Bretton Woods system history

The international monetary structure devised at a conference held at Bretton Woods, New Hampshire, beginning in 1944. Even before World War II ended, the Allies realized that the postwar period would require a new exchange rate system in order to prevent a recurrence of the distortions that characterized the foreign exchange markets in the 1920s and early 1930s and led to World War II. The power given to the International Monetary Fund (IMF) at the conference to monitor exchange rates lasted until 1971 and was known as the fixed parity system.

The Bretton Woods conference was called in order to create a viable monetary system that would take effect when World War II ended. One of its main objectives was to create a system in which unilateral devaluations of currency would not be possible without a country consulting its major trading partners. During the 1930s, unilateral devaluations were common as many major trading countries attempted to make their exports cheaper by devaluing their currencies, adding to the international economic slowdown. Bretton Woods created two major international economic organizations—the International Bank for Reconstruction and Development (World Bank) and the International Monetary Fund (IMF). The IMF was charged with maintaining the new dollar parity system adopted by the countries attending. The World Bank originally was charged with helping rebuild Western Europe but later began making development loans to less developed countries by borrowing funds in the international bond markets.

Under the Bretton Woods system, the U.S. dollar was given a gold value of $35 per ounce, and the rate was fixed. Other currencies were then given a value in dollars that was allowed to fluctuate only ± 1.00 percent from their parity value. If a currency fluctuated from this band, the country’s central bank was obliged to intervene on its behalf. The dollar thus became the new international exchange standard, although gold remained the underlying standard because of the fixed rate given to the metal in dollar terms. The major trading currencies (hard currencies) traded in the FOREIGN EXCHANGE MARKET were quoted in dollar terms.

When trade conditions warranted, some currencies could become overvalued or undervalued with the fixed parity system. If a currency was overvalued, its exports would fall while imports rose, causing an imbalance in trade suggesting that the currency needed to be devalued. Under the system, the country involved would seek permission from the IMF to officially devalue its currency in dollar terms. A devaluation by a major trading country normally meant that one of its major trading partners would have to revalue its currency, stating its dollar terms higher than in the past.

In the summer of 1971, the U.S. dollar came under severe pressure in the markets because the United States was experiencing a balance of payments deficit. Political and economic pressure mounted for the United States to devalue, but the Nixon administration maintained that it would not do so. Then in August, President Nixon announced devaluation as part of an economic package designed to fight inflation. The convertibility of the dollar was severed, and the currency began to decline in the markets. After months of uncertainty, an international monetary conference, held at the Smithsonian Institution in Washington, officially ended the Bretton Woods system of fixed parities. The old band of 1 percent was replaced by a new one of 2.25 percent and gold officially revalued at $38 per ounce. But the attempt at stability was short-lived, and within months the Smithsonian agreement collapsed. The new system that emerged was referred to as one of floating exchange rates.

Under the floating rate regime, the power of the IMF was substantially reduced over the major trading countries. Also, exchange rates for the major trading currencies were determined by market forces and used no fixed parities. Since 1972, the floating exchange rate system has become more volatile since no bands exist to constrain trading, and spot rates between currencies can fluctuate without any restraint unless a central bank decides to intervene on behalf of its own currency. The new volatility caused problems for American business since it required changes in the ways in which corporations hedged their foreign exchange exposures. Many companies began to experience wide swings on their balance sheets since their overseas assets and liabilities began to fluctuate more widely than in the past.