c
 

  

The Bretton Woods system was a monetary management system that established a new monetary
order. In July 1944. Forty five countries met in Bretton Woods, NH, to design the Bretton
Woods system. The name comes from the location of the meeting where the agreements were
drawn up i.e, Bretton Woods, New Hamshire where the delegations from over forty five
countries met to deliberate on proposals for a post-war international monetary system.
This meeting took place in July 1944. The Bretton Woods agreement was responsible for the set
up of the International Monetary Fund. The Bretton Woods System was an attempt to avoid
worldwide economic disasters such as the ones experienced in the 1930's

  

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The purpose of the Bretton Woods meeting was to set up new system of rules, regulations, and
procedures for the major economies of the world. The main goal of the agreement was economic
stability for the major economic powers of the world. The system was designed to address
systemic imbalances without upsetting the system as a whole.


  

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Four main features of the Bretton Woods system was as follows.

÷ First, it was a US dollar-based system. Officially, the Bretton Woods system was a gold-
based system which treated all countries symmetrically, and the IMF was charged with
the responsibility to manage this system. In reality, however, it was a US-dominated
system with the US dollar playing the role of the key currency (the dollar¶s dominance
still continues today). The relationship between the US and other countries was highly
asymmetric. The US, as the center country, provided domestic price stability which other
countries could ³import,´ but did not itself engage in currency intervention (this is called
benign neglect; i.e., the US did not care about exchange rates, which was desirable). By
contrast, all other countries had the obligation to intervene in the currency market to fix
their exchange rates against the US dollar.
÷ Second, it was an adjustable peg system. This means that exchange rates were normally
fixed but permitted to be adjusted infrequently under certain conditions. As a
consequence, exchange rates were supposed to move in a stepwise fashion. This was an
arrangement to combine exchange rate stability and flexibility, while avoiding mutually
destructive devaluation. Member countries were allowed to adjust ³parities´ (exchange
rates) when ³fundamental disequilibrium´ existed. However, ³fundamental
disequilibrium´ was not clearly defined anywhere. In reality, exchange rate adjustments
were implemented far less often than the builders of the Bretton Woods system imagined.
Germany revalued twice, the UK devalued once, and France devalued twice. Japan and
Italy did not revise their parities.
÷ Third, capital control was tight. This was a big difference from the Classical Gold
Standard of 1879-1914, when there was free capital mobility. Although the US and
Germany had relatively less capital-account regulations, other countries imposed severe
exchange controls.
 ÷ Fourth, macroeconomic performance was good. In particular, global price stability and
high growth were simultaneously achieved under deepening trade liberalization. In
particular, stability in tradable prices (wholesale prices or WPI) from the mid 1950s to
the late 1960s was almost perfect and globally common. This macroeconomic
achievement was historically unprecedented.

  
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The Bretton Woods system established the US Dollar as the reserve currency of the world. It also
required world currencies to be pegged to the dollar rather than gold. The demise of Bretton
woods started in 1971 when Richard Nixon took the US off of the Gold Standard to stem the
outflow of gold.

By 1976 the principles of Bretton Woods were abandoned all together and the world currencies
were once again free floating. Bretton Woods is an important event for forex traders because it
was truly the founding of forex trading.

The two main contending proposals were ³the White plan´ named after Harry Dexter White of
the US Treasury and the ³Keynes plan´ whose architect was Lord Keynes of the UK. Following
the Second World War, policy makers from victorious allied powers, principally the US and UK,
took up the task of thoroughly revamping the world monetary system for the non-communist
world. The outcome was the so called ³Bretton Woods System´ and the birth of new supra-
national institutions, the International Monetary Fund (the IMF or simply the ³Fund´) and the
World Bank.

Under this system US Dollar was the only currency that was fully convertible to gold; where
other countries currencies were not directly convertible to gold. Countries held US dollars, as
well as gold, for use as an international means of payment.

The system proposed an international clearing union that would create an international reserve
asset called ³bancor´. Countries would accept payment in bancor to settle international
transactions without limit. They would also be allowed to acquire bancor by using overdraft
facilities with the clearing union.

In return for undertaking this obligation, the member countries were entitled to have access to
credit facilities from the IMF to carry out their intervention in the currency markets.

The novel feature of regime which makes it an adjustable peg system rather than a fixed rate
system like the gold standard was that the parity of a currency against the dollar could be
changed in the face of a fundamental equilibrium. A fundamental equilibrium is said to exist
when at the given exchange rate, the country repeatedly faces balance of payment disequilibria,
and has to constantly intervene and sell foreign exchange (persistent deficits) or buy foreign
exchange (persistent surpluses) against its own currency. The situation of persistent deficits is
much more difficult to deal with and calls for a devaluation of the home currency. Changes of
upto 10% in either direction could be made without the consent of the Fund and obtaining their
approval.

Under the Bretton Wood System, the US dollar in effect became international money. Other
countries accumulated and held dollar balances with which they could settle their international
payments; the US could in principal buy goods and services from other countries simply by
paying with its own money. This system could work as long as other countries had confidence in
the stability of the US dollar and in the ability of the US treasury to convert dollars into gold on
demand at the specified conversion rate.




 
Professor Robert Triffin warned that gold exchange system was programmed to collapse in the
long run. To satisfy the growing needs of reserves, the US had to run BOP deficits continuously
which would eventually impair the public confidence in the dollar, triggering a run on the dollar.
If reserve currency country runs BOP deficits to supply reserves, they can lead to a crisis of
confidence in the reserve currency itself causing the down fall of the system. This dilemma is
known as 


 

The system came under pressure and ultimately broke down when this confidence was shaken
due to various political and some economic factors starting in mid-1960s. On August 15, 1971,
the US government abandoned its commitment to convert dollars into gold at the fixed price of
$35 per ounce and the major currencies went on a float.



 
  
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This system did not provide for any revision in the price of gold. Due to inflation, it became
uneconomical to produce gold. This led to the suspension of gold production in various countries
leading to stagnation of gold reserves which had an adverse impact on international liquidity.

The system did not provide for any revaluation of parties due to which surplus countries such as
West Germany and Japan continued to enjoy export competitiveness against US economy. This
aggravated the US trade deficit.

The system did not provide for a revision in the price of gold in terms of USD. Due to this, it was
not possible to devalue the US Dollar despite continued trade deficit. The devaluation of the
dollar would have adversely affected all countries having USD reserves.

The continued trade deficit of the US created an over-supply of USD in the interational financial
markets which reduced the acceptability of the USD. When the Gold convertibility Clause was
invoked, the US authorities could not honour their commitment

 


 

An attempt was made to resurrect the system by increasing the price of gold and widening the
bands of permissible variation around the central parity. An agreement reached by a group of 10
countries (G10) in 1971 that effectively ended the fixed exchange rate system established under
the Bretton Woods Agreement. This was the so called  


 
 The
Smithsonian Agreement reestablished an international system of fixed exchange rates without
the backing of silver or gold, and allowed for the devaluation of the U.S. dollar. This agreement
was the first time in which currency exchange rates were negotiated. That too failed to hold the
system together, and by early 1973, the world moved to a system of floating rates.

After a period of wild fluctuation in exchange rates ± accentuated by real shock such as the oil
price crises in 1973 ± policy makers in various countries started experimenting with exchange
rate regimes which were hybrids between fixed and floating rates. A group of countries in
Europe entered into Bretton Woods like engagement of adjustable pegs within themselves. This
was the European monetary system. Other countries tried various mixed versions.

 


 !"

The Bretton Woods also known as IMF system was an improvement on the gold standard. The
IMF system had all the merits of the gold standard minus its demerits. It ensured exchange
stability without the country having to undergo the expense of maintaining a costly currency
system. Under the IMF system, exchange parities were fixed in gold but it was unnecessary to
keep large gold reserves for currency purposes. Besides gold stocks and current output were
utterly inadequate to meet the requirements of over-expanding volume of international trade,
thus giving rise to the serious problem of international liquidity. The IMF sought to provide
multilaterism. The IMF quota facilitated foreign exchange transactions and there was no need to
export gold to meet a trade deficit. It also facilitated convertibility of currencies and provided
adequate and convenient currency reserve for the use of member countries. However, fast
changing circumstances are necessitated changes in the IMF system. In September 1967, the
Board of Governors approved a plan for a new type of international asset known as the SDRs
(Special Drawing Rights).

SDRs is an international reserve asset created by the IMF to supplement existing foreign
exchange reserves. It serves as a unit of account for the IMF and other international and regional
organizations, and it is also the base against which some countries peg the rate of exchange for
their currencies. Defined initially in terms of a fixed quantity of gold, the SDR has been
redefined several times. It is currently the weighted value of currencies of the five IMF members
having the largest exports of goods and services. Individual countries hold SDRs in the form of
deposits in the IMF. These holdings are part of each countryµs international monetary reserves,
along with official holdings of gold, foreign exchange, and its reserve position at the IMF.
Members may settle transactions among themselves by transferring SDRs.

Under the Scheme, the IMF is empowered to allocate to various member countries SDRµs on a
specified basis, which in effect amounts to raising the limit to which a member country can draw
from the IMF in time of need. Besides, the SDRµs supplement gold, dollars and pounds sterling
most countries use as monetary reserves. They can be used unconditionally by the participating
countries to meet their liabilities and they are not backed by gold. They are meant to be used by
the Central banks of the Fundµs member countries. With the SDRµs, the Central banks can buy
whatever currencies they need for settling their balance of payments deficits. The resources of
the new scheme are not a pool of currencies but simply the obligation of participating members
to accept the SDRµs for settlement of payments between them. Thus, SDRµs serve as an
international money as good as other reserve currencies.

But a nicely and diligently built up system of exchange stability by the IMF collapsed like a
house of cards. This was caused by the dollar crisis created by the adverse American balance of
payments. Among the measures taken by the American administration, there was one which
delinked dollar from gold. The delinking of dollar from gold knocked out the very foundation of
the IMF. In January 1975, the IMF abolished the official price of gold and SDRµs have instead
become the basis of the present international monetary standard. The SDRµs are not convertible
into gold; that is why alternatively the present standard may also be referred to as Paper Gold
Standard.

#$$%&'(
A country's exchange rate regime under which the government or central bank ties the official
exchange rate to another country's currency (or the price of gold). The purpose of a fixed
exchange rate system is to maintain a country's currency value within a very narrow band. Also
known as pegged exchange rate

Fixed rates provide greater certainty for exporters and importers. This also helps the government
maintain low inflation, which in the long run should keep interest rates down and stimulate
increased trade and investment.

A fixed exchange rate is usually used to stabilize the value of a currency against the currency it is
pegged to. This makes trade and investments between the two countries easier and more
predictable, and is especially useful for small economies where external trade forms a large part
of their GDP

)


 


 
1First of all, fixed exchange rates offer much greater stability for the enterprisers and
stimulate international trade, since the exchange rates stay on the same level, the
importers and exporters can plan their policy without begin afraid of depreciation or
appreciation of the currency. Moreover, fixed exchange rates make the producers more
disciplined, i.e. they are forced to keep up with the quality of their production and to
control the costs of the production to stay competitive compared to international
enterprisers. This advantage of fixed exchange rates allows the government to decrease
inflation level and stimulate international trade and economical growth in the long period
.
2.Secondly, it is believed that fixed exchange rates stimulate the reduction of speculative
activity worldwide,but this statement is true under the condition that the adopted
exchange rates are profitable for the foreign dealers as well as for domestic ones (closer
examination of this condition shows us that monetary and fiscal policies attempting to
protect domestic producers ± which are often required to preserve economical stability ±
violate this condition and therefore create the ground for speculative intervention).
 
)


 


 
1.The main disadvantage of it is the high vulnerability of the economical system to
speculative attacks. Any economy experiences excess supply and demand in either
national or foreign currency: and if the national banks are unable to cover the gap
between the existing resources and demand, the fixed rate needs to be changed,this
situation reduces the positive effects of the fixed rate exchange system and decreases the
credibility of the currency

2.One more disadvantage of this system is that if the government artificially supports the
exchange rate, which is not adjusted to changed economical condition, the development
of the country¶s economy is not as efficient as it could be if the rate was adjusted to the
situation. Moreover, interest rates, which directly depend on the exchange rate, can stop
possible economical growth in case of their disparity to market needs.
In the conditions when the national currency is tied to some international currency, there
exists very significant dependence of the condition of these countries¶ economical
stability. In this case the government is actually forced to solve the economical problems
of the countries, with currency of which it is linked. This situation creates the possibility
for dominating countries to improve the state of their economy at the expense of related
countries with weaker economies and at the same time destabilizes the market situation in
these related countries.
taking into consideration the growing economical and political integration, the
strengthening of the economical connection between countries, the fast development of
world trade and economical specialization, the advantages of fixed interest rates do not
cover the losses caused by the restrictions imposed by this system.

*



A country's exchange rate regime where its currency is set by the foreign-exchange market
through supply and demand for that particular currency relative to other currencies. Thus,
floating exchange rates change freely and are determined by trading in the forex market. This is
in contrast to a "fixed exchange rate" regime.

After the failure of Bretton Woods system several currency regimes have emerged spanning the
spectrum of rigidly fixed rate regime to independently flexible regimes.

Every country that has its own currency must decide what type of exchange rate arrangement to
maintain. In academic discussions, the decision is often posed as a choice between a fixed or a
flexible exchange rate.
Floating exchange rate is known as a floating currency. This currency is set by the foreign
exchange market through supply and demand for that particular currency relative to other
currencies. The central bank needs to keep the stability of the market of buying or selling
currencies to avoid the instability of the exchange rate from getting too high or too low.
However, there are some advantages of the floating exchange rates such as full employment,
stable growth and price stability. In the Meantime, the Exchange rate adjustment has purposed to
promote those goals by work as an automatic stabilizer.

Also, a government wanting to maintain a fixed exchange rate does so by either buying or selling
its own currency on the open market. This is one reason governments maintain reserves of
foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys
its own currency off the market using its reserves. This places greater demand on the market and
pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the
opposite measures are taken.

  




+






 are determined in the foreign exchange market. Authorities can
and do intervene, but are not bound by any intervention rule. Often accompanied by a separate
nominal anchor, such as inflation target. The arrangement provides a way to mix market-
determined rates with stabilizing intervention in a non-rule-based system. Its potential drawbacks
are that it doesn¶t place hard constrains on monetary and fiscal policy. Absence of rule
conditions credibility, gain on credibility of monetary authorities. Limited transparency.


 The exchange rate is determined in the market without public sector intervention.
Adjustments to shocks can take place through exchange rate movements. Eliminates the
requirement to hold large reserves. This arrangement does not provide an expectations anchor.
Exchange rate regime places no restrictions on monetary and fiscal policy; time inconvenience
arises unless addressed by other institutional measures.

 


)  







÷  
*


 


,
 - Any balance of payments disequilibrium
will tend to be rectified by a change in the exchange rate. For example, if a country has a
balance of payments deficit then the currency should depreciate. This is because imports
will be greater than exports meaning the supply of sterling on the foreign exchanges will
be increasing as importers sell pounds to pay for the imports. This will drive the value of
the pound down. The effect of the depreciation should be to make your exports cheaper
and imports more expensive, thus increasing demand for your goods abroad and reducing
 demand for foreign goods in your own country, therefore dealing with the balance of
payments problem. Conversely, a balance of payments surplus should be eliminated by
an appreciation of the currency.
÷ 



  - With a floating exchange rate, balance of payments
disequilibrium should be rectified by a change in the external price of the currency.
However, with a fixed rate, curing a deficit could involve a general deflationary policy
resulting in unpleasant consequences for the whole economy such as unemployment. The
floating rate allows governments freedom to pursue their own internal policy objectives
such as growth and full employment without external constraints.
÷ *
  - Fixed rates are often characterised by crises as pressure mounts on a
currency to devalue or revalue. The fact that, with a floating rate, such changes are
automatic should remove the element of crisis from international relations.
÷ * - Post-1973 there were great changes in the pattern of world trade as well as a
major change in world economics as a result of the OPEC oil shock. A fixed exchange
rate would have caused major problems at this time as some countries would be
uncompetitive given their inflation rate. The floating rate allows a country to re-adjust
more flexibly to external shocks.
÷ A  


) - A country with a fixed rate usually has to hold large
amounts of foreign currency in order to prepare for a time when they have to defend that
fixed rate. These reserves have an opportunity cost.


)


  




÷ 


 - The fact that a currency changes in value from day to day introduces
instability or uncertainty into trade. Sellers may be unsure of how much money they will
receive when they sell abroad or what their price actually is abroad. Of course the rate
changing will affect price and thus sales. In a similar way importers never know how
much it is going to cost them to import a given amount of foreign goods. This uncertainty
can be reduced by hedging the foreign exchange risk on the forward market.
÷ A
- 
)
 - The uncertainty can lead to a lack of investment internally as well
as from abroad.
÷ 

- Speculation will tend to be an inherent part of a floating system and it can
be damaging and destabilising for the economy, as the speculative flows may often differ
from the underlying pattern of trade flows.
÷ A
- 






 - As inflation is not punished there is a
danger that governments will follow inflationary economic policies that then lead to a
level of inflation that can cause problems for the economy. The presence of an inflation
target should help overcome this.
÷  




 

  
 - UK experience indicates that a
floating exchange rate probably does not automatically cure a balance of payments
deficit. Much depends on the price elasticity of demand for imports and exports.
÷ #


- The floating exchange rate can be inflationary. Apart from not punishing
inflationary economies, which, in itself, encourages inflation, the float can cause inflation
by allowing import prices to rise as the exchange rate fall.
#






  
 
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./0.
After 1971, the IMF lost its sense of purpose as guardian of the international monetary system.
The international monetary system was scrapped for flexible exchange rates. At the end of 1996,
every country has its own system.1 An international monetary system on the strict sense of the
world does not presently exist.2 Under the impression of IMS, large numbers of employees of
banks and financial institutions has to carry out their work under a set of rules individually and
the internal control for the operational stability has been removed3

The world¶s monetary officials were deliberating the problem of international liquidity in the
period of 1966-1971. They had been discussing this problem for several years but they were by
no means agreed that the supply of liquidity in the international monetary system was actually
inadequate or that unusual new arrangements for creating liquidity were necessary.4 In addition,
the unstructured nature of the current international monetary system is apparent in the way it
deals with each of the three fundamental tasks of any monetary system which were supplying
international liquidity, determining exchange rates, and providing an international framework for
national economic policies.5 However, the reform of the international monetary system has not
been on the political agenda for many years after Bretton Woods system collapsed.

%
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+

  
After Bretton woods collapsed, the European countries agreed to maintain stable exchange rates
by preventing exchange fluctuations. This arrangement was called the European µsnake in the
tunnel¶ because the community currencies floated as a group against outside currencies such as
the dollar.6 However, a new effort to achieve monetary cooperation was launched. EC


established European Monetary System, and created the European Currency Unit (ECU).7 The
European Monetary system (EMS) was launched as a bridge to help lead the ultimate goal of
Economic and Monetary Union (EMU).8 Since then, the European leader were keen to maintain
the principle of exchange rate and faced many difficulties in setting the right rate for all
European members and wasn¶t entirely successful because some member was less committed to
9
it than others. The important part of EMS is to commit all member governments to keep their
currencies exchange rates/ within bands. This particular role was designed to help create stable
commerce without the fear of sudden changes in the value of currencies.

%
#+
The IMF is an organization that formed with a stated objective of stabilizing international
exchange rates and facilitating development which is located in Washington, D.C., in the United
States.10 The IMF initiated with 29 nations but there are now about 186 countries become
members. The term µcountry¶ also refers to some territory areas that are not states. The IMF is
working to foster global monetary cooperation, secure financial stability, facilitate international
trade, promote high employment and sustainable economic growth, and reduce poverty around
the world.11 IMF current task is to monitors the world's economies by keeping track of economic
developments on a national, regional, and global basis, consulting regularly with member and
providing them with macroeconomic and financial policy advice. IMF also provides practical
guidance and training on how to upgrade institutions, and design appropriate macroeconomic,
financial, and structural policies to third world countries. The main mission of IMF is to provide
loans to countries that have trouble meeting their international payments and cannot otherwise
find sufficient financing. This financial assistance is designed to help countries restore
macroeconomic stability by rebuilding their international reserves, stabilising their currencies,
and paying for imports²all necessary conditions for re-launch growth.


REFERENCES

WEBSITES:

http://forextrading.about.com/od/forexhistory/a/bretton_woods.htm

http://www.mbaknol.com/international-finance/exchange-rate-regimes-the-bretton-woods-
system/

www.investopedia.com

www.forextraders.com

www.scribd.com

www.bized.co.uk

www.wikipedia.com

BOOKS:
International Finance ± Govind Sowani