The Bretton Woods System In 4,000 Words Or Less

31yhbFeRoLL._BO2,204,203,200_PIsitb-sticker-arrow-click,TopRight,35,-76_AA300_SH20_OU01_

I think to understand the current, dollar-based global financial regime, one must understand its immediate predecessor, the Bretton Woods System.

The purpose of the Bretton Woods Agreement was to create a system of fixed exchange rates between nations in order to facilitate global trade.  Investors are far more likely to invest in a country’s businesses if they have faith that the country’s currency will retain its value.

Before World War One, the world had gone along fairly successfully for decades under a near-universal gold standard.  But when the Gold Standard was rebooted after the First War ended, it never worked quite as well.  So after the Second World War, leaders representing the major economies of the world meet in Bretton Woods, New Hampshire to see how they could improve the Gold Standard.

Under the Bretton Woods Agreement they made there, instead of currencies being pegged to a certain quantity of gold (as they would have been under a typical Gold Standard), it was decided that they would be pegged to the American dollar.  In turn, the dollar would be backed by gold, with each dollar exchangeable for 1/35th ounce of gold (or to say another way, one ounce of gold would be equal 35 dollars).

Under the Bretton Woods agreement, the U.S. was not obligated to intervene in the exchange market to prop up or push down the dollar.  It’s only responsibility was to be prepared to buy and sell gold at 35 dollars an ounce.  Only the U.S. had a currency fixed by law to a certain value of gold, and only the U.S. had to keep its reserves in gold.  Other countries could hold reserves in whatever mixture of gold and dollars they chose.  It sounds like, according to Gilbert, countries could also hold reserves in other “liquid international assets” as long as they were liquid enough to be “readily available for intervening in the market” when the need arose.

Why did countries not mind holding dollar reserves instead of gold?  We learn in The Gold Standard In Theory And History that countries didn’t mind holding dollars because dollar reserves could earn INTEREST in money-market accounts and time deposits, whereas gold could not.  If it had not been for the interest bonus, countries would have probably just held mostly gold.

However, there was some risk in holding dollar reserves.  The U.S. would sometimes, for political purposes, freeze dollar-denominated accounts over which it exercised jurisdiction.

Though it’s a little hard to believe for those of us who grew up knowing America The Dominating SuperPower– at the time of Bretton Woods, the United States did NOT push the idea of having the dollar take on such a prestigious and powerful role.  It accepted the responsibility, but did not strongly advocate for it.

Bretton Woods attempted to provide a stable system of exchange rates without actually committing the globe to a single world currency.  A single currency would have ruled out a sovereign nation’s ability to maintain some flexibility in its currency– and thus harmed a country’s ability to regulate its own economy. Barry Eichengreen states that “political solidarity and economic convergence are prerequisites for monetary unification.”  The world was certainly not ready to go that far in the mid-1940s.  I have no reason to think it ever will be.

The Bretton Woods System was maintained for only three decades, and as early as the 1960s it was already showing signs of stress.  Problems in the system culminated in the 1970s when President Nixon effectively ended Bretton Woods by refusing to any longer exchange gold for dollars at the pre-determined amount.  Today, the world operates on a floating exchange rate system, with most countries attempting to keep the value of their currencies within a certain band of values relative to another currency (such as the dollar) or to a basket of other currencies.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s