Breton Woods - Key points

• led to creation of IMF and the World Bank
• monetary....led to a system of fixed exchange rates
• failed because US was printing too much USD. Other countries wanted to exchange for too much gold, more than the US had.
• Us inability to support dollar by supplying gold...led to break down

Table of Contents:

The Gold Standard

• the gold standard lasted for 60+ years
• countries fixed their currency exchange rate with gold
• central banks held gold reserves
• if a country imported more than exported, then there would be more of your currency in the market than what foreigners wanted to hold.  The exporter wouldn't want your currency, so he would sell it to a bank, who would sell it to a central bank, who also wouldn't want it...so they would come back to your country and ask to exchange it for gold.  Your country would need to give gold, reducing your supply of gold.  Then, according to the rules, your country would also have to reduce its money supply so that the ratio of money to gold was maintained.   With less money in the system, prices would fall (see discussion of inflation).  Once this reverse-inflation occurred, and prices fell, then exports would increase, and imports would decrease. This would take the country back to a trade balance. 
• The trouble is that this process takes a very long time, and is very painful to the economy.

Competitive Devaluations

• but, after WWI, there were competitive devaluations in the 1930's which led to WWII - "beggar thy neighbor"
• there was a "floating system" during the great depression.
• was not fixed because was too expensive to maintain.
• at the end of WWII (before it ended), the Allied powers met at Bretton Woods (in the US) and agreed to a fixed exchange rate policy

Bretton Woods

The US was the only major super-power after WWII with an intact economy

so, the US would do what gold had done before...and all currencies would be fixed to the US dollar

fort knox (gold)

End of Bretton Woods

• 1973 - the US was forced to break the fixed exchange system
• not enough gold
• affected all other currencies
• but, why did it fail?
• excess demand for gold
• US was printing too much dollars to support with gold
• spending too much on VIETNAM war (this was the major reason)
• world lost confidence in US ability to support gold standard...led to run on gold
• the result was a balance of payments crisis

Interesting conclusion:

• no FX regime (currency exchange system) has ever lasted more than 75 years.
• no system is best.
• the USA has gone from fixed to floating to fixed, and back to floating.
• sometimes fixed is better, sometimes flexible

results of the collapse of Bretton Woods:

• The USD devalued
• result:  oil income to mideast dropped, leading to unhappy oil suppliers...one of the causes that led to the Oil crisis 1973 (note that the Israel "yom kippur war" was the actual event that triggered the oil shock")

A Brief History:

The gold standard was the way in which the international monetary system maintained parities until the 1930’s (with a notable interruption during WWI and the years that followed it). Later, at the end of WWII, more than 40 countries signed on to the Bretton Woods agreement, which established a fixed exchange rate system between most of the major world economies.

The accord stipulated that the undersigned fixed the value of their currencies in relation to the US Dollar (USD), and that the dollar would be convertible to gold at the fixed price of U$35/ozt. The Bretton Woods lasted until 1971, when President Richard Nixon suspended the USD convertibility to gold and unilaterally changed the USD parity with other international currencies. From 1973 to 1999, the USD, the Japanese Yen and the European currencies operated a “dirty float” exchange system, that is to say the currencies were allowed to move in accordance with market forces but the central bank of each country would intervene to move the exchange rate in one or another direction. In general, exchange rates between the European currencies stayed inside a tight band from 1973. For example the German Mark and the French Franc freely floated with respect to the USD, though they stayed within a tight band between each other most of the time by virtue of an agreement known as the European Monetary System.

In January 1999, eleven countries adopted the same currency, the Euro, issued and administered by the European Central Bank (ECB), which floats against the dollar in the same way as the various European currencies did up to 1999. Today, thirteen countries have adopted the Euro, with two more due to join in 2008. After Bretton Woods fell apart, the USD remained the focus of the international monetary system, and evidence to support that abounds. In 2000, more than 70% of international reserves were in USD. However, that proportion has fallen every year, reaching a bit under 65% in 2007. It is the Euro which has gained from the reduction of dollar holdings: Euro assets have gone from a little over 18% of world reserves to nearly 26% in 2007. The British Pound has also gained, to 4.7% of total reserves in 2007.