Bretton Woods is an agreement signed in 1944 between the major countries of the world, recognizing the dollar as the world’s reserve currency. The agreement established a new global monetary system and replaced the gold standard with the dollar as the world currency, thus establishing the United States as the dominant power in the world economy.
With the signing of the Bretton Woods Agreement, the recognition of the dollar as the world’s main reserve currency created two World Banks and the International Monetary Fund (IMF). The two were US-sponsored organizations set up to oversee the new system. In this article with the help an essay From the Balance website, we explain how the Bretton Woods agreement was formed and then collapsed.
Burton Woods What is?
More than 700 delegates from 44 countries gathered at the end of World War II and on July 22, 1944, at a place called Burton Woods in New Hampshire to form a monetary system. Shape the new. In fact, delegates from Allied countries backed by World War II came to Bretton Woods to find solutions to their economic problems. The Allies were countries that fought against allies in World War II (Germany, Italy, and Japan). The United States, Russia, and Britain were the most important members of the Allies, but other countries helped.
The conclusion of this agreement was summarized as follows:
All countries that signed the Bretton Woods Agreement should save dollars instead of gold, and the United States should keep gold in its treasury at the amount of dollars exported. The central banks of the signatory countries of the Bretton Woods agreement could turn their dollar reserves into gold at any time by going to the US Federal Reserve. Relying on this commitment, the United States became, in practice, the sole guarantor of the international monetary system. Under the agreement, the countries’ central banks undertook to keep the exchange rate constant between their current currency and the US dollar. If the value of a country’s currency weakens against the dollar, then the central bank will start buying that currency extensively in the market. Such a purchase reduces the supply of that currency and consequently increases its price. If the price of the currency goes too high, the central bank will print more; This is because it increases the supply and consequently reduces the price of the desired currency. This is a monetary policy often used by central banks to control inflation.
Members of the Bretton Woods system agreed to avoid trade wars between them. For example, they decided not to use the sharp drop in the price of their currencies to increase trade. Of course, they could regulate their currency markets under certain conditions. For example, if a foreign direct investment were to destabilize a country’s economy, they could take appropriate action. They could also restructure their currency for post-war reconstruction.
Replacing the gold standard
Before Burton Woods, most countries followed the gold standard. This meant that each country guaranteed to export as much gold as its treasury backed by its treasury. But after Burton Woods, members agreed to measure their currency against the US dollar, not gold. But it still remained a kind of gold standard.
But why dollars? The United States accounted for three-quarters of the world’s gold supply. No other currency had enough gold to back this amount of gold as an alternative. At that time, the value of each dollar was 35.1 ounces of gold, and accordingly, foreign exchange reserves could be controlled against the dollar. Burton Woods worked to move countries slowly from the gold standard to the US dollar standard.
Now the dollar had replaced gold. As a result, the dollar appreciated against other currencies. This created more demand for the dollar; However, the value of the dollar against gold remained the same. The same demand sowed the seeds of the collapse of the Bretton Woods system three decades later.
Why was this agreement necessary??
For a long time, the countries of the world used the gold standard. The outbreak of World War I caused countries to more or less violate this standard for financing. During World War I, countries’ non-compliance with the gold standard exacerbated inflation because the money supply affected demand. After the war, the countries returned to the security that existed in the shadow of the gold standard. Hyperinflation caused the value of money to fall so much that sometimes people only needed a wheelbarrow full of money to buy a loaf of bread.
“Everything was going well until”The Great Recession»Arrived. After the collapse of the US stock market in 1929, investors turned to commodity trading. This pushed up the price of gold and as a result people started converting their dollars into gold. The Federal Reserve worsened the situation by raising interest rates and supporting the country’s gold reserves.
The Bretton Woods system gave countries more flexibility to strictly follow the gold standard. The agreement also created a situation in which less economic fluctuations were experienced than in a currency system without any standards. Each member state could, if necessary, change the value of its currency to correct “fundamental imbalances” in its treasury.
The role of the International Monetary Fund and the World Bank
Coinciding with the signing of the Bretton Woods Agreement, the countries participating in the conference established two global institutions; International Monetary Fund and World Bank. The first institution was to take on the role of guardian in the new monetary system, and to prevent the monetary system from being disturbed by monitoring the relationship between the currencies and providing assistance to countries in difficulty. But the World Bank had a duty to help rebuild war-torn countries by providing easy loans. Given the financial position of the United States at the time, there was no doubt that the United States had a very strong position in both institutions. Thus, many countries began to store US dollars, which made the United States absolutely powerful.
The Bretton Woods system could not function properly without the International Monetary Fund. Member countries needed it to prevent the devaluation of their national currency. They needed a kind of central bank so that they could borrow from the bank if they needed to regulate the value of their currency and if they did not have the ability to fund it; Otherwise, they would only face trade barriers or be forced to raise interest rates.
The Bretton Woods member states decided not to give the International Monetary Fund the power of a world central bank; Instead, they agreed to donate gold and national currencies to the International Monetary Fund. Each member of the Burton Woods system then had the right to receive the amount it needed as a loan, with a limited share of the fund. The International Monetary Fund was also responsible for implementing the Bretton Woods agreement. Therefore, keep in mind that the International Monetary Fund was not established to print money and influence economies with monetary policy.
Contrary to its name, the World Bank was not and is not the World Bank. At the time of the Bretton Woods agreement, the World Bank was actually set up to provide loans to European countries devastated by World War II. Currently, the World Bank aims to lend to economic development projects in emerging market countries.
The collapse of the Bretton Woods system
In 1971, the United States suffered a massive stagflation. Inflationary recession is a combination of inflation and recession that causes unemployment and negative economic growth.
The then president, Richard Nixon, devalued the US dollar against gold in response to the dangerous devaluation caused by excessive amounts of currency in circulation. He raised the value of the dollar to 38.1 ounces of gold and then to 42.1 ounces.
The devaluation plan backfired. This prompted people to flock to US gold reserves at Fort Knox to convert dollars into gold; Dollars that were rapidly losing value. Fort Inox is a U.S. military base in Kentucky. In addition to military applications, the base is home to more than 4,700 tonnes of US gold reserves.
Burton Woods did not live to be 30 years old. In the late 1960s, the limitations of the Bretton Woods system (which put direct pressure on the Federal Reserve) made it unbearable for the United States. Unable to compete with cheaper foreign products, the country, which was struggling with the costs of the Vietnam War, could not balance the sufficient inflow of foreign currency and the replenishment of its gold reserves. On the other hand, countries like France that demanded gold for their dollars caused the US gold reserves to run out.
All of these factors eventually led to Nixon canceling gold in exchange for a dollar in a sudden decision known as the “Nixon Shock” on August 15, 1971. Without price control, gold quickly reached $ 120 an ounce in the open market. By the end of the 1970s, all countries were floating their currencies, and this was the end of the Bretton Woods system. Currently, the price of gold has reached more than $ 1,700.
After the collapse of the agreement, the gold standard was practically violated, but the countries’ dependence on the US dollar remains.
The Bretton Woods agreement prompted countries to choose the dollar as their currency backing. In turn, gold became the backbone of the dollar, and the United States dominated the global economy. The United States was the only country that could print a currency that was accepted around the world, and countries had more flexibility than the old gold standard. When this agreement was broken and the link between the dollar and the price of gold was severed, the dollar became the monetary standard and support for other currencies.