Bretton Woods Institutions - Case Study Example

Bretton woods Institutions INTRODUCTION: In 1944, delegates of 43 countries convened a meeting to discuss the reconstruction and resurrection of the economy after the Second World War. Since this meeting was held at Bretton Woods, New Hampshire, USA, the agreements came to known as Bretton Woods agreement. They set up the two financial institutions -- The World Bank and the International Monetary Fund. Together they are referred to as the Bretton Woods Institutions or BWIs. These organizations became operational in 1946. US Treasury Secretary Henry Morganthau, his chief economic advisor Harry Dexter White, and British economist John Maynard Keynes were the key people who provided the base for creation of Bretton Woods institutions. The main aims of these institutions were to finance the shattered postwar countries and to promote international economic cooperation. There were plans to start another organization -- International Trade Organization (ITO) as well. But this was finally done in 1990s, when the World Trade Organization (WTO) came into being. It was decided to keep these organizations separate from United Nations after its formation in 1945. These organizations are governed by a small group of major industrialized countries. As a result, these countries notably the US and UK have played an important role in making global economic policies and international economic and financial cooperation. (Tan, 2006) The idea was to establish a postwar economic order based on free market and minimum barriers to private trade and capital. The Bretton Woods agreement required the member countries to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value in terms of gold. They were banking on the IMF to help in fostering cooperation by providing conditional assistance to member countries experiencing balance of payments problems. WORLD BANK: Although, The World bank was created to help finance the reconstruction of war-torn Europe, it has now become the primary financier of development projects in the Third World. It is the largest creditor of the Third World countries. It is estimated that these third world countries owe more than US$160 billion to the World bank. Actually, the fact that the World bank has been governed by the industrialized countries – has resulted in the policies and decisions which favor them the most. And those countries who are subjected to their policies and form the bulk of the institutions’ operations have the least say in how these institutions are run. (Tan, 2006) And now the situation is that the developing countries that do not have any decision-making powers are shouldering the bulk of the administration costs of the Bretton Woods institutions and their activities. This is done through the charges and interest on the loan repayments and their track record in servicing the International Bank for Reconstruction and Development (IBRD) debts that contributes to the Bank’s ratings in the international capital markets (Mohammed, 2004). INTERNATIONAL MONETARY FUND : The main objectives of IMF were to promote international monetary cooperation by facilitating the expansion of international trade and keeping the exchange rate stable. The planners did not want another recession as happened in 1930s. Thus the IMF was supposed to advise and help member countries by providing them with funds to alleviate short-term balance of payments crises and stabilizing exchange-rates. But as with the World bank, IMF also is governed by countries who are not affected by its policies as such. The decision making process is in hands of few major industrialized countries. One such policy is the attachment of conditionality on the loan given to member countries These conditions sometimes result in the loss of a state's authority to govern its own economy as national economic policies are predetermined under the structural adjustment packages. Rather than assisting countries to manage with the social and economic repercussions of financial crises, the IMF’s operations are more focused on servicing external debt to private creditors and maintaining capital account convertibility (Akyüz, 2005) ECONOMIC SCENARIO : The Bretton Woods conference was the result of long planning which had started even before the end of World War II, by US and its allied forces. They tried to bring on an economic system which would facilitate trade to be conducted in an environment which is free of wild fluctuations in exchange rates or without fear of sudden currency depreciations. The US economy was at one of its strongest point with US controlling the major share of production of coal, oil and electricity. In 1945, the U.S. used to produce large quantities of machinery -- ships, airplanes, vehicles, armaments, machine tools, and chemicals. The U.S. held 80% of gold reserves. All European nations that had been involved in World War II were highly in debt and transferred large amounts of gold into the United States. Thus, the U.S. dollar was strongly appreciated in the rest of the world and therefore became the key currency of the Bretton Woods system. And thus the Bretton Woods system came up which comprised of fixed exchange rates managed by IMF and World Bank using the U.S. dollar (which was a gold standard currency for central banks) as a reserve currency. The United States defined the value of its dollar in terms of gold, so that one ounce of gold was equal to $ 35. All other members had to define the value of their money according to what was called the “par value system” in terms of U.S. dollars or gold. Thus US needed the vast European market for the large amount of goods and services it was producing and to sustain the economic prosperity it had achieved during the war. And by going in for the free trade, the U.S. stood to gain more than any other country in world. Therefore, the Bretton Woods agreement provided the U.S. with the much needed global market for its exports, and it also got unrestricted access to the raw materials and became the undisputed leader of the Capitalist world. Even the other allied forces could not offer much resistance. The European countries were already devastated, Germany was divided and the economies of Britain and France were in complete shambles. UK asked for aid from US and in 1945, the U.S. agreed to a loan of $3.8 billion. In return, they had to negotiate its trade and market measures which benefited its industries. Similarly, France also needed the loan for rebuilding its war-ravaged economy. Again, US gave the aid and in return France had to curtail government subsidies and currency manipulation that had given its exporters advantages in the world market. According to the Bretton Woods System, the US Dollars were used as the reserve currency i.e it was the gold standard currency for the banks. Thus the countries could enforce gold convertibility on the US dollars only. Nations could forgo converting dollars to gold, and instead hold dollars. Rather than full convertibility, it provided a fixed price for sales between central banks. (Bretton Woods Institutions, n.d.) Thus Bretton Woods became synonymous with the fixed exchange rate system. For the next ten years (1947 to 1958), after the establishment of BWIs, the U.S. followed a policy of encouraging the outflow of dollars. And to provide liquidity for the international community, the US ran a balance of payments deficit. To keep the dollar outflow regular, it started providing aid to different countries through different aid programmes. The US flaunted its status as the reserve-currency country to import foreign merchandise and acquire foreign companies, or engage in foreign military actions. In the 1950s the decolonialization of many developing countries took place. There was an immediate need to integrate these countries into the Western world. Thus two affiliated organizations of the World Bank were created --the International Finance Cooperation (IFC) in 1956 and the International Development Association in 1961. The idea was to provide credits to these poor countries for development projects at favorable conditions. This established the World Bank as the center of foreign aid of the United Nations. Thus, using the economic leeway through the Bretton woods institutions i.e the World Bank and IMF, The US started to trade with developing nations by acquiring the raw materials at much lower price and using them to create its own multi billion manufacturing industries. The financial convertible system , created the surplus which was used to send aid to Europe. In return, it got access to their vast markets to export its goods and services. This system worked well and without conflict and achieved the common goals of the major industrialized nations. US was able to run persistent current account deficits without the significant fall in dollar value against the developing nations’ currencies. Thus these nations purchased dollars in order to keep their exchange rates from appreciating. As the country with the deepest, most liquid and most sophisticated financial markets, the US provided financial intermediation services to the rest of the world by importing short-term capital and exporting long-term capital. (Eichengreen, 2004) The lure of US markets was such that the third world or the developing nations’ governments were reluctant to revalue against the dollar, despite their relatively rapid growth and accumulation of reserves, and reservations about US balance of payments deficits. They were worried that if the dollar was devalued against gold or other currencies, they would incur capital losses. The situation was all the more problematic since if they were to swap their dollar reserves for gold, they might precipitate the crisis and lose access to the major export market on which they were so dependent. In the 1960s the world trade grew substantially and with it came the difficulties and challenges for the Bretton Woods Institutions. By 1958, for the first time, the US balance of payments turned negative. This led to a weakening of the position of the US and a devaluation of the U.S. dollar. The reserves turned out to be inadequate to back the trade expansion and this slowed down the economic development considerably. The US administration placed import quotas on oil and other restrictions on trade outflows. The IMF tried to salvage the situation by issuing Special Drawing Rights (SDRs), which member countries could add to their holdings of foreign currencies and gold. The SDRs were assigned with a value based on the average worth of the world’s major currencies -- the U.S. dollar, the French franc, the pound sterling, the Japanese yen, and the German mark. But all this was not enough and following the United States' suspension of convertibility from dollars to gold, the system collapsed by end of 1960s. In the 1960s, the core of international monetary system was the United States and the periphery was Europe and Japan. Many developing countries had not yet fully integrated into the international system. In this period, Europe accepted wage restraint and lower levels of consumption in return for faster investment and export growth rates in the hope that there will be higher living standards later on. The same factors contributed to the high growth of Japanese economy. (Ohkawa and Rosovsky, 1973) The breakdown of the Bretton woods system can be attributed to number of changes that took place during the 1950s and 70s. The emergence of international banking in the 1960s was one such big change that contributed to the monetary independence from US economy. By 1964 various banks had formed international syndicates, and by 1971 over three quarters of the world's largest banks had become shareholders in such syndicates. (Bretton Woods institutions, n.d.). These multinational banks made huge international transfers of capital and speculated against the exchange rate fluctuations. This coincided with the decline of US supremacy as the economic power. In 1950s and 1960s, Europe and Japan benefited immensely from the fixed exchange rates and grew to be the robust economies and with total reserves exceeding those of the U.S., their per capita income approached that of the U.S. They were no longer the also-rans but economic powers in their own right. In the late 1960s and early 1970s, the Bretton Woods system began to break down and Japan and Europe re-emerged as economic powers. CONCLUSION: In conclusion, we can say that Bretton Woods system was a good one and helped the restructuring of post was Europe. The international trade and investment flourished and the economies grew stronger. The rate of inflation was low, the real per capita income growth was high and the interest rates were low and stable. (Bordo, Eichengreen, 1993) The main weakness was that it was heavily dependent on US economy and US dollar. Moreover, it provided US with the supreme status which it used to interfere in political as well as social problems of the developing countries. REFERENCE: 1. Akyüz, Y. ,2005. “Reforming the IMF: Back to the Drawing Board”, TWN Global Economy Series 7. Penang: Third World Network. 2. Bordo, Michael D. & Eichengreen, Barry (1993). A Retrospective on the Bretton Woods System. Chicago and London: The University of Chicago Press 3. Eichengreen, B. 2004, Global imbalances and the lessons of Bretton woods, Économie internationale 100 , p. 39-50. 4. Mohammed, A.A., 2004. “Who Pays for the World Bank ?”. G24 Discussion Paper Series 5. Ohkawa, K., Rosovsky, H., 1973. Japanese Economic Growth, Stanford: Stanford University Press. 6. Tan, C., 2006. Reclaiming development: streamline the Bretton Woods institutions Third World Network Read More