What is the Bretton Woods Agreement

What is the Bretton Woods Agreement At the start of the 19th century, free trade, globalization, and international trade became the new economic system and numerous steps have been taken since then to create schemes and policies which ensure the strength of the international monetary system.It’s quite obvious that the world economy has never functioned in a perfect state; however, the aim to attain such has never dwindled.Between 1944 to 1977, the worlds economic system went through the Bretton Woods era; one of the only few successful policies the world powers developed in attempting to attain economic utopia.Even though it only existed for a brief period, it has been termed one of the most powerful international monetary systems.The economic growths and stability of the era were so impressive that there have been numerous talks for the return of the system.As the chart below shows, after the fall of the Bretton Woods System, there has been much financial crisis. This is why the system has been considered again as a solution. Source: Bretton Wood ProjectWHAT IS THE BRETTON WOODS AGREEMENT? The Bretton Woods Agreement was developed after the Second World War by all Allied nations which participated in the war. It happened in 1944 at Bretton Woods, in New Hampshire.Bound by the agreement, the various nations in participation agreed to maintain a fixed exchange rate at their individual central banks.This fixed rate was between their currencies and the United States dollar.The system was to work in such a way that if a particular nation’s currency value began to fall in relation to the dollar, the bank would purchase its currency.This would be done in foreign exchange markets and would result in the currencys supply lowered simultaneously, raising its price.If on the other hand for currency rises too high, it necessitates that the bank would have to print more, which would result in low price and increased supply.Asides from these the various members of this agreement or system agreed to not engage in trade wars.For instance, a country would not decrease its currency for the sole purpose of trade increment.However, it permitted the nations to regulate their currencies in specific conditions, such as when direct foreign investment is responsible for the destabilization of their economy or readjust currency values in order to stabilize their economy in the aftermath of a war.BRIEF HISTORY OF THE BRETTON WOODS AGREEMENT AND NOW IT WORKEDAfter the Second World War had ended, Over 40 allied countries, inclusive of Argentina, meet in Bretton Woods, United States, in the Mount Washington Hotel.They had a major motive of this meeting and it was to correct the damages of the post-war era.The post-war era was characterized by international economic chaos, such as beggar-thy-neighbor economic policies, which saw nations trying to get out their depressed conditions embrace them. However, this was done at the expense of other nations.Hence, the overall purpose of the convergence was to enable a st able exchange rate with the secondary purpose of the promotion of world peace.There was agreed for the need of an institutional body for International cooperation with regards to monetary matters.This was so that in the outbreak of worldwide challenges, such as the world war there would exist, an internationally recognized solution, instead of individual nations embracing selfish systems.THE MAKEUP OF THE SYSTEMPrior to the 1944 meeting in Brent Woods, New Hampshire, the need, had been recognized.This recognition sparked discussions between the American and British governments, as well as their economic advisors, who had proposed various plans.These economic advisors included Lord Keynes of the United Kingdom on one hand and Harry Dexter of the United States Treasury on the other.Hence, the Bretton meeting was basically for mere formalization as well as closing the agreements previously embraced.The final decisions that were embraced during the conference at Bretton Woods were major ly from the United States end. This proved the military and economic prowess of America during this period.The fact that power was concentrated in the vault of a few nations and all countries involved had a singleness of mind in reaching a specific goal (of course not in for policies with which these goals were to be achieved).And also, the ability and willingness of the United States to take the reins of leadership were part of the reasons the Bretton Woods Agreement saw much success.HOW IT WORKEDThe system of the Bretton Woods Agreement was created in such a way as to incorporate the positives of both a flexible exchange rate known as flexibility and a fixed rate system like the gold standard which was a stable exchange rate.This occurred because, after the Second World War, the United States of America possessed gold reserves which totaled 705,479,239 ounces or about 20,000 metric tons, which at the time was 60% of the world gold supply.What this implied to the financial confiden ce of the dollar is that it could command a buying rate of 35 dollars per gold ounce, hence making the United States dollar more stable than any other currency post world war 2. Source: Logic TankThis introduced a system termed the adjustable peg rate. The Peg and Exchange Convertibility involved the United States dollar being pegged at a fixed rate to gold at $35 per ounce.All other countries’ currencies were then fixed to the U.S dollar at par value. This value had to be adhered too or defended by selling and buying the dollar in the international currency market.Even though an international central bank didnt exist to create an international currency, and manage its supply, the dollar became the world currency.Using the fixed price of 35 dollars per ounce of gold, all countries involved could now exchange their individual currencies for gold and back.This made the United States dollar as valuable as gold and saw increased belief in the dollar.This agreement afforded the ability of all exchange rates of the nations involved to be fixed for some time, in a 1% band on the pegged rate.It permitted a country to change its gold pegged rate, outside of the 1% band, only in the event that the completion of its payment was made in fundamental disequilibrium.WHY WAS THE UNITED STATES DOLLAR CHOSEN? The United States at the time was the only nation with its currency backed by gold.Whats more, during that period it held three-quarter of the entire worlds monetary gold, due to the gold transferred to the United States by European countries during the world war.This left the dollar as the most powerful currency compared to every other currency.The United States has also had the strongest economy after the Second World War ended, and was considered powerful enough to satisfy the demand of rising global and internalization trade.HANDLING LIQUIDITYIn order to handle international liquidity, and also prevent a recurrence of the gold shortage which happened in the 1920s, as well as the fixed rate fallout of the 1930s, a decision had to be made with regards to the sufficient supply of the official monetary reserves.This was most essential to the eff iciency of the adjustable peg rate. The agreement decided to utilize a system of quotas and subscriptions which showcased each nation’s economic power.The quota of every member of the country was built up of 25% gold, with the remaining 75% being the nations domestic currency.These quotas were vital because they were the determinant of the voting right and the size of foreign currency, which each participant country was allowed to collect from the fund.COMMISSIONS3 commissions were created during the meeting in order to achieve its intended purpose. The first saw Harry Dexter of the United States Treasury at its head.It was designed to develop the International Monetary Fund Articles of Agreement, which was the foundational aspect of the system.The second commission which was led by the United Kingdom’s Lord Keynes was also created to develop the Articles of Agreement; however, it was for the International Reconstruction and Development Bank.It then possessed the goal of financi ng the development and reconstruction of various nations due to the aftermath of the war.Today it is called the World Bank, and still remains a highly influential global body possessing a much greater capacity.The last commission headed by Dr. Eduardo Suarez from Mexico, was delegated to find various other methods of international financial cooperation.OBJECTIVES OF THE BRETTON WOODS AGREEMENTThe Bretton Woods Agreement was made to create an international framework which had many objectives.Below are the things that were meant to be achieved by the Bretton Woods Agreement:1. Stable and Flexible Currency System The major objective and primary focus of the agreement was to introduce a currency system which was not as rigid as the gold standard but was as stable as the Gold standard.Based on the chart below, the public and private debt of the United States was at an all-time low when pegged against gold, so the objective was definitely timely. Source: KitcoThe Gold standard also has lots of weakness which needed to be eliminated.Some of the weaknesses include the high cost of the movement of gold to execute international trade transactions, and the absence of an adequate regulatory mechanism (the gold standard was of more benefit to countries that produced gold at the expense of the world economy).There was a problem with the two-way convertibility between national currency and gold and there was also an inability to match the supply of gold with the increased need for liquidity in the world.2. International Reserve Asset Apart from Gold One of objectives of the system was the need to have an international reserve asset.This was meant to be different from the Gold standard which would be used to make international transactions as well as create an avenue where member countries give loans and make contributions to members who were in need due to the balance of payment deficit.3. Creation of Financial Institutions for Indivi dual National Development Projects Another objective of this agreement was to create institutions that would finance the individual national development projects of member countries and also conduct international monetary policies.This aim was what led to the creation of the International Monetary Fund (IMF) and the World Bank.These institutions were meant to promote international monetary cooperation and also supervise, collaborate and consult on monetary problems.4. Foreign Exchange InterventionThe central banks of member countries apart from the US had the responsibility of maintaining fixed exchange rates between the dollar and their currencies.If the currency of a country was higher than the dollar, the central bank of such a country had to sell its currency in exchange for the dollar; this would bring down the value of the countrys currency.If on the other hand, the value of the currency of a country was low, it would buy its own currency and this would increase the value of t he currency.This was aimed at ensuring that the exchange rate was stable and also aimed at avoiding any form of competitive exchange depreciation.5. Elimination of Foreign Exchange Restrictions This agreement also sought to eliminate any form of foreign exchange restrictions and also the creation of a new efficient system of payments for multilateral trade transactions among member countries.6. Avoidance of Trade War Another objective of the agreement was the avoidance of any form of a trade war.The world had just finished a war that left every nation drained and starting a trade war would further increase global hardship.It was agreed that members could regulate their currencies under certain conditions but they were not supposed to lower their currencies in order to increase trade.If foreign direct investment destabilized their economies, they could take action; they were also permitted to adjust the value of their currency in order to rebuild their economy after the war.THE ROLE PLAYED BY INTERNATIONAL MONETARY FUND (IMF) AND WORLD BANK IN THE BRETTON WOODS AGREEMENTThe Bretton Woods Agreement was a financial agreement and such financial institutions needed to be created in order to effectively implement the content of the agreement.With this in mind, two financial institutions, the International Monetary Fund, and the World Bank were created. Without these two institutions, the aim of the agreement would have been frustrated.The IMF helped in the implementation of the Bretton Woods Agreement by playing some key roles in the economies of the member nations.First, lets explore the roles that were played by the IMF in the Bretton Woods Agreement.It is important to note that the implementation of many of the contents of the agreement was anchored on the IMF, if it didnt exist, the Agreement wouldnt have seen the light of day.The IMF helped to bail countries out of the financial difficulties that arise from the loss of the value of their currency especially whe n the country is going bankrupt. They could go to the IMF and borrow from it in order to adjust the value of their currency.If they didnt have some sort of global central bank where they could borrow from, they would have resorted to raising interest rates or even trade barriers and if this persisted it could lead to a trade war, which was what the Bretton Woods Agreement didnt want.Despite the fact that the IMF functioned as a world central bank, it was not given the power of a global central bank such as printing of money when needed.Instead of printing money, the IMF got her money from the fixed pool of national currencies and gold that was contributed to it by member countries.It was on the basis of these contributions that members could borrow money from IMF whenever the need arose. The countries could however only borrow within the limits of their contributions.The IMF also facilitated the expansion of international world trade and this promoted and sustained income and high l evel of employment.In addition, the IMF reduced foreign exchange restrictions among the member countries; this was achieved by designing an acceptable payment system for multilateral trade among its members.It also ensured that there was exchange stability and exchange arrangements were made among its members to prevent any form of competitive exchange depreciation.Furthermore, the IMF assisted in the establishment of a multilateral system of payments which helped members to make payments for transactions among themselves.This also helped to eliminate any form of foreign exchange restrictions that could hamper the growth of world trade.The second financial institution that was created as a result of the Bretton Woods Agreement was the World Bank.The World Bank was another major source of financial support to member nations whose economies were crumbling as a result of the war that had just ended.There was however a flaw in the operation of the World Bank because even though it was c reated to give assistance to member countries, it only lent to the European countries that were ravaged physically and economically by the second World War.The World Bank was created to promote long term poverty reduction and economic development by providing financial and technical support to member countries.This financial and technical support would help the countries to implement specific projects or to reform certain sectors of the economy. This assistance was given on a long term basis and the funds came from the contributions made by member countries.To a very large extent, these two financial institutions helped to give credence to the Bretton Woods Agreement and even after the agreement ceased to exist, these two institutions were not dissolved.They exist until today, carrying out their main objectives and helping to raise the financial strength of member nations.REASONS FOR THE COLLAPSE OF THE BRETTON WOODS AGREEMENTThe Bretton Woods Agreement functioned for a while but in 1971 it had to be suspended due to the fact that the US gold supply was no longer enough to cover the number of dollars in circulation.Dollars convertibility into gold was suspended and by 1973 it was clear the Bretton Woods system has already collapsed.This gave the member countries the freedom to choose any kind of exchange arrangement for their currencies but they were still not permitted to peg the value of the currency to the price of gold.You may be wondering what lead to the collapse of the Bretton Woods system, below are some reasons for the collapse.1. Increased Capital MobilityIt became more convenient for investors to move their capital from one country to the other in anticipation of a possible devaluation; this was not possible during the Gold Standard system.The release of a possible devaluation due to the pulling out of investors could easily trigger an economic crisis.This didnt favor member countries with weaker currencies and they were unwilling to take part in th e devaluation of the exchange rate in order to correct the anomalies of the balance of payment.This led to friction in the foreign exchange market and also international monetary system rigidity.2. The Burden on the United States Another reason for the collapse of the system was that since the design of the system was hinged on the military, the political and economic strength of the US, it meant that the US carried all the burden of the system.When it was obvious that industrial countries were already recovering well from the effect of the war on their economy, the United States wanted a revision of the arrangement, which would bring about a balanced partnership in the sharing of the burden.This move showed that the US was losing its influence in the system and this brought about fear of uncertainty among the members.As a matter of fact, the rise in inflation in the United States in 1965 was one of the major reasons for the collapse of the Bretton Woods Agreement. Source: Naked Capitalism3. Third-world Countries Emergence The emergence and involvement of the third-world and developing countries in the system caused some issues in the system.These countries were not part of the original conference which held in 1944 and their emergence meant that a lot of things had to be changed.4. Improper Exchange Rates AdjustmentsThe inability of Bretton Woods to make adjustments to the exchange rates as relative costs changed was another major reason why it collapsed. This led to many balance of trade payment crises.These crises revealed the dangers of solely relying on the US balance of payment.CONCLUSIONThe Bretton Woods Agreement was a collaborative effort to save for the worlds economic fallout due to the damaging effects of the World War.Its success was hinged on the ability of a single nation to take the lead and other nations willing to follow for the sake of a common goal.