The Bretton Woods System Essay

Published: 2020-02-02 21:10:23
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Category: Inflation

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The Bretton Woods System (BWS) was implemented in 1946 under the Bretton Woods Agreement, each government obliged to maintain a fixed exchange rate for its currency vis- -vis the dollar or gold. As one ounce of gold was set equal to $35, fixing a currencys gold price was equivalent to setting its exchange rate relative to the dollar. The fixed exchange rates were maintained by official intervention in the foreign exchange markets. This intervention was about purchases and sales of dollars by foreign central banks against their own currencies whenever the supply and demand conditions in the market deviate from the agreed on par values. Any dollars acquired by the monetary authorities in the process of an intervention could then be exchanged for gold at the U.S Treasury. In principle, the stability of exchange rates removed uncertainty from international trade and investment transactions.

Normally, if a country followed its own policies leading to a higher inflation rate than its trading partners would experience a balance of payments deficit as its good became more expensive, which means its exports will decrease. A deficit has consequences, an increase in the supply of the deficit countrys currency on the foreign exchange markets. The excess supply would demoralize the exchange value of the currency of that country, forcing its authorities to intervene. The nation would be required to buy with its reserves the excess supply of its own currency, in order to reduce the domestic money supply. In addition, as the countrys reserves were depleted, the authorities would be forced to change economic policies to eliminate the source of deficit. The reduction in the money supply and the adoption of restrictive policies would reduce the countrys inflation.

Basically, Bretton Woods was a fixed exchange rate system in name only. With 21 major industrial countries, only the U.S and Japan had no change in par value between 1946 and 1971. From the 21 countries, 12 devalued their currencies more than 30% against the dollar, four had revaluations, and four others were floating their currencies till the end of the system. On mid-1971, the president Richard Nixon was obliged to devalue the dollar to deal with Americas emerging trade deficit. The two reasons for the collapse of (BWS) are, inflation in U.S, they financed the escalating war in Vietnam, so they were printing money instead of raising taxes. Another reason is that West Germany, Japan, and Switzerland refused to accept the inflation because a new fixed exchange rate with the dollar will be imposed on them. Thus, the dollar depreciated sharply relative to the currencies of those three countries.

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