THE BRETTON WOODS SYSTEM:
(Also called the IMF’s Fixed Exchange Rate System)
Representatives of 45 major economies met at Bretton Woods, 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 two international multi – lateral institutions namely,
1. International Monetary Fund (IMF)
2. International Bank for Reconstruction and Development (IBRD) – known as the World
Bank.
The IMF was given the mandate to establish a suitable exchange rate system. The Fixed
Exchange Rate System proposed by them was implemented in 1946. The main features of
this system were as follows:
1. In addition to gold, the US Dollar (USD) was to be given the status of universal
reserve asset. This means that in addition to gold reserves, countries could issue
domestic money against USD reserves. The value of USD was fixed at 1 ounce of
gold = USD 35.
2. The US Federal Reserve Bank (The American Central Bank) provided an
unconditional guarantee to buy and sell unlimited quantity of gold at this price. This
was called the Gold Convertibility Clause.
3. No other country was required to provide for redemption of its currency against gold
nor were they required to fix an official gold price.
4. Each member country was required to fix a PARITY VALUE for its currency against
USD. (The process of fixing the value for a currency as a multiple of another currency
is called PEGGING. The actual rate or multiple is called PARITY. The equality between
gold, USD and domestic currency was called the PAR VALUE MECHANISM.)
5. The USD functioned as the universal vehicle currency. All currencies were pegged to
USD at fixed parity rates therefore their cross relationships were also constant.
6. Effectively every currency was redeemable in terms of USD and only 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.
7. Variation in the exchange rate was permitted on either side of parity in a range of (+/-)
1%
8. The extreme points of the variation zone were called ‘support points’ or ‘intervention
points’.
9. The system introduced the concept of Central Bank intervention as a means of
ensuring protection of parity rates (intervention means proactive participation of a
Central Bank in the domestic markets with the intention of influencing exchange rate
movement.)
10. The IMF provided a commitment to the member countries to provide assistance to
countries facing temporary balance of payment deficits.
11. In case of structural imbalances in the Balance of Payments, member countries could
devalue their currencies in consultation with the IMF. On account of this flexibility, the
system was also viewed as ‘The Adjustable Peg System’
12. The concept of ‘dual exchange rates’ was abolished.
13. All member countries accepted the supervisory authority of the IMF in regards to the
exchange rate management system and the domestic foreign exchange market. This
was the first instance in history when all countries of the world voluntarily accepted to
give up a part of their sovereignty (freedom to decide) in connection with their foreign
exchange management systems.
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