Published: 26-Feb-2018 Last Edited: 01-Sep-2018
The Bretton Woods System started immediately after the end of the World War II and commonly used to refer the international monetary regime. It was named so because the agreement was signed in the Bretton Woods, New Hampshire, United States. Bretton Woods System was a monetary order, signed in 1944 in a fully negotiated manner and was proposed in order to administer currency relations within sovereign states.
The Bretton Woods System established a fixed exchange rate after the unsuccessful attempt to revive the gold standard subsequent to the Second World War. As per this system, central banks of different countries have to maintain fixed exchange rates between respective currencies and the U.S. dollar (Lien 2008).
Thus, under this system if the currency of any country is too high compared to the U.S. dollar, the central bank of the same country would sell it, in exchange for dollars, in order to bring down the value of its currency. On the contrary, if for instance, the value of any country’s currency is too low, the country would purchase its own currency.
The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), was set up beneath the Bretton Woods System, to observe the exchange rates, which are currently part of World Bank Group. However, the Bretton Woods System collapsed in the 1971 because during that period inflation in the U.S. and an increasing trade deficit undermine the value of the U.S. dollar (Gele and Hägele 2010).
The fixed value of the U.S. dollar overvalued in opposition to gold, in the early 60’s. Although the U.S. recommended help from Germany and Japan, and asked them to appreciate their currencies, but both countries reluctantly stepped back, as appreciating their currency will raise prices of good and in turn it would have affected exports.
In the late 60’s, the U.S. neglected the fixed value of the dollar, and approved it to fluctuate in front of other currencies. The key driver in the collapse of the Bretton Woods System is the inflating economy of America (Stephey 2008).
It served as the chief catalyst in the Bretton Woods System failure because the internal monetary system, which was founded on the U.S. dollar, began to collapse. The balance of payment deficit in the U.S caused the oversupply of the dollar and in turn expenditures of the U.S. government rose. Speculative business attack on the foreign currencies collapsed the fixed rate dollar.
As a result, in the year 1971, the agreement between the U.S. dollar and other currencies broke down. On August 15, 1971 the U.S. unilaterally finished convertibility of U.S. dollar into gold. And the President declared that the U.S. would no longer sell gold against the dollar. This step fully finished the Bretton Woods System and the termination of the system led the major currencies float freely (Reinert, Rajan, Glass and Davis 2010).
When the Bretton Woods System collapsed in 1971, it was replaced by Smithsonian Agreement, which was designed to overcome shortcomings of the system. However, the agreement also had the same flaws and it did not lived longer.
After the collapse of the system, IMF in conjunction with the World Bank started lending funds to all the developing nations for supporting them in the developmental process. Furthermore, the exchange rates progressed into the free market wherein, the value of currency was determined by the demand and supply measure (Lien 2008).
Therefore, the floating rate system substitutes the fixed rate system. The Bretton Woods System completely altered the perception for the U.S. dollar. Several academics debated that the failure of the Bretton Woods Systme marked the U.S. as a powerful economy or it reflected a loss in the power of the country. Some stated that the relative importance of the U.S.
Economy after the 1971 Bretton collapse narrowed and the year registered a downfall in the economic power of the United States. Debaters also mentioned that the collapse declined the hegemony of the U.S. On the contrary some regarded dollar as the most reliable currency and made it the most powerful and unique (Baylis, Smith and Owens 2010).
It is an influential economy, which affects several other related economies of the world. After the collapse, the U.S. dollar allowed the country to borrow it cheaply and indefinitely from the rest of the world (International Monetary Fund and World Bank 1995).