Bretton Woods System Essay Example

The Bretton Woods System was brought into effect after the Bretton Woods Agreement of 1944 to take care of financial management issues around the world economies. It established rules for business and financial relations among countries such as the United States of America, Canada, Australia, Japan, and the Western European Countries. These have been viewed as the world's major industrial countries for a long time. Since the system sought to streamline and enhance efficiency in the monetary system at the time when the world was grappling with the unfortunate effects of the Second World War, some basic principles had to be put in place. There were three major principles for the world monetary system. This comprised facilitation of unrestricted trade investments, the introduction of national currencies defined in terms of gold parties and of fixed exchange rates and finally the availing of international liquidity to all countries for overcoming the temporary Balance of Payment (BOP). Additionally, some major features in the global financial space came up. The paper is, therefore, premised on a discussion about the main features of the Bretton Woods and the causes that saw its demise.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Save 25%

Some features were retained from the previous financial arrangements. These included the easy adjustment mechanisms of markets, market freedom of floating rates, the unrestrained control over market forces of the flexible rate system, selective use of controls and most importantly, the stability of the gold standard. In addition to these, some new and modified approaches were given to the global monetary system, and many are still in place to date. It is also worth noting that these measures helped salvage the world economy from the destructive effects of the great depression (Berry n.p).

To begin with, among the introduced features included the gold exchange standard among the world economies. With this, countries could keep their currency parity indirectly with gold while being needless to maintain as large gold reserves as was demanded by the gold standards. The exchange rate had a par value, for which only fluctuations of plus or minus one percent could be accepted, and the United States of America was to maintain the fixed gold price of $35 per ounce. She was to be further ready to exchange her currency, the dollar, for gold at that fixed price without issuing any bottlenecks or hindrances (Liao 640). The dollar served as direct comparison tool on which other nations were to fix their currency prices.

Secondly, the most remarkable feature as a result of the agreement was the creation of the International Monetary Fund (IMF). The main objectives of this financial body were overseeing total adherence to the set of agreed rules on international commerce by member states and providing financial borrowing facilities to the member countries who were caught up in Balance of Payment difficulties. Borrowings from IMF were to be repaid within short durations of from three to five years and involved a nation repurchasing its currency from the fund with other convertible currencies approved by the Fund until the IMF held no more than three-quarters of the nation's quota in the nation's currency (Liao 648). Such short durations ensured that the IMF was not tied up for long durations. Additionally, to ensure that the member nations were taking appropriate measures to eliminate Balance of Payment deficits, the IMF charged higher interest rates and imposed more supervision and control on the countries that borrowed in the subsequent years (credit tranche). Presently, the IMF membership is 184 states, having grown from trifling 30 at its inception in March 1947.

As development on the above feature, the International Development Association (IDA) was founded in the year 1960. Its main mandate was to issue concessional funds to the less developed states for development projects. Also, an affiliate of the World Bank known as the International Finance Corporation (IFC) was founded in 1956 to help initiate private investments in the developing economies from local and international coffers. For long-term development assistance, however, the only institution that could help was the International Bank of Reconstruction and Development (IBRD), popularly known as the World Bank. At this point, a focus on reducing the parity between the world's richest and poorest states could achieve some momentum (Metzger, 89).

Under the Bretton Woods system, while taking into account the country's economic importance and the volume of its international trade, each member country was assigned a quota. The voting power and the ability of a member state to borrow funds were heavily pegged on the number of quotas it held. For instance, in the year 1989, the United States of America borrowed funds easily and had the most voting powers since it had the largest quota at 21 percent. In the same financial year, the UK had 7% quota at the second place followed by France and Germany each at six percent and Japan closed the top five slots at 5 percent (Liao 649). The country joining the IMF was to pay 25 percent of its quota in gold and the remaining bit in its currency. Borrowing of 25 percent of the quota belonging to a nation was allowed within one year and of up to 125 percent throughout five years. It is also worth noting that a nation could borrow the first 25 percent of its quota (gold tranche) almost automatically without restrictions or conditions attached.

Another significant feature was the allowed intervention of the member states in exchange markets to prevent the fluctuations beyond the recommended levels. The rate of fluctuation was to be only determined by market forces of demand and supply, which promoted free trade arrangement. Only under special cases of grave disequilibrium in the Balance of Payment would a country be allowed to adopt an exchange rate beyond plus or minus one percent by the International Monetary Fund. With this, an adjustable peg system on exchange rates was, therefore, put in place that enhanced both the stability and flexibility of the fixed exchange system that was the case with the outfaced gold standard.

The system was also characterized by the elimination of all the restrictions that could be imposed by other market players on the exchange of currencies of member states into the dollar or those of the other countries. Member states were prohibited from imposing any punitive trade restrictions and sanctions against others, but in case there were any such restrictions in place, multilateral negotiations were encouraged to do away with them gradually. On the contrary, restrictions on international liquid capital flows were allowed. Member states could invoke this to protect their currencies against large destabilizing international money flows. Also, the system ensured that no countries were allowed to pass conflicting national economic policies to minimize foul play and exploitation of some nations by others. The Bretton Woods regime saw close checks on capital control (Metzger 89). Contrary to the situation that had existed between 1879 and 1914 during the times of the Classical Gold Standard when there was free capital mobility, most countries imposed severe exchange controls in this era. The only countries that could be seen to have had fewer relatively fewer capital-account regulations were the United States of America and Germany.

There was also an evident good macroeconomic performance between the 1950s and 1960s that largely attributed to the monetary system. The system entrenched trade liberations that resulted in the stability of global prices and high growth. A particular focus goes into the stability of the tradable prices (WPI or wholesale prices) that was almost perfect at these times. No other years in history have ever experienced the same macroeconomic achievement. Bretton Woods's system, therefore, appears as one who had played a primary function in shaping the world economy in the post-war period. Even though different successes marked the system, it was short-lived coupled with the unwillingness of certain sovereign members and flaws in the basic structures. Many scholars hack the lessons drawn from the Bretton Woods as an example that can restore the high order and stability to the present global monetary system. We can argue that the primary causes of its demise were pegged on three major problems ((Liao 648). The problems include liquidity problems, confidence, and adjustment.

The provision of liquidity to the world became an issue of concern following the elimination of the U.S. balance of the payment deficits. The situation was opined as one which could create a possible global liquidity shortage program. A concern was raised in the 1960s following the procedures which were undertaken when the liquidity was being offered. One Robert Triffin argued that the Bretton Woods had made a mistake in undervaluing the production of gold, and the price of gold, an issue which was seen as insufficient in the provision of resources aimed at providing resources in financing the global trade. The shortfall was, therefore, projected to get met with possible capital outflows from the United States of America. Robert Triffin went further to posit that the outstanding U.S. dollars mounted, a situation which would have been projected to increase the running of the classic banks at a time when the global monetary authorities would be projected to convert their dollars to gold.

The effect of confidence was also another factor that caused the demise of Bretton Woods based on the worry of the U.S. monetary authorities about the balance of payment deficits. Considering how the official dollar liabilities anchored on abroad coupled with successive deficits, there was a possibility that the dollars were going to get converted into gold and the monetary gold stock of the United States of America was going to a point low that would trigger a run. Justification on the same can be deduced in 1959 when the U.S. monetary gold stock got equated to the overall external monetary liabilities (Berry n.p). At the same time, the rest of the global monetary gold stock equally exceeded that of the United States of America. Towards 1964, as demonstrated in the figure below, the actual dollar liabilities reviewed by the foreign financial authorities went higher to that of the United States gold stock, an issue which became unmanageable thus a possible demise of the Bretton Woods.

The adjustment was also a problem in Bretton Woods; it was one which was reflected in the downward rigidity especially in prices and wages that obstructed the normal price adjustment of the gold price standard. Consequently, the payment and managerial deficit were also noted to get associated with the rising rate of unemployment and matters about recessions. It was a problem which was mostly experienced by the United Kingdom, an issue which also alternated between the expansionary fiscal and the monetary policies (Polak, Jacques, and James 26). The countries which experienced surplus were also characterized by the emergence of the inflationary pressure, something which blocked capital controls and sterilization. The other aspect of adjustment challenge was based on the asymmetric adjustment that lied between the United States of America and the other parts of the globe. From the view of the pegged exchange rate system, the United States of America acted as a primary reserve country and was not a must to consider an adjustment to the balance deficit. Most of the European nations resented to the asymmetrical aspect, an issue which made it possible for the Bretton Woods to demise.

Conclusion

Other factors that led to its demise included Bretton Woods not having autonomy in the maintena...