The Most Important Features of the Bretton Woods Agreement - Assignment Example

Running head: The Bretton Woods Agreement Name: Institute: Course: Date THE BRETTON WOODS AGREEMENT The most important features of Bretton Woods Agreement When the World War II was over, the Bretton Woods System was the successor of the gold standard monetary system (Orin Kirshner, 1996). As a new system adopted the top mast industrialized countries had to come together and come up with an agreement which came up with the following features: - The International Monetary Fund (IMF) –This IMF was had a responsibility of supervision over the policies and rules of a new fixed exchange rate regime and also had to ensure that stability of other countries was maintained thus promoting foreign trade (Uzan, 1996). Also the World Bank was created as part during the comprehensive plan for starting a new IMS. The U.S dollar turned out to be the only currency supported by gold, after it reinstated gold as the vital convertibility standards for currencies all over the world (Kim, 2011). During the agreement, there was establishment of an exchange rates system which was fixed on the modifiable peg system-Here, there were gold fixed dollars whereby, the fixed rates were relatively expressed to the dollar since the rates of exchange were fixed and not favoring the gold (Orin Kirshner, 1996). Sterling was pegged from 1949 to 1967 at two point eight. During this time the involved countries were grateful to interfere with the markets of foreign exchange hence maintain the authentic rates at one percent of the two point eight. The IMF rules permitted the governments to modify the pegged rate- Pegging of a currency is connected to stability, mostly in the urbanizing countries whereby a country may come up with a decision of pegging its currency thus creating a constant impression for foreign investment (Michael D. Bordo, 2003). In addition, investors having a peg are able to know their investment values are thus reducing worries about the daily fluctuations. When currencies are pegged, inflation rates are lowered thus generating demand due to high confidence in currency stability (Primer, 2003). This was done to cause an effect of either devaluing or revaluing the currency, if and if only when the country experienced surplus or deficit on balance of payments of an elementary nature. They also agreed to make the dollar the most important worldwide reserve asset- If there was any need of conversion of currency into gold, only the USA did the conversion. However in 1950’s the largest gold stocks were held by USA and this was worldwide thus dollar becoming valuable as much as the gold hence making other countries willingly and majorly use the dollar (Michael, 2003). During this time the agreement seemed to work very well and in the 1950’s the world trade growth was at record rates thus the world experiencing the golden age of capitalism. All in all, the Bretton Woods System collapsed due to certain problems which urbanized in two decades time (Uzan, 1996). Reasons why Bretton Woods Systems Broke Down The US were expected to process a number of deficits in a balance of payment in more than 25 oncoming years after the down fall of the system, so that the currency could be reserved for the world (Kim, 2011). The reserves of U.S. gold had depleted by early 1970s whereby it led to minimal gold in its treasury that could cover all the dollars for U.S. preserved in central banks of foreign countries. Finally, in the year 1971 all the gold windows were closed meaning that they had closed the chapters of exchanging their gold which was held in the other foreign countries’ reserves for the U.S dollar (James, 2009). The following are some of the reasons of the Bretton Wood Brake down: - (a) Both devaluation and revaluation were depended on by the system thus ensuring rates of exchange remained within the targeted range thus expressing competitiveness. •Surplus-Nations not pushed or forced to revalue since real economic problems were not exposed by reserves of foreign exchange being accumulated (Michael, 2003). •Deficit- Nations assumed that economic policy failure is due to devaluation. However, long after the devaluation had become most important, UK kept on resisting it until the year 1967. To protect excess exchange rates of values, the deficit nations were required to use the deflationary policy (Kim, 2011). Countries were not willing to take or accept the system fixed exchange rates deflationary charges because the problem emerged to be more serious as the Inflation rates increased and diverged. (b) The system was not able to defend itself because of the assumptions made and they were not reversible hence, a deficit nation could devalue or remain not tempered with. However, there was pressure which developed on deficit countries mostly when capital flows are increased due to the growth of the markets of the Eurocurrency (James, 2009). (c) There was an intrinsic flaw in the system whereby, also the dollar was taken in as the most important reserve currency by the system. In order there could be sufficient assets to finance the trade; international liquid assets in form of dollars were provided for sufficiency since the world trade enlarged. For a continuous world supply of dollars to carry on, USA exported the dollars thus running a deficit of balance of payment through financing it (James, 2009). Later on, there was a restriction of dollars being moved than USA’s gold holdings value. In addition, there came in the doubt of conversion of dollar into gold hence there reduced the confidence they had in the dollar. In one way or another, many countries started using the floating exchange rates after the Bretton Woods System collapsed. However, the less positive choice the governments made showed that they were already defeated to maintain the system. They tried to revive the fixed rate system but they were not able hence they realized that it would (James, 2009). take long time to restore the fixed exchange rates and there were some steps would be followed and also some features so that they would familiarize themselves with the new system therefore having agreement as the most important outcome that: - Measures with an exception of gold would be fixed against the currencies in the various Nations. In maintenance of stable systems of rates of exchange and the ordinary exchange arrangements by the IMF members, the floating rates of exchange were accepted (Kim, 2011). In the year 1985, the five principle governments in industrial economics held a meeting in USA to mull over the suggestions put across over what was thought to be serious over the US valuation. They also thought that the international trade growth was to be damaged by the major currency disarrangements therefore; the outcome was a work out in Co-Ordination of international policy whereby there was an agreement among the five countries in undertaking policies manipulate strong fall in dollar value exchange (Michael, 2003). This was done largely and successfully thus encouraging more attempts this round being done by the seven great countries (G-7) group that is; German, France, Italy, USA, Japan, UK and Canada. This G-7 group agreed to provide maintenance to their rates of exchange management so that stability of rates of exchange can be generated (Orin Kirshner, 1996). The following is what got involved:- a) In prevention of solemn short-term exchange rate fluctuations, they had to interfere with the foreign exchange markets. However, the interference was to be implemented in a co-ordinate style and on large scale (James, 2009). b) In order there could be a long term exchange rates stability could be produced; there is involvement of monetary policy and Co – ordination of overall fiscal. The management of the short term and long term exchange rates, their interest rates level and the inflation control would be centralized (Kim, 2011). What replaced the broken Bretton Woods System? In the year 1976, there was the Jamaica agreement whereby the floating exchange rates were accepted worldwide after the break down of the Bretton Wood System. The acceptance of the floating exchange rate system, there would be a permanent abolishment of the gold standard use (Andrews, 2008). However, it is not that the governments adopted purely the Free-floating rates of exchange system but the following three exchange rate systems were also used up to date by many governments (Frank MacDonald, 2002); Pegged rate Dollarization Managed floating rate  Pegged Rates This happens when there is a direct fixation of a country’s exchange rates to a currency of a foreign country to enhance the country more stability which is higher than the normal float (Eichengreen, 2007). To expound on this, pegging is the allowance countries have during the exchange of a currency whereby they are expected to exchange them at a fixed rate with either a specific or single foreign currencies basket (Helleiner, 1996). There will be no any currency fluctuation when the currencies pegged change. The following is an example; between the years 1997 and 2005, the China Yuan was pegged at the rate of 8.28 Yuan to US$1 to the United States dollar. The situation of the pegged currencies economic would be brought about by the mercy of currency’s value being downsized (Andrews, 2008). A good example is if the U.S. dollar substantially goes up against all other types of currency, there would also be an appreciation of the Yuan which may be against the intentions of the Chinese central bank (Eichengreen, 2007). It is difficult to keep a peg at high standards in the long-run thus the fixed regimes can frequently cause financial crises which are severe. This was highly portrayed in Asian, Russian and Mexican financial crises between the year 1995 and 1997 whereby the overvalued currencies resulted from the high maintenance of the local currency value attempt in pegging. This predestined that the governments were unable to fulfill the local currency conversion demand into pegged rate foreign currency (Frank MacDonald, 2002). Many investors moved quickly to pick up their money with panic and speculations for conversion of their currency because the local currency would once be devalued thus being unable to be pegged and eventually, supplies of foreign reserve became depleted (Eichengreen, 2007). Devaluation by 30 percent on peso was done by the Mexican government after being forced to do it. The Thailand government finally allowed the float of the currency and as the year 1997 ended, 50 percent of the value of the b hut got lost thus readjusting the supply and demand of the market local currency value (Helleiner, 1996). Frequently, we find that countries associated with pegs are also associated with weak regulating institutions and primitive capital markets. The peg is mainly availed for helping in creation of stability in those kinds of environment. In order to have a nice maintenance of float, both a mature market and a stronger system are required. It is necessary for a country forced to devalue the currency it has to go on with the types of economic reforms it has for example its financial institutions being strengthened through implementing greater transparency. Depending on the different types of choices the governments have on peg, some of these governments might decide to work with crawling or floating peg whereby the peg’s value is periodically reassessed by the government and then the peg rate changes accordingly (Andrews, 2008). Normally devaluation is the change but a controllable one such that the panic due to the market is avoided. This kind of a method is applied generally during the transition thus to a floating regime evolving from a peg and this helps the government to be save from being enforced to devalue due to crisis which are uncontrollable (Eichengreen, 2007). However, monetary stability and global trade are part of the work the peg has done hence this was easily applicable when all the main economies plaid a part in it. The floating regime has proved to the countries using it that it is more efficient in determination of the long term value of the currency even without its flaws and also in the international market by being able to create equilibrium (Frank MacDonald, 2002). Dollarization Dollarization is the ability of a certain country to adopt a currency of another country and make it its national currency while not issuing its real and own currency (Helleiner, 1996). Due to dollarization the central bank of the involved country is affected because it won’t have to make any monetary policy or largely print the money although it is already seen to be at a more stable place (Andrews, 2008). Some of the countries which use this dollarization mechanism are the Zimbabwe using the South African Rand and also the El Salvador's using the U.S. dollar. Managed Floating Rates When rates of exchange of a currency is authorized to freely fluctuate due to the demand and supply as the market forces that’s when the managed floating rates system is created. However, whenever there are extreme fluctuations the central bank or the government might decide to intervene thus stabilizing the exchange rates (Helleiner, 1996). An example for the same is when there is a very high depreciation of a currency of a certain country; the government may decide to set higher interest rates for a short while hence trying to stabilize the currency. An increase in rates will also slightly increase the currency thus bringing it to the equilibrium level. Also when the there is an appreciation which is beyond the equilibrium and far, the interest rates are set to be a beat lower than usual until stability/ equilibrium is attained (Frank MacDonald, 2002). Generally there are a number of tools which need to be employed by the central bank so that the currency can be managed. References Andrews, D. M. (2008). Orderly change: international monetary relations since Bretton Woods. U.S: Cornell University Press,. Eichengreen, B. (2007). A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform. Australia: University of Chicago Press,. Frank MacDonald, F. B. (2002). International business. Thyland: Cengage Learning EMEA. Helleiner, E. (1996). States and the reemergence of global finance: from Bretton Woods to the 1990s. North America: Cornell University Press,. James R. Barth, J. A. (2009). China's emerging financial markets. Hong Kong: Springer,. Kim, K. A. (2011). Global Corporate Finance: A Focused Approach. New York: World Scientific,. Michael D. Bordo, B. E. (2003). A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform. Chicago: University of Chicago Press. Orin Kirshner, E. M. (1996). The Bretton Woods-Gatt System: Retrospect and Prospect After Fifty Years. USA: M.E. Sharpe,. Primer, A. F. (2003). A Foreign Exchange Primer. German: John Wiley & Sons, . Uzan, M. (1996). Financial System Under Stress. New york: Routledge, . Read More