of the Bretton Woods (Markwell, 2006). For instance, the International Bank of Reconstruction and Development (IBRD) and the International Monetary Fund (IMF) were established by policymakers at the Bretton Woods became immediately operational in 1945 following ratification of the agreement by a number of countries (Eichengreen, 1996). The primary attributes of the Bretton Woods System included the requirement that each country had an obligation to implement a monetary system that would maintain the exchange rate by relating its currency to that of the United States dollar as well as IMF’s ability to close the momentary imbalance of payments (Van, 1978). As set out by the Bretton Woods System, each country’s central bank, aside from the United States, was charged with upholding fixed exchange rates between the dollar and their respective currencies. To ensure this, each country had to mediate in foreign exchange markets. In case a country had a currency that was relatively higher than the U.S. dollar, its central bank would sell off its currency in return for the U.S. dollars, thus pulling down the value of its currency. On the other hand, if the value of the money held by a particular country was relatively lower than the U.S. dollar, then the country would have to purchase its own currency, thus shoveling up the price. Another feature of the Bretton Woods System was adjustable and stable currency rate. For nearly 25 years following the World War II, this international monetary system was based on adjustable and stable currency rates. This meant that the exchange rates were not rigid as they are faced with periodic devaluations of individual currencies, which would correct the basic disequilibria in the BP (balance of payment) (McKinnon, 1993). An additional feature includes the loss of national sovereignty. Once the nations signed the agreement, they were obligated to submit their exchange rates to international regulators. This resulted to a substantial submission of national independence to international agencies. Further, Bretton Woods Agreement represented the world’s first ever wholly negotiated monetary system whose design was intended to regulate currency relations of independent states. It integrated bilateral decision making with binding legal obligations enabled through IMF, which had supernatural authority. In principle, the subsequent effectiveness and the ultimate disintegration of the Bretton Wood Agreement directly relied on the policies and influences of its most powerful member state, the United States. Next, the Bretton Woods System was characterized by its advantages over gold currency standards. With this regard the system’s deflationary policy, nations had to opt for the classical remedy of deflating domestic economy whenever they were confronted with chronic balance of payment deficits. Indeed, before the Second World War, nations across Europe such as Great Britain often applied the policy. Despite the fact that few currencies could be converted into gold, policymakers perceived that the currencies would be backed up by gold (Hondroyiannis, Swamy and Tavlas, 2009). In the adjustable peg system, politicians would no longer comply with the concepts of gold standard. In addition, they were required to limit their domestic supplies or deficits, and where circumstances permitted a reduction in the nominal value of their money, it was imperative that the nation should devalue up to 10 percent following the formality of securing the permission of other nations. This was referred as the adjustable peg system. Bretton Woods system also practiced devaluation. In all, this adjustable peg was perceived as an immense upgrading of the gold exchange standard that had a fixed parity. This means that currencies would be converted into gold although unlike the gold exchange standard, nations had the capacity to alter par values of their currencies. Consequently, Bretton Woods System was dubbed “the opposite of gold standard. Within the Bretton Wood system, the United States was recognized as the hub of the region with basically unregulated capital goods or market. Japan and Britain whose economies had been destroyed by the Second World War comprised the emerging periphery. These countries selected a development strategy of undervalued currency, accumulation of reserves, capital flows and utilization of the centre as s financial mediator that loaned credibility to their individual financial systems. In exchange, the United States issued long-term loans to the periphery through the FDI. The obligation to maintain exchange rate within a specified fixed value, for instance minus or plus 1 percent, with regard to IMF’s ability to close temporary BPS and gold. Despite the rising financial constraint, the system collapsed following a decision by the United States to end dollar convertibility to gold. This necessitated further financial constraints in the global economy thus creating a special situation in which the U.S. Dollar was set out as the “reserve currency” for nations which had signed the Bretton Woods agreement (CSS Forum, 2009). Further, the agreement was characterized by efforts to prevent currency competition and promotion of monetary cooperation among nations. Under the Bretton Woods agreement, nations that were signatory to the IMF settled on a system of exchange rate that could be suitably adjusted using the U.S. Dollar by the defined parties with the consent of the IMF, adjusted to corrected a fundamental disequilibria in the BP. Bretton Woods Agreement’s perspective was on helping nations to exercise their capacities of inflationary currencies. In this way, government leaders were of the common opinion that the gold standard hedged them from duly pursuing domestic goals that relied on spending on deficit and lengthened the periods of “booms” that were induced artificially. Such nations were opposed to the gold standard for their respective fixed rules that enabled unfavorable economic consequences in instances that they refused to comply with them and whenever they were not in favor of flexible exchange rates that indicated their government’s policies of depreciation of currency. The Bretton Woods system was also characterized by fixed exchange rates. The temptations by nations to artificially increase their supplies of money to be able to stimulate their individual economies won over the gold standard and heralded the new era of fixed exchange rates regulated by non-rigid rules. An additional feature included the fact that the Bretton Woods system was superficially designed to stabilize the exchange rate while at the same time anticipating that the governments would fail to defend respective currency values. In this way, the Bretton Woods agreement initiated a method that permitted future currency depreciation (Bordo and Eichengreen, 1993). Breakdown of Bretton Woods System Bretton Woods System faced its eventual demise in 1971. This was because of the high attacks on the US dollar in the 1960s. It was later replaced with a reign of floating exchange rates. At that time, the United States faced serious inflation and trade deficit which determined the dollar value. Ultimately, the United States left the fixed dollar value allowing it to float thus fluctuating against other currencies. In 1971, the industrialized nation sought to replace the Bretton Woods System with Smithsonian Agreement. As a result, the Bretton Wood system ended after US President Richard Nixon ended gold trading at a fixed rate of $35 per ounce. In this way, formal connections between the top world’s currencies were disengaged (Gowa, 1983). The new system was called a ‘managed float regime,” which meant that even as exchange rates for major currencies floated, nation’s central banks still mediate to avert sharp changes (Swamy and Tavlas, 2005). At that time, nations that had huge trade surpluses sold their currencies to prevent the form appreciating. This in essence hurt exports. In the same manner, nations that had huge deficits bought their own currencies to prevent depreciation. This as a result raised domestic prices. However, there were limitations on what could be achieved via intervention, particularly for nations that had trade deficits. Ultimately, a nation with interventions to back its currency may diminish its international reserves which would inhibit the efforts to continue supporting the currency thus leaving it in a situation where it would be unable to fulfill its international obligations (James, 1996). In December 1971, negotiations of the international monetary were assumed within the structure of the Group of Ten where details were laid down during a meeting at the Smithsonian Institution in Washington DC. An accord was later ratified by the IMF. The resulting Smithsonian Agreement was a temporary regime that allowed nations to fluctuate their exchange rates within the range of 2.25 percent on each side of the central rates. Another feature of the Smithsonian Agreement included currency realignment. When the Japanese Yen appreciated by 17 percent, French Franc by 9 percent, British Pound by 9 percent and Deutsch Mark by 13.5 percent. Later, par value of the world’s minor currencies was changed. In exchange for the efforts to revalue other currencies, the United States consented to roof its price of gold by $3 to $38 an ounce. This was equal to the devaluation of dollar of 8.5 percent. However, this kind of devaluation had no specific importance as the US dollar was inconvertible. In this way, import surcharge of 10 percent was suppressed (Triffin, 1988). The Smithsonian Agreement was widely criticized as a “useless” attempt to bring about the adjustable peg system through new currency alignment. In 1973, the Smithsonian Agreement was discarded allowing other currencies to float against the U.S. dollar. For instance, Bank of Japan soaked up billions of U.S. dollars in a single week, but ultimately quit (Hunt, 2008). In conclusion, the Bretton Woods system’s key feature was the fact that each country was obligated to implement a monetary policy that upheld the exchange rate through efforts of tying their individual currencies to the U.S. dollar (Hudson, 2003). An additional feature included the IMF’s ability to close the temporary balance of payments. Its major outcomes included the creation of IMF and the IBRD and most significantly, the suggested institution of an adjustable pegged exchange rate system. This international monetary system fell apart in 1971 and was replaced by the Smithsonian Agreement. References Bordo, M.D. and Eichengreen, B. (eds.) (1993) A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, Chicago: University of Chicago Press. Bloch, F.L. (1977) The Origins of International Economic Disorder, Berkeley and Los Angeles: University of California Press. Calleo, D.P. and Rowland, B.M. (1973). America and the World Political Economy, Bloomington, IN: Indiana University Press. Cohen, B. (n.d.) Bretton Woods System. (Online) Retrieved from: [http://www.polsci.ucsb.edu/faculty/cohen/inpress/bretton.html] Accessed 6 May 2013 CSS Forum. (19 Nov 2009). The Bretton Woods System (Online) Retrieved from [http://www.cssforum.com.pk/css-optional-subjects/group/economics/28936-bretton-woods-system.html] Accessed 6 May 2013 Eichengreen, B. (1995). Endogeneity of Exchange Rate Regimes, in Understanding Interdependence: The Macroeconomics of the Open Economy, NJ: Princeton University Press, pp.3 - 34. Eichengreen, B. (1996) Globalizing Capital: A History of the International Monetary System, Princeton, NJ: Princeton University Press. Gowa, J. (1983) Closing the Gold Window: Domestic Politics and the End of Bretton Woods, Ithaca, NY: Cornell University Press Hondroyiannis, G., Swamy & Tavlas, G. (2009). ‘The New Keynesian Phillips curve in a Time Varying Coefficient Environment: Some European Evidence’, Macroeconomic Dynamics, Vol. 13, pp. 149-166. Hudson, M. (2003). Super Imperialism: The Origin and Fundamentals of U.S. World Dominance, 2nd ed. VA: London and Sterling, VA: Pluto Press, ch. 5. Hunt, C. (2008). ‘Financial Turmoil and Global Imbalances: the End of Bretton Woods II?’, Reserve Bank of New Zealand, Bulletin, Vol. 71, No. 3, pp. 44-55. James, H. (1996) International Monetary Cooperation since Bretton Woods, New York and Oxford: Oxford University Press. Markwell, D . 2006. John Maynard Keynes and International Relations: Economic Paths to War and Peace. London: Oxford University Press McKinnon, R. (1993). ‘The Rules of the Game: International Money in Historical Perspective’, Journal of Economic Literature, vol. 22, pp. 1-44 Roubini, N. (2006). ‘The BWII Regime: An Unstable Equilibrium Bound to Unravel’, International Economics and Economic Policy, Vol. 3, pp. 303-32. Swamy, P. & Tavlas, G. (2005). ‘Theoretical Conditions under which Monetary Policies are Effective and Practical Obstacles to their Verification’, Economic Theory, Vol. 25, pp. 999-1005. Triffin, R. (1988) Gold and the Dollar Crisis, New Haven, CN: Yale University Press. Van, D. (1978). Bretton Woods : birth of a monetary system. London: MacMillan Read More