Brettonwood Institution 2022

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Nov 24, 2024

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Running head: BRETTON WOOD SYSTEM 1 Bretton Wood System Name Institution

BRETTON WOOD SYSTEM 1 Question One Origins of Bretton Woods System The history of the Bretton Wood system dates to July 1944, a year before the war ended. In 1944, over 700 delegates (economic experts and world leaders) from allied powers (Britain and the USA) met at Bretton Woods, to establish a global monetary ecosystem to guide global economic matters (Grips.ac.jp, n.d.). During this conference, the delegates decided to revolutionize the international monetary ecosystem. The primary goal was to address the economic selfishness among countries by establishing a system that would address issues such as currency devaluation, protectionism, or trade blocs. Originally, the delegates were from Britain and the USA, with the British side represented by John Keynes and the American side represented by Harry White. Essentially, economists from the two countries negotiated the contents of the new global economic system. As the leading economic powerhouse, the USA took over the leadership of the new system ( Henning, 1996 , p.173) . Keynes' ideal of the global monetary system was rejected, while the American proposal succeeded. According to Keynes’ proposal, each country had to create a current official account to allow recording of the balance of payment (BOP) to record surpluses and deficits. Therefore, this meant that countries were responsible for correcting trade or BOP imbalances. Main Features of Bretton Woods System Bretton Woods system had several features that informed its exchange rate regimes. One major feature of the Bretton Woods System involved the obligation for all countries to adopt a monetary policy regime that provided for a fixed currency exchanged pegged on gold. During

BRETTON WOOD SYSTEM 2 the Bretton Wood system creation, delegates chose gold because it was the least volatile currency, unlike the national currencies. Another major feature of the Bretton Woods system involved the creation of the international financial institutions IMF (International Monetary Fund) and World Bank. Both the two institutions formally came into existence in 1945 after the war (Grips.ac.jp, n.d.). On the one hand, the IMF became responsible for monitoring exchange rates and maintaining currency reserves to address BOP (balance of payment) deficits with the IMF. On the other hand, the World Bank was responsible for offering financial aid for economic reconstruction. Even after the Bretton Woods system collapsed, the IMF and World Bank have remained instrumental players in the global world economy. Another fundamental feature of the Breetonwood system is that dollar turned into a reserve currency. In 1958, the international community agreed to allow the dollar to serve as the reserve currency ( Ikenberry, 1993 , p.155 ) . Under this arrangement, national currencies were pegged on the dollar. The international community also gave the USA special responsibility of addressing currency volatilities by ensuring that the dollar supply was sustainable. In other words, the USA had to adjust its dollar supply depending on the market circumstances. This arrangement allowed nations to trust the gold exchange rate system to have confidence and trust. An adjustable peg system constituted another feature of the Bretton Woods system. Although countries agreed to adopt a gold system pegged on the dollar, adjustment based on prevailing market conditions was allowable under the Bretton Woods system (Grips.ac.jp, n.d.). As a result, this allowed national currencies to move stepwise. In addition, this allowed countries to combine exchange rate stability with flexibility while overcoming mutually destructive devaluation.

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BRETTON WOOD SYSTEM 3 Tight capital control was another major feature of the Bretton Woods system. In 1944, the world shifted from the classical gold standard system and implemented tight capital controls to address economic instabilities and inflationary concerns (Grips.ac.jp, n.d.). Finally, macroeconomic stability constituted a major feature and success of the Bretton Woods system. Following the implementation of the Bretton Woods system, there was significant currency stability. Factors Contributing to the Fixed Rate Regime Collapse in the Early 1970s Despite being an ambitious global economic record, the Bretton Wood system did not stand the test. Rather, it collapsed in the early 1970s. Various factors drove this collapse. Internal inconsistency was the primary factor contributing to the Bretton Woods system collapsed (Grips.ac.jp, n.d.). As mentioned earlier, the American monetary regime was the anchor to the survival of the Bretton Woods system. However, American monetary policymakers hijacked the system by inflating the US economy with dollars. By the 1970s, the dollar supply surpassed the gold supply, causing the global monetary system pegged on the dollar to crumble. Various events lead to internal inconsistencies in managing the global economic system. One factor was the dollar shortage. In the 1950s, European countries and Japan, devastated by the war, sought to increase imports to reconstruct and rebuild their countries (Grips.ac.jp, n.d.). However, the dollar was the only internationally acceptable currency. Hence, this implied that the dollar-denominated system was a major limitation for these countries to import. In the 1960s, events took a dramatic turn with the dollar oversupply across the world economy. The geopolitical events, including heightened competition for the global dominance between Soviets/Russians and Americans, led to the dollar oversupply ( Henning, 1996 , p.173) .

BRETTON WOOD SYSTEM 4 For example, Americans increased military expenditure to finance proxy wars, especially the Vietnamese war. Since the early 1960s, the USA accelerated space program expenditure after Russia’s Yuri Gagarin landed in space as the first human being in 1961 and after a successful launch of the first satellite into orbit by the Soviets in 1956 (Grips.ac.jp, n.d.). Hence, this shows how the geopolitical competition was instrumental in the crush of the Bretton Woods system. Domestic inflation in the mid-1960s also heightened at an alarming rate. Before the 1960s, global prices were stable, encouraging countries worldwide to use the dollar as a reserve currency by surrendering their monetary independence. As a result, this stabilized the price levels. However, nations stopped importing the dollar after the USA began realizing a high inflation rate. Moreover, the downward pressure on the dollar also contributed to the Bretton Woods system collapsing. Towards the end of the 1960s, the world abandoned the pegging of the dollar to the gold. As a result, this led to a downward spiral of the dollar. In 1971, the USA ended the Bretton Wood system via press conference when President Richard Nixon announced that America would no longer allow the gold to be linked to the dollar ( Ikenberry, 1993 , p.155 ) . After this, the world officially ended a fixed exchange regime and adopted a free-floating system. The Role of Hegemonic Powers Britain and the USA were arguably the most influential powers influencing the Bretton Wood system. Towards the end of the war, the USA and Britain began negotiating about post- war economic order. In 1944, British and American policy specialists formed an Anglo- American alliance to alter the global financial landscape ( Ikenberry, 1993 , p.165 ) . Although there were disagreements, these policy specialists shared similar ideological views on global

BRETTON WOOD SYSTEM 5 economic management. The similar political virtues between the UK and the USA mainly defined the Bretton Wood system ( Ikenberry, 1993 , p.165 ) . With the two countries being capitalists, they established policies to transform the global economic order. Although the Bretton Wood system was camouglaged to promote equity in the global financial system, selfish political interests superseded the national interests. For example, Britain and the USA influenced an international financial system that resonated with their democratic and capitalistic ideals. Since Britain was at the mercy of the USA during WW2, the USA dictated the terms of the Bretton Wood system favored her economy. The USA also used the military and political might it had gained in WW2 to its advantage in dictating the terms of the Bretton Wood system( Ikenberry, 1993 , p.165 ) . Therefore, this shows how the dollar emerged as the reserve currency, whereby all other currencies were pegged. The Evolution of the Global Monetary Governance in the Post-Bretton Woods Era Although the Bretton Woods system collapsed in the early 1970s, Bretton Wood institutions such as IMF and World Bank remained and continued to govern international monetary governance. After the Bretton Woods system failed, the IMF allowed countries to adopt a floating exchange system ( Henning, 1996 , p.173) . A country could also peg its currency on other national countries besides gold. During the early transitioning period, many countries were wary that their economies would stagnate, especially when the world was experiencing oil price shocks. In the early 1970s, the world experienced fuel price shocks and the greatest oil crisis ( Henning, 1996 , p.173) . The crisis emerged when many oil-producing countries in the Middle East hoarded oil as a protest

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BRETTON WOOD SYSTEM 6 against the Israeli occupation of Palestine. However, these fears were short-lived because of the smooth transition toward a free-floating system. The Effectiveness of the Current Economic Framework in Promoting International Coordination and Cooperation Even after the fall of the Bretton Woods system, countries have continued to cooperate and coordinate economic policies worldwide through economic blocs (EU, NAFTA, COMESA, ECOWAS) and supranational organizations, including World Bank, IMF, WTO, G7, G20, and OECD ( Agénor & Pereira da Silva, 2022 , p.80 ) . The current international collaboration and coordination have been effective, as attested by various events, including the economic crisis. For example, the OECD members led the world to intervene collectively when the 2008/09 crisis emerged. The OECD also led the world to introduce financial reforms, including AML (anti- money laundering) reforms and financial management policies to mitigate a similar crisis. In addition, the IMF and World Bank provide professional financial advice to the economies on how to respond to the pandemic ( Agénor & Pereira da Silva, 2022 , p.80 ) . In IMF warns countries about ineffective fiscal and monetary plans, such as excessive borrowing. Finally, the IMF and World Bank offer financial assistance to the economies, especially emerging countries. Question Four “Unholy trilemma” is an economic policy dilemma that explains the trade-offs faced by the government to deciding about international monetary policy (Economicshelp, n.d.). Notably, this dilemma supposes that it is impossible to meet three major economic objectives: free capital movement, managed (fixed) exchange regime), and autonomous monetary regime.

BRETTON WOOD SYSTEM 7 (Economicshelp, n.d.) The diagram above shows the trilemma. From the diagram above, the government can choose any three interconnected aspects (fixed exchange regime+ free capital mobility; free capital mobility+ monetary independence; fixed exchange regime+ monetary independence). Reasons for Trilemma A= Free Capital Mobility + Fixed Exchange Rate Regime On the one hand, the government must set interest rates based on external pressures if it wants to establish a fixed exchange system or allow free capital movement ( Aizenman, 2010 , p.4 ) . For instance, if Britain intended to keep the sterling pound fixed to the US dollar, the British central bank would have to use a similar exchange rate to the federal reserve rate. B= Fixed Capital Mobility+ Monetary Independence

BRETTON WOOD SYSTEM 8 The government would need to embrace a floating exchange regime if the latter wished to implement monetary autonomy. For example, the government would hike the interest rates to achieve price stability ( Aizenman, 2010 , p.4 ) . The government will have to cut interest rates to stimulate economic growth in the country. C= Monetary Independence+ Fixed Exchange Rate The government would need to control the money outflow to maintain a free exchange regime and adjust interest rates as per its preferences. For instance, if a country aims to keep its currency rate fixed but wishes to reduce interest rates to ignite economic growth, it will experience downward pressure because inventors will sell the local currency ( Aizenman, 2010 , p.4 ) . The government can respond to this by restricting sales in the local currency to maintain the local currency price high.

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BRETTON WOOD SYSTEM 9 References Agénor, P. R., & Pereira da Silva, L. A. (2022). Financial spillovers, spillbacks, and the scope for international macroprudential policy coordination. International Economics and Economic Policy , 19 (1), 79-127. https://doi.org/10.1007/s10368-021-00522-5 Aizenman, J. (2010). The impossible trinity (aka the policy trilemma). https://escholarship.org/content/qt9k29n6qn/qt9k29n6qn.pdf Economicshelp. (n.d.). Policy trilemma – the impossible trinity. https://www.economicshelp.org/blog/glossary/policy-trilemma-the-impossible-trinity/ Grips.ac.jp. (n.d.). 2. History of International Monetary Systems, Part 2. https://www.grips.ac.jp/teacher/oono/hp/lecture_F/lec02.htm Henning, C. R. (1996). Political economy of the Bretton Woods institutions: Adapting to financial change. The World Economy , 19 (2), 173-193. http://www.randallhenning.com/uploads/2/9/3/5/29350993/political_economy_of_the_bret ton_woods_institutions.pdf Ikenberry, G. J. (1993). The political origins of Bretton Woods. In A retrospective on the Bretton Woods system: Lessons for international monetary reform (pp. 155-198). University of Chicago Press. https://www.nber.org/system/files/chapters/c6869/c6869.pdf

Brettonwood Institution 2022

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