The Bretton Woods System 1944 : Agreement and Currency Exchange

by Sharoz Dawa | Posted on Tuesday, July 18th, 2017

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:

  1. International monetary fund  ( IMF)
  2. 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.

About the Author Sharoz Dawa

Co-founder & Developer at IAS Paper I am a 20-year-old guy from Mumbai (Maharashtra) currently doing Software Engineering.I love helping people and providing free education. Official Website http://www.sharozdawa.comFacebook

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