[Economy] Bretton Woods and Fixed Exchange Rate system :

Meaning Explained
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What is Bretton Woods?

Why is important?
Result of Bretton Woods
Main Players in this Conference
Impact of World War II on Economy
Agenda of conference
Fixed Exchange Rate system.
Roosevelt Vs Mohan:
Fast forward to 1970s
Inflation and Gold Prices
Do we need Bretton Woods?

While reading newspaper columns about global economy or

Eurozone crisis etc. you may have come across a sentence,
multiple times : we need another Bretton woods. so,
What is Bretton Woods?
Its a place in New Hampshire State of USA, just like BASEL is a
city in Switzerland.
Why is important?

In 1944, President Roosevelt hosted a conference here, to

rebuild the world economy, after Second World War.
Delegates of 44 allied nations had came to participate in this
conference.

Officially it is known as United Nations Monetary and

Financial Conference, commonly known as Bretton Woods
because of the place where it was held.

This conference resulted into creation of four extremely

important things
Result of Bretton Woods

1. IMF
o
They give short-term loans to help nations settle the
balance of payment crisis.

Theyve a system called SDR :Special Drawing

rights. (requires another article)

2. World Bank
o
Officially known as IBRD :International bank for
reconstruction and Development, that time
o
They give long term soft loans to rebuild the third
world.
o
Soft loans= interest rate is very low. Sometimes you
dont have to pay back the principle.

3. GATT (General Agreement on Trade and tariff) later

becomes WTO
o
To facilitate the international trade.
o
This will later become WTO.

4. Fixed Exchange Rate system. (although Discarded in

1970s)
o
Explained in this same article.
o

Main Players in this meeting

Total 44 nations participated, but Main players were:

US President Franklin D Roosevelt
UK Prime Minister Winston Churchill
Lord John Maynard Keynes, Famous economist, UK
treasury advisor.

India @Bretton Woods

India was represented by Sir C.D. Deshmukh, he was the

first Indian Governor of RBI.

Impact of World War II on Economy

Second world war started in 1939, ended in 1945

There is large scale bombing and destruction in the world.

Production has declined.

Agriculture, Dairy, Manufacturing, Export- everything is

brought to standstill=huge inflation

Agenda of conference

Help rebuilt the World Economy. Provide money, loan and

finance to needy nations. (World Bank)

After WW2, lot of colonies will get independence (India, Sri

Lanka), theyll introduce their own national currencies
without control of big superpowers (Britain, France etc) and
theyll enter in international trade in their own capacity.
(Exchange rates, IMF)

Hence, Some rules/order had to be created to facilitate

smooth international trade. (GATT)
Fixed Exchange Rate system.

What is Fixed Exchange Rate System?

Under this system, if RBI says $1=30 rupees, and youve

30 rupees and want to convert it in dollars but the
Foreigners are willing to give 1 dollar to youdont worry.

RBI will accept your 30 rupees and give your one dollar
out of its own reserve and vice versa.

Cons are obvious : When India is not exporting enough

and not attractive enough foreign investment (in dollars) and
still RBI keeps paying people in dollars, one day the bank
lockers will be empty, there will be no dollars to pay. System
will collapse.

But it has Pros (advantages) in the times of uncertaintyWhen youre writing on a clean slate, after WW2, if every
nation decides to have a fixed exchange rate system- it
leads to stability and predictability in Exchange rates = good
for foreign trade.

Roosevelt Vs Mohan: Pegging the Currencies

(Fictional, technically incorrect, imaginary)
President Roosevelt: ok I say we put fixed exchange rate
system. Lets fix the rates that 40 Rupees will equal to 1 dollar.
15 Yens will equal to 1 dollar. 12 Pounds will equal to 1 dollar
and so on. In short, Im pegging your currencies to US Dollar.

Thus Dollar will be the international reserve currency. AND Your

countrys RBI (central bank) will make sure these exchange
rates dont fluctuate more than 1% from these values.
Mohan: ya man, but what if the exchange rate fluctuates? for
example, What If I start running my country in a totally pathetic
and irresponsible manner and hence nobody wants to invest in
India so supply of dollar is low but demand of dollar is highbecause Indians love gold and weve to import crude oil and
pay in dollars. In short, this will fluctuate the exchange rates
between Dollar vs Rupee.
President Roosevelt: Let me ask you a question. Suppose
Onions are selling 100 rupees a kilo because of low supply but
suddenly farmers produce fresh new 50 million tonnes of onions
and supply it to market, what will happen?
Mohan: Easy! Onion Price will drop down to 40 rupees a kilo
because the supply has increased.
President Roosevelt: yes dude, the same way, whenever
exchange rate fluctuates from our standard rate, youll tell your
RBI to supply dollars from its own forex reserves in to the
market to calm down the demand and bring the rate back to
normal level.
If the reverse happens: (Onions are selling @ 2 rupees a kilo)
then you tell your RBI to buy all Onions dollars using its own
rupees, until the supply is reduced and price is back to normal.
Mohan: What nonsense is this? If 40 rupees equals 1 dollar but
then what does 1 dollar equal to? What is the value of your own
dollar? Why should we accept your dollar as international
reserve currency?
President Roosevelt: Ive fixed the value of your currency to
my dollars. And Im fixing the value of my own dollars to Gold.
1 ounce of Gold shall equal to 35 dollars. Meaning you walk in
with 35 dollars in my RBI (Federal Reserve Bank of USA), and
youll get one ounce of gold in return. Gold will remain precious
forever. So, its not like were running the show in thin air.
Dollars are backed by GOLD.
Mohan: ya man but what if my RBI doesnt have enough
dollars in its lockers? What will we do then?
President Roosevelt: dont worry, come to IMF. Theyll
arrange short term loans for you, in dollars.
Mohan: but still, why should we fix price of our currency to
dollars? Why should we accept dollar as the reserve currency

and not Yuan, Yen or Pound? Why should we accept you as our
big boss?
President Roosevelt: Because Ive the aukaat to pay enough
gold, so I say dollars will be the international reserve currency.
IF youve enough gold reserve in your RBI, come sit in the chair
and well see whether rupee is strong enough to become the
international reserve currency or not.
Even Britain is so financially bankrupt after Second World War,
they dont have the guts to tell me set this exchange rate
according to their Pounds. Btw, I also got some nuke missiles in
my limousine.
Mohan: no noI was just kidding man. Im well aware that
youre the superpower both financially and military wise.
President Roosevelt: Besides When weve a stable and fixed
exchange system like this, itll ensure smooth and long term
trade deals between merchants of various countries. When you
dont have fixed exchange rate system, it is bad for economy.
For example, today your call-center boss may give you free
lunch and coffee because $1=60 rupees but next day when
value of rupee declines and it is $1=50 rupees, same boss will
even stop running the water-cooler in your office. Third day
when $1=40 rupees, He will just kick you out because
outsourcing generate that much profit for him. Such
uncertainty, is not good for economy.
And since Gold is in limited supply, Dollar will be spent
carefully, and so your currency will be in spent carefully. i.e.
Since currencies are pegged, you will not indulge in
extravagant spending in subsidies, welfare schemes, tax-reliefs
or debt-waivers to farmers. This ensures fiscal discipline =>
That ensures less Fiscal deficit = less inflation.
Mohan: Mr. President Sir, I think I got the point now. Ill tell my
RBI Governor here to sign the Bretton Woods agreement
papers, because fixed exchange rate system sounds safe and
good.
Fast forward to 1970s

As you can see, the fixed exchange rate system, is good

for stable international trade environment, atleast on paper.

But this system can run smoothly only as long as USA has
the aukaat to pay gold to every swinging dude that walks
with dollars into their RBI (US Treasury).

Problem started with Cold War. Both USA and USSR (not
Russia), are busy in an arms race, building new tanks,
missiles and submarines every week.

Theyre also giving huge donations and help to poor

nations, in order to win their support and dominate the
region. This is a non-productive activity, theyre basically
wasting money.

Now, USA gets involved in a very lengthy and expensive

Vietnam War from 1959 to 1975.
Inflation and Gold Prices

Fact: War leads to inflation

Fact: Inflation decreases the value of your money.
Fact: Gold becomes more expensive because of Inflation.
US still kept fixed value of 35 dollars = 1 ounce of gold.
But thanks to this inflation, Gold is trading at higher price in
open market 40 dollars per ounce.
So there is an opportunity to make quick money, just tell
the RBI manager to take suitcase full of dollars from RBIs
locker to US Federal Reserve, take their gold in return, and
sell it to the local jeweller at higher market price and use this
profit to fix Indias problems- poverty, education etc.
For a while, US Presidents had enough clout over
international politics so that they could force other nations
RBI managers not to indulge in such cheap profiteering. But
Vietnam war is fast deteriorating Americas clout and now
RBIs of various countries have started lining up with their
suitcases full of dollars and they want gold in return.
1971, President Nixon decides that if we continue giving
gold for dollars, we will go bankrupt. There will be no gold
left in our lockers. So I give up. Im not going to let anyone
exchange their dollars for my gold.
And thus Bretton Wood system breaks down.
1973, World moves to floating exchange rate system.
What is Floating Exchange rate? Governments / Central
Banks dont fix exchange rates here. It is left to the Forex
markets, private players and laws of supply and demand.
Government /RBI will only intervene if there is huge
fluctuation in the exchange rates.

Do we need Bretton Woods?

With respect to the Eurozone crisis (click ME), many

columnists write We need another Bretton Woods.
They dont actually mean that we need to move back to
the same old Fixed Rate exchange system, in which every
currency was pegged to Dollar and Dollar was pegged to
Gold. Because that fixed rate thing is impractical in real life
scenario, as we saw in above paragraphs.
Just imagine, if tomorrow World starts running according to
Bretton Woods system, what will happen?
We know that China already has more than 1000 billion
dollars in its Forex Reserves. So Peoples Bank of China will
send its Probationary officer with suitcases full of dollars and
take away all the gold from Fort Knox*. They dont even
need to fight a war, USA will come down to its knees
financially.
[*Fort Knox is a place in Kentucky State, US Government
keeps the gold reserves in this place.]
In real life, not that China will actually do so, but the mere
threat and possibility will keep USA on its toes. Hence US will
not agree to Fixed Exchange rate in the first place.
There is no chance any other country will agree to become
the big brother and let their currency become the reserved
currency and peg it to gold.
Especially India, because if we peg our 10,000 Rupees to
one ounce of Gold and declare that we are the new
international reserve currency, just like dollar before 1970s,
What will be the Result? Pegged currency means
Government cant do extravagant spending in MNREGA.
Theyll have to stop subsidy on diesel, kerosene, LPG and
fertilizers, because they can dole out only as much
rupees as the amount of gold held in RBIs locker.
As You can understand, no political party has the guts to
do that, hence no nation will want to become the big brother
or Sacrificial goat (Bali kaa Bakraa) for another Bretton
Woods.
So, The sentence We need another Bretton Woods is just
a metaphor, to say that all the Presidents, Prime ministers
and Economists of the world should meet up once again and
hold conference in some gambling den, drink some Desi
liquor, watch some Item-song, brainstorm for new ideas and

start something from scratch, totally new, Just like the

Gentlemen at Bretton Woods did, in 1944.
Then what to do?

It could be anything, untried and untested before likeChina could agree that well not dump our products in
foreign market, we will not keep our yuan under-valued,
US could agree that well bring back our troop from
Afghanistan and cut down on our Defense Expenditure and
its inflationary effect on world economy. We will also stop
supporting Pakistan. Thus reducing defense Expenditure of
India in the arms race= that will also reduce fiscal deficit of
India= India could decrease taxes=boost for economy and
world trade.
Iran could agree that well stop our irrelevant obsession
with nuke weapons and give up, So that UN removes the
sanctions and our traders can make more money, thus
improving the standard of living for Iranian aam-aadmis.
EU could agree that well kick out Greece, because its just
way too messed up beyond fixing.
And India could agree that well bring all the black money
from Switzerland and use it to finance our bogus
Government schemes and subsidies instead of looting the
aam-aadmi via direct and indirect taxes, to finance those
things.