The main cause of collapsing of the Bretton woods system - Essay Example

re of the system was a promise each country made to all that their monetary policies would keep the currency of the country close to a fixed value (within 1%) to gold. The IMF would have the authority to close temporary payment imbalances between countries and would monitor the fiscal activities of other nations. While the system worked well for several years, it collapsed in 1971 once the United States pulled out from the gold standard (Bird, 1994). The simplest cause of failure in economic terms is that the system was useful for the time it was created but it was far too optimistic of the creators of the systems that all other things would remain the same.

Without a doubt, economic realties change for us on a daily basis even though the majority of economic activity can be explained by the process of supply and demand. The creators of the system thought that the system would be large enough to control and contain market forces and economic systems but they learnt quickly that while market forces take the upper hand to established systems. While the final cause of failure was the American pullout from the system, the foundations were being weakened long before the event.

The first change was the monetary interdependence which countries faced with respect to each other and the convertibility of the Japanese Yean and the Western European countries. This made it possible for banks and monetary organizations to take part in large financial transactions further adding to the financial interdependence of various countries (Cooper & Sneddon, 2001). Banks are able to make huge transfers of capital from one country to another for investment and lending purposes but that money can also be used for currency speculation.

In the Bretton Woods system, exchange rates were more or less fixed and countries were hesitant in revaluing their currencies (Bird, 1994). Speculators could therefore convert large sums of money from a soft to a hard currency hoping to gain value when the