Conference was held at Bretton Woods in USA in July, 1944, in order to put in place a new international monetary system. The main characteristics of the International Monetary System developed at Bretton Woods are summarized below:
a) Fixed Rates in terms of gold, but only the US $ was convertible into gold as the US ensured convertibility of the dollars into gold at international level.
b) A procedure for mutual international credits.
c)Creation of International Monetary Fund to supervise and ensure smooth functioning of the system. Countries were expected to pursue the economic and monetary policies in a manner so that currency fluctuations remained within a permitted margin 11%. This cause meant the Central Bank of every country has to intervene to buy or sell foreign exchange, depending on the need.
d) Devaluation or Revaluation of more than 5% had to be done with the permission of IMF.
The Bretton Woods System lasted from 1944 to 1971. The Bretton Woods planners expected that after a brief transition (5 years) the international economy would recover and the system would enter into operation. From 1945 to 1947, the US actively pressed for implementation of the Bretton Woods system as originally conceived (US provided resources to the IMF and the World Bank and urged other countries to do likewise) By 1947, the US conclude that the Bretton Woods system was not working and that the Western system was on the verge of collapse (WWII had destroyed the European economic system, and the IMF’s modest credit facilities were insufficient to deal with Europe’s huge needs).
In 1960s the US balance of payment deficits started mounting. In 1968, convertibility of privately held Dollar into Gold was abandoned and in 1971 convertibility was completely abandoned. The US managed the international monetary system by providing liquidity: gold production was insufficient; the dollar was the only strong currency to meet the rising demands for international liquidity. The strength of the US economy, the fixed relationship of the dollar to gold ($35 an ounce), and the commitment of the US government to convert dollars into gold at that price made the dollar as good as gold. But there was a huge dollar shortage (the US was running trade surpluses); and in order for the system to work, it would be necessary for the US to reverse this flow and to run a payment deficit, which of course happened
The primary factor for the collapse of the system was currency convertibility into Gold. This idea can be explained with the “Triffins Paradox”. It is said that the entire monetary system depended on the Dollar performing its role as the key currency. Countries other than the US had to accumulate dollar balances as the dollar was the means of international payments. This meant that the US had to run balance of payment deficits (Foreign Exchange Deficits) so that the other countries could build up a stock of claims on the US. As long as US deficits were moderate, this worked fine, but when they started mounting it lead to crisis of confidence viz. Other countries started losing faith in the ability of US to convert dollar into gold. Gold demands for such conversion began to be made in the early 60s by the French followed by other countries in suit. Soon it was obvious that US did not possess enough gold to honour its convertibility commitment if all holders of dollar assets decided to demand gold.
Thus, a series of events finally led to the US abdicating its role as an anchor of the World Monetary System. Several attempts to revise the system trough a series of parity realignments, Dollar revaluation (in terms of gold) and widening the brands of permissible variations around central parties, failed thus making the Bretton Woods System totally invalid in 1978.
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