This article has been written by Oishika Banerji of Amity Law School, Kolkata. This article provides a detailed analysis of the Bretton Woods Agreement which was responsible for creating a collective international currency exchange regime.
This article has been published by Rachit Garg.
Table of Contents
Introduction
Delegates from 44 countries negotiated an agreement in July 1944 at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire. As a result, the agreement is known as the ‘Bretton Woods Agreement.’ The United States (US) dollar was tied to the value of gold under the Bretton Woods System, while other currencies were fixed to the value of the US dollar. When President Richard M. Nixon stated that the US would no longer exchange gold for US money in the early 1970s, the Bretton Woods System essentially came to an end. The present article discusses the Bretton Woods Agreement in detail.
The Bretton Woods Agreement : an insight
In July 1944, around 730 delegates from 44 nations gathered in Bretton Woods with the primary aims of establishing an efficient foreign exchange system, eliminating competitive currency devaluations, and fostering worldwide economic growth. These objectives were made possible by the Bretton Woods Agreement and System. The Bretton Woods Agreement also established two major institutions, namely, the International Monetary Fund (IMF) and the World Bank. Despite the fact that the Bretton Woods System was disbanded in the 1970s, the IMF and the World Bank have maintained significant foundations for international currency exchange.
The Bretton Woods System did not become fully operational until 1958. Once it was enacted, it called for the US dollar to be tied to the value of gold. Furthermore, the value of all other currencies in the system was then tied to that of the US dollar. The exchange rate applied at the time set the price of gold at $35 an ounce. The inflationary monetary policy, which was improper for the key currency country of the system, was a major factor in Bretton Woods’ demise. The Bretton Woods system was built on regulations, the most essential of which was to stick to the official peg’s monetary and fiscal policies.
Background of the Bretton Woods Agreement
- The United Nations Monetary and Financial Conference was held at Bretton Woods, New Hampshire, in July 1944, where delegates from forty-four countries formed the Bretton Woods system, a new worldwide monetary system. Following World War II, these countries recognized an opportunity for a new international system that would draw on the lessons of past gold standards as well as the Great Depression‘s experience to provide for post-war rebuilding. For nations that had been erecting barriers between their economy for more than a decade, it was an extraordinary coordinated effort.
- They aimed to design a system that would not only avoid the rigidity of prior international monetary systems but would also solve the nations’ lack of collaboration in earlier systems. After World War I, the traditional gold standard was abandoned. Governments not only conducted competitive devaluations throughout the inter-war period but also enacted restrictive trade policies that exacerbated the Great Depression.
- At Bretton Woods, participants envisioned an international monetary system that would maintain exchange rate stability, avoid competitive devaluations, and foster economic progress. The aims of the new system were agreed upon by all parties, but the strategies to achieve them differ. It took a massive worldwide effort to secure a collective bargaining agreement. Financial experts had innumerable bilateral and international discussions to come to a consensus approach more than two years before the summit. While the Treasury Department in the United States had primary responsibility for foreign economic policy, the Federal Reserve played a role in the new system by providing guidance and counsel. John Maynard Keynes, a British Treasury consultant, and Harry Dexter White, the Treasury Department’s senior foreign economist, were the principal architects of the new system.
- One of the most famous economists of the period (and possibly even today), John Maynard Keynes, advocated for the establishment of a big organisation with the means and power to intervene when imbalances arise. This was in line with his idea that government institutions should be able to act in times of crisis. The Clearing Union, according to Keynes’ concept, would be a global central bank. The “bancor,” a new international currency issued by this bank, would be used to redress international imbalances. For the Clearing Union, Keynes advocated financing $26 million. Each country would be given a restricted line of credit to avoid running a balance of payments deficit, but surpluses would be discouraged because extra bancor would have to be remitted to the Clearing Union. Keynes’ concerns about the global post-war economy were reflected in the proposal. He predicted that the United States will go through another depression, forcing other nations to run balance-of-payments deficits and forcing them to choose between domestic and exchange rate stability.
- White’s proposed new institution would have fewer authorities and resources. It expressed worries that much of the financial resources of the Keynes-envisioned Clearing Union would be utilised to buy American goods, resulting in the US owning the bulk of bancor. The Stabilization Fund was a new monetary organisation suggested by White. Instead of issuing a new currency, it would be backed by a limited pool of national currencies and $5 million in gold, essentially limiting the amount of reserve credit.
- The Bretton Woods proposal was similar to the White plan, with certain concessions made in response to Keynes’ objections. In the event that a country’s balance of payments surplused and its currency became scarce in international commerce, a provision was included. The fund might regulate that currency and allow only a limited number of imports from the surplus nation. In addition, the fund’s total assets were increased from $5 million to $8.5 million.
- At Bretton Woods, 730 delegates decided to establish two new organisations. The International Monetary Fund (IMF) would keep an eye on exchange rates and lend reserve currency to countries with budget deficits. The International Bank for Reconstruction and Growth, currently known as the World Bank Group, was in charge of providing financial aid for post-World War II reconstruction and economic development in developing nations.
- When the first twenty-nine member countries signed the IMF’s Articles of Agreement in December 1945, the IMF was formally established. The countries decided to keep their currencies fixed but adjustable to the dollar (within a 1% range), and the dollar was set at $35 per ounce of gold. When a nation joins the IMF, it is assigned a quota based on its relative standing in the global economy, which affects how much it pays into the fund.
- As currencies became convertible in 1958, the Bretton Woods system became fully operational. Dollars were used to settle foreign accounts, and they were convertible to gold at a predetermined rate of $35 per ounce. The US was responsible for maintaining the price of gold and had to alter the quantity of dollars in order to retain trust in future gold convertibility. The Bretton Woods system was in effect until recurrent US balance-of-payments deficits caused foreign-held dollars to surpass US gold stock, meaning that the US would be unable to redeem dollars for gold at the official price.
- President Richard Nixon abolished the dollar’s gold convertibility in 1971. Representatives, financial leaders, and political agencies made several attempts to restore the system and maintain the currency exchange rate stable. By 1973, however, practically all major currencies had begun to float in relation to one another, and the system as a whole had failed.
Key clauses of the Bretton Woods Agreement
At Bretton Woods, participants envisioned an international monetary system that would maintain exchange rate stability, avoid competitive devaluations, and foster economic progress. The main clauses of the agreement are mentioned hereunder:
- International Monetary Fund;
- Fixed Exchange Rate;
- Special Drawing Rights;
- Exchange Rate;
- Gold Standard;
- Exchange Rate Regime;
- Euro;
- Balance of Payments;
Need for the Agreement
- The gold standard was used by most governments until World War I. They did, however, break their ties with gold in order to create the money they needed to pay for the war. Hyperinflation developed as a result of the inflow of cash, as the supply of money outstripped the demand. Following the war, countries reverted to the gold standard as a safe haven.
- Everything was well until the Great Depression. Following the stock market crash of 1929, investors shifted their focus to commodities trading. It caused the price of gold to rise, causing consumers to exchange their dollars for gold. The Federal Reserve made matters worse by hiking interest rates to protect the nation’s gold reserve.
- The Bretton Woods system provided countries more freedom than the gold standard, which was rigid. It also had less volatility than a monetary system with no fixed value. A member country’s currency value might still be changed if necessary to remedy a ‘fundamental imbalance’ in its current account balance.
Entry of the International Monetary Fund
The Bretton Woods Agreement established the IMF and the World Bank as Bretton Woods Institutions. Both organisations were formally established in December 1945 and have endured the test of time, functioning as major cornerstones for international capital finance and trade activity. The IMF’s job is to keep track of currency rates and identify countries that require international monetary assistance. The IMF has 189 member nations in the twenty-first century and continues to foster global monetary cooperation.
The Articles of Agreement
On July 22, 1944, the United Nations Monetary and Financial Conference (Bretton Woods, New Hampshire) established the International Monetary Fund’s Articles of Agreement. They were first adopted by 29 nations, and a total of 190 member countries have signed and ratified them since then. The Fund’s aims are outlined in the Articles, which include promoting “international monetary cooperation through a permanent institution that offers the machinery for consultation and collaboration on international monetary challenges.”
The Articles also establish the Organisation’s mandate, as well as the rights and obligations of its members, its governance structure, and the roles of its organs, as well as a number of operational rules, including those governing the conduct of the Organisation’s operations and transactions involving Special Drawing Rights. The IMF’s main responsibilities include overseeing the international monetary system and monitoring members’ economic and financial policies, as well as providing technical help and financial services to member nations in need.
The Articles of Agreement have been revised seven times since their ratification in 1944, the most recent being on December 15, 2010 (effective January 26, 2016). The Articles are supplemented by the Fund’s by-laws, which are in turn supplemented by the Executive Board’s Rules and Regulations.
The birth of World Bank : an effect of the Bretton Woods Agreement
A detailed timeline of the World Bank can be accessed here. The events that unfolded to the formation of the World Bank have been discussed hereunder:
- The Bretton Woods Conference created the Articles of Agreement, establishing the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF) at its conclusion. Bretton Woods was preceded by years of planning and discussion, which established the groundwork for the conference’s success. While the early intentions of the United States, with additions from the United Kingdom, had a substantial effect on the final Articles, other nations attended discussions and made suggestions including their own vision for an international bank prior to the meeting.
- The United Nations Monetary and Financial Conference, as it was officially titled, began on July 1, 1944, with 730 delegates in attendance. The meeting was presided over by US Treasury Secretary Henry Morgenthau Jr. The proposal for a bank for rebuilding and development was handled by Commission II, which was chaired by Lord John Maynard Keynes of the United Kingdom delegation. The commission’s committees were entrusted with reviewing the conference’s preliminary document and soliciting new recommendations and proposals. Among the active players were Mexico, Chile, Brazil, Russia, Belgium, the Netherlands, Czechoslovakia, Poland, Canada, China, and India. The planned bank’s twin aims of rehabilitation and development, as well as its capital structure, drew a lot of attention.
- Although many decisions remained to be taken, the delegates signed the Final Act of the United Nations Monetary and Financial Conference on July 22, 1944, which included charters establishing the purposes and methods of both the IMF and the IBRD. Representatives from twenty-one nations met in Washington, DC on December 27, 1945, to ratify the IBRD Articles of Agreement and become the Bank’s first members.
- The World Bank, like the IMF, did not exist formally at or soon after the summit, and hence had no recordkeeping responsibilities. After the meeting, country representatives may have taken the documents back to their nations, and archival records connected to Bretton Woods were likely to be discovered in the custody of archive institutions in those forty-four countries. The United States’ records are unusually extensive because it hosted the conference. The IMF Archives thereafter became the depository for the conference secretariat’s documents.
- The World Bank Group Archives’ Bretton Woods records were gathered as a consequence of Bank units and personnel gathering copies for reference purposes. The Secretary’s Department, Office of the President, Central Files, and the personal papers of the Bank’s first Research Department Director, Leonard B. Rist contains records such as early draft proposals by countries, conference proceedings and working documents, pamphlets, government reports, and drafts and commentary on the Articles leading up to the December 1945 ratification. Internal IBRD memos and annotated copies of the Articles discussing interpretation and revisions after the Bank began operations in 1946 are also accessible, in addition to the aforementioned materials.
The benefits surrounding Bretton Woods currency pegging
There were 44 nations in the Bretton Woods System. These nations were brought together to aid in the regulation and promotion of cross-border commerce. Currency pegs are supposed to offer currency stabilisation for the trade of goods and services as well as financing, as with all currency pegging regimes. All members of the Bretton Woods System agreed to a fixed peg against the US dollar, with only 1% deviations permitted. Countries were expected to maintain and control their currency pegs, which they did largely by using their own currency to purchase and sell US dollars as needed. As a result of the Bretton Woods System, international currency exchange rate volatility was reduced, which aided international commercial ties. Foreign currency exchange stability was also a factor in the World Bank’s effective backing of international loans and grants.
The breakdown of the Bretton Woods Agreement
The Bretton Woods System had crumbled by 1973. Countries were free to adopt any exchange arrangement for their currency at the time, with the exception of pegging its value to the price of gold. They may, for example, tie its value to the currency of another nation or a basket of currencies, or simply let it float and let market forces decide its value in relation to other currencies.
Conclusion
The Bretton Woods Agreement is still seen as a watershed event in international finance. The International Monetary Fund and the World Bank, which were established at Bretton Woods, were instrumental in helping to reconstruct Europe following World War II. Subsequently, both organisations have maintained their founding purposes while also shifting to serve modern-day global government interests.
References
- https://history.state.gov/milestones/1937-1945/bretton-woods.
- https://www.gold.org/about-gold/history-of-gold/bretton-woods-system.
- http://www2.econ.iastate.edu/classes/econ355/choi/bre.htm.
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