The Bretton Woods Agreement - Essay Example

Bretton woods agreement Name of the Student: Name of the Instructor: Name of the course: Code of the course: Submission date: Bretton woods agreement Describe the most important features of the Bretton Woods Agreement. Why did the Bretton Woods ‘system’ breakdown and what has replaced it? Introduction It is an apparent fact in the era of globalization, there is the propensity of rapid changes in the economic environment. In this regard, there are increased volumes of capital flow which escalate to become less controllable. Subsequently, the dire need for the establishment of a stabilizing mechanism becomes increasingly evident. It is against the backdrop of such a past which informed the establishment of a system to address this issue at the conference of Bretton Woods, New Hampshire (Dammasch, 2000). In a generic sense, the Bretton Woods system can be perceived as a mechanism of monetary management which instituted the rules of financial and commercial relationships between the major industrial countries around the globe in the mid-20th Century. In this case, majority of the scholars and practitioners perceived this system as representing the first model of a monetary order which was fully negotiated and primarily aimed at governing monetary relations between different nation-states in the global platform. It has been noted that the architects of the Bretton Woods system envisioned a monetary arrangement which would play a principle role in combining the exchange rate stability advantage of the classical gold standard with the advantage floating rates (autonomy in pursuit if national full employment policies (Bordo, 1993). On this background, this paper will explore the most important features of the Bretton Woods Agreement. Additionally, it will explore the rationale behind the breakdown of the Bretton Woods ‘system’ and lastly give an insight into what has replaced it. Important features of the Bretton Woods Agreement It is imperative to note at this point that despite the dates which have been recognized as characterizing the existence of the Bretton Woods system spanning from 1944 to 1971, some of the scholars have noted that the fact of the matter is that the full operation of this system was realized in 1959. This was when there was full convertibility of the European currencies. These scholars have also noted that the ultimate breakdown of this system in 1971 had been foreseen in 1968 which was occasioned by demonetarization of gold by the establishment of the two-tier gold market (Schwartz, 2000). In this case, different scholars like Bordo (1993), Meltzer (1991) and Cohen (2002) have sometimes referred to the period between 1959 and 1967 as the heyday of the Bretton Woods system. Despite this eventual breakdown in 1971, there are evidently some salient features which underpinned that Bretton Woods Agreement. Some of these features are explored in the subsequent section. The first feature of the Bretton Woods Agreement was the adoption of a monetary policy by different countries which maintained the exchange rate. In this case, each country was obliged to adopt a monetary policy which was central in the maintenance of the exchange rate through binding its currency to the U.S dollar. This fact is revealed by Dammasch (2000) who revealed that under the Bretton Woods Agreement, there was consensus over the implementation of a system of fixed exchange rates where the U.S dollar was selected as the key currency. It is imperative to note that this feature which obliged different countries to adopt monetary policies which were tied to the U.S dollar was aimed at avoiding the exchange rate instability of the floating-rate currency regime which had been apparent in the 1920s. This latter system has been perceived as having impeded external adjustment and the reconstruction efforts on trade and finance in the post-World War I period (Hall et. al., 2009). The rationale behind the choice of the US dollar is underpinned by the fact that after WWII, the US was considered as the country with the greatest economic potential in the global perspective. Thus, the US dollar which was backed by gold was endowed with the greatest purchasing power. This is founded on the fact that the European countries which had extensively participated in WWII were in great debts to the US and proceeded to transfer large amounts of gold to the US which greatly contributed to the supremacy of the US. Therefore, this informed the appreciation of the US dollar by other countries in the world which went on to become the chief currency of the Bretton Woods system (Dammasch, 2000). The second feature of the Bretton Woods Agreement was the capacity of the International Monetary Fund (IMF) to temporarily bridge the imbalances of payment. This fact is supported by Hall et. al. (2009) who determined that one of the key characteristics of the Bretton Woods Agreement is that it sought to achieve symmetric adjustment between the countries which had surprises in their balance of payment with those which exhibited deficits in their balance of payment. It’s worth noting that the IMF was officially opened on 27th December, 1945 where the each of the 29 participants in the Bretton Woods conference signed its Article of Agreement. The IMF instigated its financial operations on March 1st 1947 and in the modern days consists of 183 member countries. In this case, the member countries which had disequilibriums in their balance of payment were afforded with a chance to rectify their problems through availing the financial resources of the IMF to them (Dammasch, 2000). In a situation whereby the holdings in the IMF of a particular currency were insufficient in the satisfaction of the demand for this currency by other member countries, then the fund was at liberty of declaring this currency to be scarce and eventually urge the members to ration the use of this currency through discriminatory exchange controls (Bordo 1993). The third feature of the Bretton Woods agreement was that it rudimentary structure was geared towards averting the repetition of the beggar-thy-neighbor policies which had previously been the central characteristic of the latter stages of the interwar gold-exchange standard. This feature is underpinned by scholars like Solomon (1977) and Cohen (2002) among others who revealed that in these stages mentioned above, countries had the tendency of using trade restrictions as well as competitive currency devaluation aimed at elevating trade surpluses (or minimize trade deficits). These were profound attempts to minimize the level of unemployment at the domestic level through shifting this unemployment to other countries around the globe. Rationale behind the breakdown of the Bretton Woods ‘system’ The breakdown of the Bretton Woods system was perhaps one of the most generally predicted economic event of the time. Retrospection after this even sharpens the view of the inevitability of the events that culminated in this collapse. Nonetheless, it has been pointed earlier in this analysis that the events ranging from 1967 through to 1971 had predicted the ultimate collapse, with literature best epitomized by the work by Triffin (1960) providing a formidable warning. This provided the direction for the policymakers who were executing serious transformations in diverse provisions related to liquidity and the generic administration of capital controls in desperate attempts to salvage the system (Galber, 1993). With the eventual collapse of the Bretton Woods system, there has never been an agreement between various scholars and practitioners on the causes of the breakdown of this system with six distinct explanations being forwarded at the NBER conference (Eichengreen, 1993). Eichengreen, (1993) outlined some of the most probable causes which include the differences between US and foreign fiscal policies, differences between US and foreign monetary policies and a secular deterioration in the international competitive niche of the United States. Additionally, the reasons of the revaluing failure by the surplus countries, failure of the deficit countries to devalue and the generic errors in the larger structure of the Bretton Woods system (most notably the Triffin’s dilemma) have also been forwarded as the possible causes of this breakdown. Most of these reasons for the breakdown of the Bretton Woods system are captured in the explanation regarding the collapse of this system by Dammasch (2000). According to this author, the persistent imbalances of payment between the industrialized countries in the west, most notably in the 1960s and 1970 played a key role in weakening the Bretton Woods system. One of the most outstanding problems was founded on the backdrop that despite the dollar being the national currency of the United States, it had concurrently to be the international reserve currency. As a result, this had the cumulative effect of making the national monetary and fiscal policy of the US to be free from external economic pressure, while at the same time these policies by the US greatly influenced these external economies. Moreover, in the move to ensure international liquidity, the United States was obliged to run deficits in their balance of payments, failure to which would have resulted in a world inflation. Nonetheless, 1960s saw the US implement a very inflationary policy and proceeded to limit the level of convertibility of the US dollar. This latter move was informed by the fact that reserves were inadequate in meeting the demand of this currency around the world. Subsequently, other member countries clearly expressed their unwillingness to accept the excessive inflation rates which would have been caused by the par value system. This culminated in the weakening of the dollar and it being unwanted in other countries which resulted in the collapse of the Bretton Woods system in 1971 (Dammasch, 2000). Dammasch (2000) also noted that another paramount problem which is founded in the general weakness of this system is founded on the delayed adjustment of the general parities to changes which were prevalent in the economic environs of different countries. In this case, it was a great political peril by various governments in different regions which had distinct economic environments to adjust to the parity and eventually, any significant change in the par value of a major currency in the world ended being a crisis for the entire system. This had the detrimental impacts of generating mistrust as well as destabilizing speculations. All these backdrops saw the collapse of the Bretton Woods system. By March 1973, the par value system which was the central feature of the Bretton Woods system was deserted and there was an agreement among the member countries to permit diverse models of ways in the determination of the exchange value if the currency of different countries. Subsequently, the IMF proceeded to allow its member countries not to base their exchange value on gold and it became public knowledge how each of the member nation determined the value of its currency (Dammasch, 2000). Replacement of the Bretton Woods system Decades after the collapse of the Bretton Woods system in 1971, there has been a gradual emergence of a new system which different authors have terms as Bretton Woods system II. Under this system, they have argued that in the decades occasioning the 2000s, there is an existence of an international system which is characterized by a core which issues a dominant international currency and on the other hand, a periphery. Nonetheless, it is imperative to note that unlike during the earlier Bretton Woods system, the old periphery which was initially Europe and Japan has graduated to join the original core which was the US. In this case, the new periphery is Asia. In this case, there has been an emergence of a new system whereby the currency from different core countries in Europe and other regions have become dominant in the global economic platform. Additionally, there has been elevated reserve accumulation in the recent decades. These have been primarily underpinned by the emerging market economies in Asia and expedited by various factors (Hall et. al., 2009). Thus, this complex system has grown to replace the initial Bretton Woods system which saw the dominance of one core country and its currency. Conclusion The preceding discourse has evidenced various features which underpinned the Bretton Woods system since its instigation in 1944 till its collapse in 1971. Additionally, this review has forwarded different reasons behind the breakdown of this system. The last section of this analysis has revealed the contemporary system which has replaced the old, Bretton Woods system mostly commonly referred to as Bretton Woods system II. References Bordo, M.D. (1993). The Bretton Woods International Monetary System: A Historical Overview. In M.D. Bordo & B. Eichengreen, (eds.), A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform (p. 1-108). Chicago: University of Chicago Press. Cohen, B. J. (2002). Bretton Woods System. In R. J. B. Jones (ed.), Routledge Encyclopaedia of International Political Economy. London: Routledge. Dammasch, S., (2000). The System of Bretton Woods: A lesson from history. Retrieved April 25th, 2013 from http://www.hiddenmysteries.org/money/policy/b-woods.pdf Eichengreen, B. (1993). Epilogue: Three Perspectives on the Bretton Woods System. In M.D. Bordo & B. Eichengreen, (eds.), A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform (p. 621 - 658). Chicago: University of Chicago Press. Galber, P.M. (1993). The Collapse of the Bretton Woods Fixed Exchange Rate System. In M.D. Bordo & B. Eichengreen, (eds.), A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform (p. 461 - 494). Chicago: University of Chicago Press. Hall, S.G. et. al., (2009). Bretton-Woods Systems, Old and New, and the Rotation of Exchange- Rates Regimes. Working Paper No. 09/15, Leicester: University of Leicester. Meltzer, A. (1991). U.S. Policy in the Bretton Woods Era. Federal Reserve Bank of St. Louis Review, 73: 54-83. Schwartz, A.J. (2000). Do we need a new Bretton Woods?. Cato Journal, 20(1): 21-25. Solomon, R. (1977). The International Monetary System, 1945-1976: An Insider’s View. New York: Harper & Row. Triffin, R. (1960). Gold and the Dollar Crisis. New Haven, Connecticut: Yale University Press. Read More