How the Bretton Woods System Shaped the International Monetary and Financial Order
Bretton Woods system
The Bretton woods system is the post-World War II international monetary system which was agreed by 44 nations that met in July 1944 in Bretton Woods.
After the great depression of the 1930s, the economic policies adopted by governments to combat economic recessions focused on protectionism using high tariff barriers, competitive currency devaluations and protected trading blocks. This created a dysfunctional international monetary system.
The largest nations of the world concluded that the only way to recover from the great depression and the problematic global economy after the World War II was economic operation.
The Bretton Woods conference took place from the July 1 to 22 of 1944 in Bretton Woods, New Hampshire. It was a gathering of representatives from the largest forty-four nations with aiming to agree on a set of new rules which would form a new international monetary system.
The “Final Act” was signed in Bretton Woods which created the International Monetary fund and the International bank for reconstruction and development (IBRD).
The international monetary fund (IMF) was responsible for maintaining a system of fixed exchange rates designed around the U.S. Dollar. The IMF was responsible for providing liquidity to countries experiencing temporary balance of payments deficits.
Under the new monetary system, the US dollar was fixed to the price of Gold and most of international currencies were pegged to the US dollar. The US Dollar was suitable for the world’s reserve currency since at the time the US held two thirds of the world’s gold, had 50% of the world’s economic production and was the dominant military power.
When imbalances arose either in form of financial crisis or balance of payments deficits the IMF was responsible for intervening by providing liquidity.
The new monetary system was based on the notion that paper currency could be exchanged by other countries’ central banks to gold at a fixed price of $35 per ounce. To keep this fixed exchange rate, the US dollar money supply (is the production of new paper) was restricted to the mining of new gold. this kept the US dollar’s value steady.
The US dollar became the world’s reserve currency, which is the default currency for paying for goods and services globally.
Between 1950 and 1970 period the new monetary system worked fine. This was a period of productive debt growth for the US and the development of equity markets which was essential for financing development. During the same period however, Germany and Japan economies recovered, and the US share of world economic output fell. The US transitioned from a net exporter to a net importer with a balance of payments deficit.
The US issued more debt to finance the Vietnam war and its domestic needs. The US treasury issued debt and the federal reserve printed money to purchase the debt. The value of the US dollar versus Gold became increasingly unstable.
France followed by other countries started converting their US Dollar holdings into gold. The quantity of gold held by the US fell while claims against the existing gold reserves increased.
The Bretton Woods system finally broke down on the 15th of August 1971 when President Nixon announced the termination of convertibility of the dollar into gold. The dollar was devalued against gold and other currencies. The gold price rose from $35 in 1944 to $60 by 1980.