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The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States , Canada , Western Europe , Australia , and Japan after the Bretton-Woods Agreement. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent states.
The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained its external exchange rates within 1 percent by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments.
Also, there was a need to address the lack of cooperation among other countries and to prevent competitive devaluation of the currencies as well. The delegates deliberated during 1—22 July , and signed the Bretton Woods agreement on its final day. The United States, which controlled two thirds of the world's gold, insisted that the Bretton Woods system rest on both gold and the US dollar.
Soviet representatives attended the conference but later declined to ratify the final agreements, charging that the institutions they had created were "branches of Wall Street". On 15 August , the United States unilaterally terminated convertibility of the US dollar to gold , effectively bringing the Bretton Woods system to an end and rendering the dollar a fiat currency.
At the same time, many fixed currencies such as the pound sterling also became free-floating. The political basis for the Bretton Woods system was in the confluence of two key conditions: There was a high level of agreement among the powerful nations that failure to coordinate exchange rates during the interwar period had exacerbated political tensions.
This facilitated the decisions reached by the Bretton Woods Conference. Furthermore, all the participating governments at Bretton Woods agreed that the monetary chaos of the interwar period had yielded several valuable lessons.
The experience of World War II was fresh in the minds of public officials. The solution at Versailles for the French, British, and Americans seemed to be "make Germany pay for it all. Intransigent insistence by creditor nations for the repayment of Allied war debts and reparations, combined with an inclination to isolationism , led to a breakdown of the international financial system and a worldwide economic depression. In the s, international flows of speculative financial capital increased, leading to extremes in balance of payments situations in various European countries and the US.
The various anarchic and often autarkic protectionist and neo-mercantilist national policies — often mutually inconsistent — that emerged over the first half of the decade worked inconsistently and self-defeatingly to promote national import substitution , increase national exports, divert foreign investment and trade flows, and even prevent certain categories of cross-border trade and investment outright.
Global central bankers attempted to manage the situation by meeting with each other, but their understanding of the situation as well as difficulties in communicating internationally, hindered their abilities.
Britain in the s had an exclusionary trading bloc with nations of the British Empire known as the " Sterling Area ". If Britain imported more than it exported to nations such as South Africa, South African recipients of pounds sterling tended to put them into London banks.
This meant that though Britain was running a trade deficit, it had a financial account surplus, and payments balanced. Increasingly, Britain's positive balance of payments required keeping the wealth of Empire nations in British banks. One incentive for, say, South African holders of rand to park their wealth in London and to keep the money in Sterling, was a strongly valued pound sterling.
Unfortunately, as Britain deindustrialized in the s, the way out of the trade deficit was to devalue the currency. But Britain couldn't devalue, or the Empire surplus would leave its banking system.
Nazi Germany also worked with a bloc of controlled nations by Germany forced trading partners with a surplus to spend that surplus importing products from Germany. The US was concerned about a sudden drop-off in war spending which might return the nation to unemployment levels of the s, and so wanted Sterling nations and everyone in Europe to be able to import from the US, hence the US supported free trade and international convertibility of currencies into gold or dollars.
When many of the same experts who observed the s became the architects of a new, unified, post-war system at Bretton Woods, their guiding principles became "no more beggar thy neighbor" and "control flows of speculative financial capital". Preventing a repetition of this process of competitive devaluations was desired, but in a way that would not force debtor nations to contract their industrial bases by keeping interest rates at a level high enough to attract foreign bank deposits.
John Maynard Keynes , wary of repeating the Great Depression , was behind Britain's proposal that surplus nations be forced by a "use-it-or-lose-it" mechanism, to either import from debtor nations, build factories in debtor nations or donate to debtor nations. Today these key s events look different to scholars of the era see the work of Barry Eichengreen Golden Fetters: The Gold Standard and the Great Depression, — and How to Prevent a Currency War ; in particular, devaluations today are viewed with more nuance.
Ben Bernanke 's opinion on the subject follows:. For a variety of reasons, including a desire of the Federal Reserve to curb the US stock market boom, monetary policy in several major countries turned contractionary in the late s—a contraction that was transmitted worldwide by the gold standard.
What was initially a mild deflationary process began to snowball when the banking and currency crises of instigated an international "scramble for gold". Sterilization of gold inflows by surplus countries [the US and France], substitution of gold for foreign exchange reserves, and runs on commercial banks all led to increases in the gold backing of money, and consequently to sharp unintended declines in national money supplies.
Monetary contractions in turn were strongly associated with falling prices, output and employment. Effective international cooperation could in principle have permitted a worldwide monetary expansion despite gold standard constraints, but disputes over World War I reparations and war debts, and the insularity and inexperience of the Federal Reserve , among other factors, prevented this outcome.
As a result, individual countries were able to escape the deflationary vortex only by unilaterally abandoning the gold standard and re-establishing domestic monetary stability, a process that dragged on in a halting and uncoordinated manner until France and the other Gold Bloc countries finally left gold in In at Bretton Woods, as a result of the collective conventional wisdom of the time, [ citation needed ] representatives from all the leading allied nations collectively favored a regulated system of fixed exchange rates, indirectly disciplined by a US dollar tied to gold [ citation needed ] —a system that relied on a regulated market economy with tight controls on the values of currencies.
Flows of speculative international finance were curtailed by shunting them through and limiting them via central banks. This meant that international flows of investment went into foreign direct investment FDI —i. Although the national experts disagreed to some degree on the specific implementation of this system, all agreed on the need for tight controls.
Also based on experience of the inter-war years, U. Specifically, he had in mind the trade and exchange controls bilateral arrangements [17] of Nazi Germany and the imperial preference system practiced by Britain, by which members or former members of the British Empire were accorded special trade status, itself provoked by German, French, and American protectionist policies.
The developed countries also agreed that the liberal international economic system required governmental intervention. In the aftermath of the Great Depression , public management of the economy had emerged as a primary activity of governments in the developed states. Employment, stability, and growth were now important subjects of public policy. In turn, the role of government in the national economy had become associated with the assumption by the state of the responsibility for assuring its citizens of a degree of economic well-being.
The system of economic protection for at-risk citizens sometimes called the welfare state grew out of the Great Depression , which created a popular demand for governmental intervention in the economy, and out of the theoretical contributions of the Keynesian school of economics, which asserted the need for governmental intervention to counter market imperfections.
However, increased government intervention in domestic economy brought with it isolationist sentiment that had a profoundly negative effect on international economics.
The priority of national goals, independent national action in the interwar period, and the failure to perceive that those national goals could not be realized without some form of international collaboration—all resulted in "beggar-thy-neighbor" policies such as high tariffs , competitive devaluations that contributed to the breakdown of the gold-based international monetary system, domestic political instability, and international war.
To ensure economic stability and political peace, states agreed to cooperate to closely regulate the production of their currencies to maintain fixed exchange rates between countries with the aim of more easily facilitating international trade.
This was the foundation of the U. Thus, the more developed market economies agreed with the U. In a sense, the new international monetary system was in fact a return to a system similar to the pre-war gold standard, only using US dollars as the world's new reserve currency until the world's gold supply could be reallocated via international trade.
Thus, the new system would be devoid initially of governments meddling with their currency supply as they had during the years of economic turmoil preceding WWII. Instead, governments would closely police the production of their currencies and ensure that they would not artificially manipulate their price levels.
If anything, Bretton Woods was a return to a time devoid of increased governmental intervention in economies and currency systems. The Atlantic Charter , drafted during U. The Atlantic Charter affirmed the right of all nations to equal access to trade and raw materials.
Moreover, the charter called for freedom of the seas a principal U. As the war drew to a close, the Bretton Woods conference was the culmination of some two and a half years of planning for postwar reconstruction by the Treasuries of the U. Without a strong European market for U.
By the end of , there had already been major strikes in the automobile, electrical, and steel industries. In early Bernard Baruch described the spirit of Bretton Woods as: United States allies—economically exhausted by the war—needed U. Before the war, the French and the British realized that they could no longer compete with U.
During the s, the British created their own economic bloc to shut out U. Churchill did not believe that he could surrender that protection after the war, so he watered down the Atlantic Charter's "free access" clause before agreeing to it. The combined value of British and U.
While Britain had economically dominated the 19th century, U. One of the reasons Bretton Woods worked was that the US was clearly the most powerful country at the table and so ultimately was able to impose its will on the others, including an often-dismayed Britain.
At the time, one senior official at the Bank of England described the deal reached at Bretton Woods as "the greatest blow to Britain next to the war", largely because it underlined the way in which financial power had moved from the UK to the US. A devastated Britain had little choice. Two world wars had destroyed the country's principal industries that paid for the importation of half of the nation's food and nearly all its raw materials except coal.
The British had no choice but to ask for aid. For nearly two centuries, French and U. But in de Gaulle—the leading voice of French nationalism—was forced to grudgingly ask the U. Free trade relied on the free convertibility of currencies.
Negotiators at the Bretton Woods conference, fresh from what they perceived as a disastrous experience with floating rates in the s, concluded that major monetary fluctuations could stall the free flow of trade.
The new economic system required an accepted vehicle for investment, trade, and payments. Unlike national economies, however, the international economy lacks a central government that can issue currency and manage its use. In the past this problem had been solved through the gold standard , but the architects of Bretton Woods did not consider this option feasible for the postwar political economy.
Instead, they set up a system of fixed exchange rates managed by a series of newly created international institutions using the U. In the 19th and early 20th centuries gold played a key role in international monetary transactions.
The gold standard was used to back currencies; the international value of currency was determined by its fixed relationship to gold; gold was used to settle international accounts.
The gold standard maintained fixed exchange rates that were seen as desirable because they reduced the risk when trading with other countries. Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be rectified.
Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend. This decrease in the amount of money would act to reduce the inflationary pressure.
Supplementing the use of gold in this period was the British pound. Based on the dominant British economy, the pound became a reserve, transaction, and intervention currency. But the pound was not up to the challenge of serving as the primary world currency, given the weakness of the British economy after the Second World War. The architects of Bretton Woods had conceived of a system wherein exchange rate stability was a prime goal.