Brettonwoods System

Brettonwoods System
Evolved in response to the dire necessity of: i) ii) Stability of Exchange Rate & Availability of adequate International Reserves.

July 1, 1944 Brettonwoods Agreement. Fixed Parity of global currencies against US $. U.S. fixed gold parity as $ 35 for one ounce of gold. U.S.A undertaken free convertibility of U.S. dollar for gold.

Global currencies backed by U.S. gold as collateral. + or 1% fluctuation band allowed. Values of other currencies fixed in U.S. $ official parity. Exchange rate maintained within 1 percent on either side of official parity.

This required U.S. to maintain gold backing its $ currency. Other member countries to maintain $ reserves. Allowed a revision of 10 percent within a year of initial selection of the exchange rate.

The Articles of Agreements requires IMF members countries to :

1.Promote international monetary co-operation 2.Facilitate the growth of trade 3.Promote exchange rate stability 4.Establish a system of multilateral payments 5.Create reserve base.

ACTIVITIES OF I M F Surveillance process of monitoring & consultation handled by I M F. Financial assistance of different kinds.

For ensuring adequate reserves flow maintaining Exchange Rate stability & avoiding competitive depreciation of currencies.

Special Drawing Rights (SDRs)

Created in 1969.
To augment world liquidity. Taking into account shortage of $ and gold supply in response to increase world trade / other global transactions & consequent shortage of world liquidity. SDRs allocation to members in proportion to their contribution to funds.

What is SDRs ?
SDRs => Not currency => Not claim on I M F => is sanction of credit limit to member countries.

Is potential claim on freely usable currencies of I M F members.

Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: i) Through arrangement of voluntary exchanges between member countries. ii) An arrangement by I M F fordesignating members with strong external positions to purchase SDRs from members with weak external positions. Deficit countries can use them to purchase stronger currencies which can be used to pay off B.O.P. debts.

Brettonwoods system ended in 1973 By 1973 many countries moved to flexible exchange rates.

Break-down of Brettonwoods system

General Force Specific Forces

French Policy Reaction to dominance of $

Tiffin's paradox continuing and growing U.S. deficits growing reserve requirements.

Huge Deficit in U.S. BOP => loss of confidence in U.S. $. Holland & Germany came out of fixed rate parity.

Central Banks met at Smithsonian Institute on December 17 & 18, 1971 to resolve the crisis.
U.S.A revised the gold parity against $ as $38 per ounce of gold. Currency fluctuation band widened from 1% to 2.25% and for some currencies 4.50%.

Prospects of the International Financial System. The International Financial System evolves in response to the environment it serves.

I.

1914 1918 => 1944 1973

The shift from classical Gold Standard to the Standard adopted at Brettonwoods came in response to i) Beggar-thy-neighbour, cut-throat competition. ii) Protectionist exchange rate policies competitive devaluations during the depression and World war. In reaction to the above environment the system chosen was characterised by extreme rigidity of exchange rates.

II.

1960s 1970s Oil shocks of the 1960s and the early 1970s. Rigidity of Brettonwoods System did not provide adjustment needed between oil using and oil producing countries. In response to the above environment, the system of flexible exchange rate has emerged.

III.

Since 1980s
The environment emerged subsequently was characterised by: i. Growing financial & economic interdependence.

ii.
iii.

Financial deregulation & growth in trade.

Massive structural imbalances of trade & fiscal deficits.

In response to the above scenario, the unfettered flexibility of the 1970s & early 1980s was replaced by the more co-operative arrangements of Plaza Agreement and Louvre Accord.

IV.

Where do we go from here ? A broad answer to this question can be discovered from review of the following challenging questions: a) The Third World Debt Problem. & b) The shift from U.S. economic hegemony to a shared U.S. Japanese European balance of Economic Power. The review of the above two burning issues suggest the possible direction of the International Finance System.