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The gold standard, the exchange rate between any two currencies
was determined by their gold content.
Example for exchange rate determination: the USA declared the
dollar to be convertible to gold at a rate of $20.67/ounce of gold.
The British pound was pegged at £4.247/ounce of gold. Thus
the dollar pound exchange rate would be determined as follow
$20.67/ounce of gold
£4.247/ounce of gold = $ 4.86656/£
• The IMF was created with the specific goal of being the
multilateral body that monitored the implementation of the
Bretton Woods agreement.
• Its role was to hold gold reserves and currency reserves that
were contributed by the member countries and then lend this
money out to other nations that had difficulty meeting their
obligations under the agreement.
• Currencies had to be convertible: central banks had to exchange
domestic currency for dollars upon request.
• Although the adjustable exchange rate system meant that
countries that could no longer sustain the fixed exchange rate
vis-a-vis the dollar would be allowed to devalue their currencies,
they could only do so with the consent of the other countries and
the auspices of the IMF.
The Breakdown of the Bretton Woods System
The trade balance of the USA became highly negative and a very
large amount of US dollars was held outside the USA ; it was
more than the total gold holdings of the USA.
During end of sixties, European governments wanted gold in
return for the dollar reserves they held.
Rate systems are classified on the basis of the flexibility that the
monetary authorities show towards fluctuations in the exchange
rates and are divided into two categories:
1. Systems with a fixed exchange rate
( “fixed peg” or “hard peg”) and
2. Systems with a flexible exchange rate ( “Floating” systems)
Fixed Exchange Rate System
In this system, a currency is pegged to a foreign currency, with
fixed parity. The rates are maintained constant or they may
fluctuate within a narrow range. When a currency trends towards
crossing over the limits, government intervene to keep it within
the band.
A fixed peg regime exists when the exchange rate of the home
currency is fixed to an anchor currency.