Bretton WoodsSystem and 1944 Agreement HowBretton Woods Introduced a New World Order By Kimberly Amadeo http://useconomy.about.com/od/monetarypolicy/p/Bretton-Woods-International-Monetary-System-And-1944-Agreement.htm 1. The Bretton Woods system was a remarkable achievement ofglobal coordination. It established the U.S. dollar as the global currency , taking the world off ofthe gold standard . It created the World Bank and the International Monetary Fund (IMF) as the twoglobal organizations to help monitor the new system. In effect, since the U.S. was the only country with the abilityto print dollars , it established America as themajor power behind these two organizations, and the global economy . The Bretton Woods Agreement: 2. Under the Bretton Woods agreement, countries promised thattheir central banks would maintain fixed exchange rates between theircurrencies and the dollar. How exactly would they do this? If their currency'svalue became too low relative to the dollar, they would buy up their currencyin foreign exchange markets . This would decreasethe supply, which would automatically raise the price. If their currency becametoo high, they'd print more of their currency, increasing the supply and automaticallylowering its price. 3. Members of the Bretton Woods system alsoagreed to avoid any trade warfare, such as lowering their currencies strictlyto increase trade. However, they could regulate their currencies if foreign direct investment began to streaminto their countries in such a way to destabilize their economies. They couldalso adjust their currency values to rebuild after a war. How the Bretton Woods Agreement Replaced the Gold Standard: 4. Prior to Bretton Woods, the world had followed the gold standard . This meant each countryguaranteed that its currency would be redeemed by its value in gold. AfterBretton Woods, each member agreed to redeem its currency for dollars , not gold. Why dollars?The U.S. held three-fourths of the world's supply of gold. The dollar's value was set at1/35 of an ounce of gold, so in a way the world was still on somewhat of a goldstandard. 5. However, for all intents and purposes, the dollar had nowbecome a substitute for gold. As a result, the value of the dollar began to increaserelative to other currencies, since there was now more of a demand for it – even though its worth ingold remained the same. This discrepancy in value planted the seed for thecollapse of the Bretton Woods system three decades later. Why the Bretton Woods System Was Needed: 6. Until World War I, most countries were on thegold standard. However, they went off so they could print the currency neededto pay for their war costs. This caused hyperinflation , as the supply of money overwhelmed the demand.The value of money fell so dramatically that,in some cases, people needed wheelbarrows full of cash just to buy a loaf ofbread. After the war, countries returned to the safety of the gold standard . 7. All went well until the Great Depression . After the 1929 stock market crash , investors switchedto trading in currencies and commodities . This drove up the price of gold , resulting in people redeemingtheir dollars for gold. The Federal Reserve made things worse bydefending the nation's gold reserve by raising interest rates . It's no wonder that, as WorldWar II wound down, countries were ready to abandon a pure gold standard. 8. The Bretton Woods system gave countries more flexibilitythan a strict adherence to the gold standard, but less volatility than no standard at all. Amember country still retained the ability to alter its currency's value ifneeded to correct a "fundamental disequilibrium" in its current account balance . Role of the IMF and World Bank: 9. The Bretton Woods system could not have been put intoplace without the IMF. That's because member countries needed a mechanism tobail them out if their currency values got too low. They'd need akind of global central bank they could borrow from in case they needed toadjust their currency's value, and didn't have the funds themselves. Otherwise,they would just slap on trade barriers or raise interest rates . 10. The Bretton Woods countries decided against giving theIMF the power of a global central bank, to print money as needed. Instead, theyagreed to contribute to a fixed pool of national currencies and gold to be heldby the IMF. Each member of the Bretton Woods system was then entitle to borrowwhat it needed, within the limits of its contributions. The IMF was alsoresponsible for enforcing the Bretton Woods agreement. 11. The World Bank, despite its name, was not theworld's central bank . At the time of the Bretton Woodsagreement, the World Bank was set up to lend to the European countriesdevastated by World War II . Now the purpose of the World Bank is to loan money to economic developmentprojects in emerging market countries. The Collapse of the Bretton Woods System: 12. In 1971, the U.S. was suffering frommassive stagflation -- a deadly combinationof inflation and recession . This was partly a result of thedollar's role as a global currency. In response, President Nixon started to deflate thedollar's value in gold. The dollar was repriced to 1/38 of an ounce of gold,then 1/42 of an ounce. However, the plan backfired. It created a run on the U.S. gold reserves at Fort Knox as people redeemed their quicklydevaluing dollars for gold. In 1973, Nixon unhooked the value of gold fromaltogether. Without price controls, gold quickly shot up to $120 per ounce inthe free market . The Bretton woods system was over. Exercises: I . ReadingComprehension: Judge whether the following statements are true (T) or false (F)based on what you have read in the passage. 1. The Bretton Woods system not only established the U.S.dollar as the global currency, but also made the U.S. the superpower. 2. Under the Bretton Woods system, members bought and soldtheir own currency to maintain a relatively fixed exchange rate against theU.S. dollar. 3. Under no circumstances should the Bretton Woods membersadjust their currencies because their currencies should be tied strictly to theU.S. dollar. 4. The Bretton Woods System set the world totally free fromthe gold standard. 5. The gold standard was abandoned before World War I becauseit was no longer suitable for the new international relations then. 6. Compared with the gold standard, the Bretton Woods systemhas more flexibility, and more stability compared with no standard at all. 7. To some extent, the IMF works as a global central bankbecause it can print money as needed. 8. The emphasis of the World Bank shifted from its early-daysconcerns on the European countries to emerging market countries now. Bretton Woods System and 1944 Agreement.docx