The Major Purpose of the Bretton Woods - Case Study Example

number International Trade Theory and Policy Bretton Woods Agreement and its Principle Purpose The Bretton Woods Agreement refers to a set of rules whose role was to facilitate establishment of a monetary order that was fully negotiable among the involved parties. The agreement sets up rules whose goal was to form financial and commercial relations among the major industrial states in the world during the mid-20th century. It aimed at regulating monetary relations that prevailed among independent nations. In order to facilitate setting up of institutions, procedures and rules that would regulate the global monetary system, for planners who were situated in Bretton Woods formed the IMF (International Monetary Fund) and IBRD (International Bank for Reconstruction and Development. The institutions became fully operational in 1945 after a satisfactory number of nations approved the agreement (US Department of State). It would not have been possible to implement the Bretton Woods System without the IMF. This is because a significant number of countries were in need of a mechanism that was capable of bailing them out in case their currency went below the accepted levels. As a result, they were in need of a global central bank that would allow them to borrow whenever they felt that they needed to adjust their currency, and would not be forced to fund themselves (US Department of State). The major purpose of the Bretton Woods agreement was to facilitate economic stability among the major economic powers around the world. It aimed at addressing a number of imbalances that affected the systematic imbalances around the world without upsetting the entire system. In order to facilitate for this move, the IMF ensured that exchange rates in the foreign exchange market were fixed, and bundled with an option of changing them if a need arose. Also, the agreement required currencies to be converted to enhance trade as well as other current account dealings. However, the government was to be held responsible in terms of regulating flamboyant capital flows. In case balance of payments for a country were unfavorable, the IMF provided governments with the option to revise foreign exchange rates by approximately 10 percent. It also allowed member states to subscribe to the capital that was availed by the institution (POLSCI). 2. Dollar Problems and Collapse of Bretton Woods Under the influence of the Bretton Woods agreement, central banks of major world economies other than the US were required to sustain fixed exchange rates. In case the currency of a particular country remained high while compared to the dollar, the central bank sold its currency in order to bring down its value. Conversely, in case the value of a particular country was extremely low, a country was required to purchase its own currency to bring its prices up (POLSCI). The Bretton Woods system remained in operation up until 1971. During that time, the US was experiencing high inflation rates and a rising trade deficit, which led to the deterioration of the dollar. Both Japan and Germany were witnessing favorable balance of payment, and America urged them to appreciate their currency. However, these nations remained reluctant since this move would lead to an increase in the prices of their goods and services. It is because of this that the US decided to adopt a floating exchange rate system to allow its currency to fluctuate against other currencies, which eventually fell. Most world leaders decided to revive the Bretton Woods system, but their efforts failed (IMF). The IMF encouraged states to establish central banks to allow nations to cope with sharp changes in exchange rates. For instance, after the collapse of the Bretton Woods system in 1971, countries that had large trade surpluses were encouraged to sell their currencies to make sure that they did not appreciate. Conversely, nations that had large deficits were encouraged to buy their currency to prevent them from depreciating (POLSCI). 3. Bretton Woods System Collapse and IMF’s Participation in Global Finance In the early 1960s, the US dollar used to be fixed against gold. This practice was carried out with the help of the Bretton Woods system, and this made the fixed exchange rate to be regarded as undervalued. As a result of a significant increase in domestic spending as well as a rise in military spending that was attributed to the Vietnam War worsened the state of overvaluation of the dollar (US Department of State). The Bretton Woods system came to an end in 1973. President Richard Nixon made an announcement of the temporary halt of the convertibility of the dollar into gold. This made made the dollar to experience a series of struggles in the 1960s as a result of the breakdown that was attributed to the system. This process marked the end of the system. There were a series of attempts that had been made regarding the revival of the fixed exchange rates, though this resulted in failure (IMF). During this period, the US was undergoing a period of massive stagflation, which was a combination of extreme recession and inflation. This is especially because of the role that the dollar played as a global currency. In 1971, President Nixon embarked on the deflation of the dollar’s value to gold. During this time, he priced the gold to 1/38 per ounce, and later to 1/42 for every ounce. However, this plan became unsuccessful and people started running for their gold at Fort Knox since people started devaluing dollars to obtain gold. In 1973, President Nixon unhooked gold’s value, and this move resulted to lack of price controls. As a result, gold ended up shooting up to $120 for every ounce while in the free market, and thus bringing an end to the Breton Woods system once and for all (POLSCI). After the Bretton Woods System came to an end, all the IMF members became free to choose the exchange arrangement that they desired. This created room for free float of the currency, and most of the members could be able to peg their currency with another one or a basket of them. This allowed for the adoption of one currency to another, and hence allowing nations to participate in currency bloc, or serve as a constituent of a monetary union. Most experts stipulated that the end of the Bretton System would result to an era of rapid economic progress. In fact, the move from fixed exchange rates to floating rates was noted to be smooth and a timely one. This allowed economies to adjust to the expensive oil, since the prices started rising in 1973. Since then, it has been possible for floating rates to adjust to shocks that come from outside causes (IMF). In response to the challenges that were posed by the oil prices, the IMF began lending instruments in order to allow oil lenders to cope with the expected inflation and deficits that were witnessed in current accounts. The IMF is the one that contributed to the establishment of the initial two oil facilities in the world (IMF). Since the mid-1970s, IMF has been embarking on initiatives that allow it confront most of the balance of payments difficulties that most of the poorest countries in the world faced. It started by coffering them concessional financing through Trust Funds. In 1986, a concessional loan program referred to as Structural Adjustment Facility (SAF) was introduced by the IMF. In 1987, SAF was overtaken by Enhanced Structural Adjustment Facility (ESAF) (US Department of State). 4. Euro Creation and Poor Economic Performance of Eurozone Members In the 19th century and early 20th century, the British pound operated as the dominant international currency. It was being used to address international financial transactions and trade in the entire British Empire. However, after the British Empire started realizing a decline in economic power during the late 20th century, the US dollar served as a replacement to the British pound to emerge as the preeminent international currency. For a period of 50 years, the US dollar has been used to serve as the leading international currency that is used to facilitate in international debt and trade contracts. Today, most of the primary commodities are basically priced in terms of dollars to facilitate in world exchanges (Pollard). The Euro, a new currency, was created on January 1999 to facilitate in the realization of progress towards monetary and economic union in Europe. The Euro replaced currencies of 11 countries in Europe. These include Finland, France, Austria, Belgium, Ireland, Germany, Italy, Luxembourg, Portugal, Spain and the Netherlands. Today, the Euro serves as the legal currency of the Eurozone, which was formed by 17 members of the European Union. Also, approximately 880 billion Euros are circulating in the Eurozone today (Pollard). Despite the adoption of the Euro to address the financial needs of the Eurozone, a number of member countries are witnessing a tough time economically. This has contributed to the Euro crisis, and it has been affecting Eurozone countries since 2009. It began when a total of 10 eastern and central European banks requested for a bailout. As a result, it made it difficult for some of Eurozone countries to refinance or repay the debt that they owed to the government without seeking for assistance from bodies such as the IMF or ECB (Pollard). In addition, the rate of economic growth has been slow in the entire Eurozone, and it is also distributed unequally across the member states. The governments of those states that have been severely affected by the Euro crisis have been forced to coordinate their efforts with a committee that has been formed by the European Central Bank, European Commission and the International Monetary Fund (Pollard). Today, with the growing sovereign debt crisis that prevails among investors has emerged from the advancing levels of debt by governments and private organizations around the world. This has led to downgrading of the debt that the government holds in various states in Europe, and hence negatively impacting on their economic performance (Pollard). Works Cited IMF. "The end of the Bretton Woods System (1972–81)." n.d. International Monetary Fund. web. 18 Mar 2014. . Pollard, Patricia. "The Creation of the Euro and the Role of the Dollar in International Markets." 2001. Federal Reserve bank of St. Louis. web. 18 Mar 2014. . POLSCI. "Bretton Woods System." n.d. Routledge Encyclopedia of International Political Economy. web. 18 Mar 2014. . US Department of State. "The Bretton Woods System." 2014. About. web. 18 Mar 2014. . Read More