The Bretton woods system: Regime for valuation of money
Many of us do not know how is money been valued? What was the first system used to value the money? In what ratio the government is printing money every year ? Do they print according to the requirement of the money in the market? Or according to the supply and demand forces in the market ? Or is there any regime for it? That they have to follow? Do they have an upper limit for printing the notes? Or a lower limit to print these notes? Well to all these questions the answer is yes, every government has to manage the printing of the money and it does have an upper limit to it and a lower limit to work in favour of the economies because regulation of the money and currencies is very important for the development of the economy. And there are regimes to be followed by all the countries .
What is a regime? Well, regime basically means a system that has been used for valuation of the currencies . There are basically three systems established till the date for the valuation of the currency which was used all over the globe for significant periods and how it had an impact on the exchange rate between the currencies and these were called as exchange rate regimes.
The Bretton wood system also known as the IMF fixed exchange rate system.
Representative of 45 major economies met at Bretton woods the USA in July 1944 to finalize a new exchange rate system based on stability and flexibility to be universally implemented after the second world war
Deliberations during this meeting resulted in the formation of the two international multi- lateral institutions namely:
- International monetary fund ( IMF)
- International bank for reconstruction and development ( IRDB)
The fixed exchange rate system proposed by them was implemented in the year 1946 . the main features of this system were as follows:
- In addition to gold, the US dollar USD was to be given the status of universal reserve asset. This means countries could issue domestic money against USD reserves . the value of USD was fixed at 1 ounce of gold = USD 35 .
- The US federal bank provided an unconditional guarantee to buy and sell an unlimited quantity of gold at this price . this was the gold convertibility
- No other country was required to provide for redemption of its currency against gold were not were they required to fix an official gold price.
- Each member country was required to fix a parity value for its currency against USD ( the process of fixing the value of the currency as a multiple of another currency is called pegging . the actual rate or multiple is called parity . the equality between gold. And domestic currency which was the basis for establishing exchange rates was called the par value mechanism.
- Effectively every currency was redeemable in terms of USD and only and USD was redeemable in terms of gold. Therefore, this system was also called the gold exchange standard . the USD, therefore, became the means of international settlements.
- Variation in the exchange rate was permitted on either side of the parity in a range of (+/-) 1%.
- The end points of the variation zone were called supports points or intervention points.
- The IMF provides a commitment to the member countries to provide financial assistance to countries facing temporary balance of payment deficits.
- In the case of structural imbalances member countries could devalue their currencies in consultation with the IMF . on account of the flexibility , the system was also viewed as “ THE adjustable peg system” .
- The concept of the dual exchange rate was abolished.
- The system introduced the concept of central bank intervention a means of ensuring the protection of parity rates ( intervention means the proactive participation of a central bank in the domestic markets with the intention of influencing exchange rate movement).
- All the members countries accepted the supervisory authority of the IMF in regards to the exchange rate and system and domestic foreign exchange market . this was the first instance in history when all the countries of the world voluntarily accepted to give up a part of their sovereignty ( freedom to decide ) in connection with their foreign exchange management system.
The Bretton woods system failed cause of the following reasons:
- No change in the rates of the gold.
- The system did not provide for any evaluation of parties .
- No revision in the price of the gold in terms of USD.
- The continued trade deficit of the US Created an oversupply of in the international financial markets which reduced the acceptance of the USD this failure on the part of the US led to the system in 1971.
So this was the Breton woods system adopted to overcome the drawbacks of the gold standard regime. Which also led to failure and then finally the flexible exchange rate system was formed to overcome the drawbacks of this system.