Brettonwoods System

Brettonwoods System
Evolved in response to the dire necessity
of:

i) Stability of Exchange Rate &

ii) Availability of adequate International
Reserves.
July 1, 1944 Brettonwoods Agreement.

Fixed Parity of global currencies against

US $.

U.S. fixed gold parity as $ 35 for one

ounce of gold.

U.S.A undertaken free convertibility of

U.S. dollar for gold.
Global currencies backed by U.S. gold as
collateral.

+ or – 1% fluctuation band allowed.

Values of other currencies fixed in U.S. $

official parity.

Exchange rate maintained within 1

percent on either side of official parity.
This required U.S. to maintain gold backing its
$ currency.

Other member countries to maintain $

reserves.

Allowed a revision of 10 percent within a year

of initial selection of the exchange rate.
The Articles of Agreements requires IMF members
countries to :

1.Promote international monetary co-operation

2.Facilitate the growth of trade
3.Promote exchange rate stability
4.Establish a system of multilateral payments

5.Create reserve base.

ACTIVITIES OF I M F

Surveillance – process of monitoring &

consultation handled by I M F.

Financial assistance of different kinds.

For ensuring adequate reserves flow

maintaining Exchange Rate stability &
avoiding competitive depreciation of
currencies.
Special Drawing Rights (SDRs)

Created in 1969.

To augment world liquidity.

Taking into account shortage of $ and gold

supply in response to increase world trade /
other global transactions & consequent
shortage of world liquidity.

SDRs allocation to members in proportion to

their contribution to funds.
What is SDRs ?

SDRs => Not currency => Not claim on

I M F => is sanction of credit limit to
member countries.

Is potential claim on freely usable

currencies of I M F members.
Holders of SDRs can obtain these currencies in
exchange for their SDRs in two ways:

i) Through arrangement of voluntary

exchanges between member countries.

ii) An arrangement by I M F fordesignating

members with strong external positions to
purchase SDRs from members with weak
external positions.

Deficit countries can use them to purchase

stronger currencies which can be used to pay
off B.O.P. debts.
 Brettonwoods
system
ended in 1973

By 1973 – many countries moved to flexible exchange rates.

Break-down of
Brettonwoods system

General Force Specific Forces

French Policy Reaction Tiffin's paradox

to dominance of $ continuing and growing
U.S. deficits growing
reserve requirements.
Huge Deficit in U.S. BOP => loss of confidence
in U.S. $.

Holland & Germany came out of fixed rate parity.

Central Banks met at Smithsonian Institute on

December 17 & 18, 1971 to resolve the crisis.

U.S.A revised the gold parity against $ as $38 per

ounce of gold.

Currency fluctuation band widened from 1% to 2.25%

and for some currencies 4.50%.
Prospects of the International Financial
System.

“The International Financial System

evolves in response to the environment it
serves.”
I. 1914 – 1918 => 1944 – 1973

The shift from classical Gold Standard to the

Standard adopted at Brettonwoods came in
response to
i) Beggar-thy-neighbour, “cut-throat
competition”.
ii) Protectionist exchange rate policies –
competitive devaluations – during the
depression and World war.

In reaction to the above environment the

system chosen was characterised by extreme
rigidity of exchange rates.
II. 1960s – 1970s

Oil shocks of the 1960s and the early 1970s.

Rigidity of Brettonwoods System did not
provide adjustment needed between oil using
and oil producing countries.

In response to the above environment, the

system of flexible exchange rate has emerged.
III. Since 1980s

The environment emerged subsequently was

characterised by:

i. Growing financial & economic

interdependence.

ii. Financial deregulation & growth in trade.

iii. Massive structural imbalances of trade &

fiscal deficits.
In response to the above scenario, the

unfettered flexibility of the 1970s & early 1980s

was replaced by the more co-operative

arrangements of Plaza Agreement and Louvre

Accord.
IV. Where do we go from here ?

A broad answer to this question can be

discovered from review of the following
challenging questions:

a) The Third World Debt Problem.

&
b) The shift from U.S. economic hegemony to
a shared U.S. – Japanese – European balance
of Economic Power.

The review of the above two burning issues

suggest the possible direction of the
International Finance System.