Economic system refers to organizational arrangement as well as processes through which any given society makes decisions concerning production and consumption. One common theme about these objectives is that they are characterized by inconsistencies and trade-offs. As a result, for one objective to be attained completely there will be at least a partial sacrifice of another. In addition the processes followed by each society in choosing objective also differ. As the new world economy closely integrates, societies have found their choices concerning modification of the economic system constrained in regard, more so when dealing in international trade (Conklin, p. 1). Furthermore the societies have realized that the decisions of one society have increasingly more effects on the economies of other societies. This has therefore called for agreement between nations on various issues affecting economies such as currency valuation, credit volume and trade balances (Eckstein, p. 3-5).
History of the Bretton Woods System
Bretton Woods system was one of such agreements that were developed after deliberations between nations that were at that time allied to the US. This system describes the international monetary regime that existed between 1944 and the early 1970s. It was named after the site where the conference took place, Bretton woods in New Hampshire and was attended by 730 delegates representing 44 nations of which Argentina was the only neutral nation. The original intention of the conference was to iron out the economic conflicts bearing in mind the problems that result from economic disparities (Wiggins, para. 1)
The nations represented acknowledged that the economic problems to some extent contributed to the world war and therefore to avoid future wars economic reform was necessary. Therefore members present were all focused on avoiding what they believed were past errors. It is also important to note that the US was undoubtedly at that time the world’s most powerful nation both military-wise and economically. Particularly because, the war did not take pace within America, and therefore during the war it concentrated on building its industrial strength by selling weapons to allied nations. Hence by he end of the war its manufacturing annual rate that was twice that of 1935-1939 (Wiggin, para.9)
Agreements and failure of the Bretton Woods conference
There were four points that particularly stood out: first there was a general agreement among negotiators that the interwar period had brought into light the negative effects of flexible exchange rates that were unrestrained. The members believed that trade and investment had been discouraged by the 1930s floating rates. They also believed that destabilizing speculations as well as competitive depreciations were as a result enhanced. They therefore sought a compromise between the two extreme positions of those who were for freely floating rates and those who were for fixed rates that were irrevocable. As a result they settled on a pegged rate currency system or per value system. Here members had an obligation to state a par value for their national currency and to limit the fluctuations of exchange rate within maximum margins of plus or minus one (Cohen, para. 4).
The right to change per value system was retained, that when they wanted to correct a disequilibrium situation. However it was to be done according to the agreed procedures. Secondly the member reached an agreement that in the event that rates were not flowing freely; an assurance would be needed to confirm that the supply of monetary reserves was enough. However negotiators saw it unnecessary to alter the gold exchange system that had been used previously in the interwar periods. The US particularly was not willing to alter the dollar or even gold value roles as they had the largest amount of both. Precisely three quarters of world reserves. Although they agreed on the need to have a supplementary liquidity source for countries with deficits the point of contention was whether to have a world central bank that would willingly create reserves when necessary or to have a mechanism where borrowing is more limited (Cohen, para. 5)
They settled on a system whereby nations were to pay a subscription fee which was to be equal to the amount of quota allocated to them. Each member was allowed to borrow from the IMF, when experiencing shortage in currency reserves. Thirdly the negotiators agreed that it was important that they prevent the occurrence of economic warfare that was witnessed in the 1930s. Therefore there was need to come up with a legal framework that would make states to do away with exchange controls that limited the convertibility of currency and adopt a free multilateral payment system (Cohen, para. 6-7)
As a result governments were prohibited from engaging in currency practices that were discriminatory. However this had two exceptions: first obligations on convertibility were only dealing with international trade, therefore regulating sales and purchases in order to trade in services and goods was not allowed. Members states could be permitted to postpone the obligations of convertibility in the period of transition after the war if they chose to. Therefore the IMF was mandated to oversee the legal code that governed the convertibility of currency (Cohen, para. 8)
Lastly, governments agreed that an institution for international cooperation on monetary issues was necessary. Negotiators believed that the lack of a set up procedure or even a machinery through which governments would inter-consult aggravated currency problems during the inter-war period. The negotiators were therefore confident that such an institution in the post war period would offer such a forum. The member states were to have voting rights based on their quota proportions. This was a monumental step as such an institution had not been formed on a permanent basis in history. As far as future decision making is concerned the US was guaranteed of a veto that was effective, particularly because it held a third of the all quotas of the IMF (Best, 83-86)
At the end of the conference, the IMF had been given the responsibility of loaning to the deficit countries and this was done with the assumption that the Fund’s liquidity pool would be able to cope with the problems of financing that emerged. However after being in place for two years, the IMF experienced an activity short burst, as a result its lending rate was pressured downwards to very low levels. As a result the role of monetary stabilization was assumed by one actor, the US who was not only willing but also able. The US exercised its monetary leadership in three ways: First it ensured that there was a relatively open market that enabled importation of foreign goods. Secondly, initiation of loans that were both long-term and short-term which were generously given out. Thirdly a lending policy that was liberal was eventually put up to provide funds in the shot-term in the event of crisis (Spero & Hart, p. 14-15)
However the US issued principal currency reserves of the world, not according to the priorities of foreign holders of the dollar but according to its own priorities. The countries that were holding foreign dollar also gave in to America’s autonomy in policy. However in 1958 the US started experiencing large balance of payments deficits as a result the Bretton Woods system was under strain. The exchange rates also experienced the heaviest load from the dollar glut. US on one side and other surplus countries (in Europe and Japan) on the other side traded blames on who was responsible of initiating change. America believed that the other side could reverse the situation by either revaluing or inflating their currencies. On the other hand America’s allies were waiting for it to take the first steps, as they believed that it had a large responsibility in the crisis being that it had the largest deficit. (Eichengreen & Flandreau, p. 220-224).
President Richard Nixon, determined to make the other side submit to mutual exchange rate adjustment effected policy changes that saw the suspension of the convertibility of dollar in to gold on 15th of August 1971, hence the Bretton Woods system collapsed. Particularly because, currencies of European major economies and Japanese yen had been let by those countries to float freely against the dollar. This was followed by an unstable transition, whereby oil prices shot up, stock prices went down and banks failed. Eventually inflation went up (International Monetary Fund, para. 1-3)
Reasons for the failure of the Bretton Woods system.
There are many theories put forward as to the reason of the collapse of the Bretton Woods system: First is the lack of leadership from the US on the international governance system. By mid-1960s its political elites had started making decisions which were not only serving its own interests but were also damaging to the other industrialized nations. As a result the transitional alliance that held together the international regulatory framework was compromised. Secondly, the financial capital structural power had increased significantly as a result of the Euromarkets rise. This meant that the Euromarkets were above political control; hence they could easily avoid the national financial regulations control because money could be diverted to them (Leyshon & Thrift, p. 284-286).
Financial interdependence was also another cause for the system collapse, western European currencies were convertible as well as Japanese yen. This was possible as a result of the expanding international transactions, whereby multinational banks were used for international flow of finance. Production also had been internationalized and as a result multinational corporations moved from place to place with their large liquidity assets that they controlled pursuing low interest rates. Another reason for interdependence was that the Eurocurrencies were held and also used for trading outside their individual home countries. As a result of these types of financial interdependence, the Bretton Woods system was under extreme strain (Joerges, Strath & Wargner, p. 83-89).
Another reason for the collapse of the system was the US accumulation of balance of payment deficits; eventually it was unable to establish how credible it was on reining that credit. On the other hand dollars had flooded other countries and hence a realistic way to ensure international reserves steadily increased was not provided. As a result there was a disequilibrium which led to an international economic crisis and this repeatedly happened in shorter intervals towards the end of 1960s. Eventually the system broke down as it had continually been weakened (Hägele, p. 18). The fifth reason for failure of the system was a design failure, whereby the negotiators did not recognize that the realignment option of currency in a world that had convertibility hinged on capital account would be different from that of a world that has exchange controls based on capital flows (Bordo, Eichengreen, p. 262-263)
Failure of the system can also be attributed to another design problem, whereby the negotiators did not provide the US with a mechanism that it would use to realign its currency option that was comparable to what other countries had. This mechanism would have allowed the US to change its foreign currency and still ensure that it did not affect the price gold in relation to the dollar. The collapse can also be explained as resulting from management failure. The US used baseless political as well as economic objections as an excuse to be reluctant in raising the price of the dollar in relation to gold. However such an increased would have been beneficial to the system as the supply of reserves would have immediately increased, which would have caused a change in the value of foreign exchange of the US dollar (Uzcan, 66-70).
President Nixon’s implementation of a new economic policy that suspended the convertibility of the dollar to gold was another major reason for the failure. This was done without consulting other countries and was meant to compel them to accept adjustment of the exchange rate that would involve the US and other countries. Although nations came together in an attempt to salvage the system through the Smithsonian agreement whereby they made changes in the Breton Woods system, the changes were insignificant. Particularly because national policies differed greatly and also flows of international capital were had greatly increased, in addition the dollar still could not be converted in to gold. Therefore world inflation went up as a result of inflation in the US coupled with a great outflow of the dollar and shortages in commodities worldwide. Eventually stability could not be achieved a because of differing national rates of inflation, hence the system collapsed (Stephey, para. 5-6)
The Bretton Woods system was developed with the original good intentions of ensuring stability in the world economy as well as preventing the effects that were experienced during the inter-war period. The system was therefore significant as it provided a platform on which the regime theory was developed. This was important mechanism through which nations with different systems of economy would be governed collectively on agreed principles. As a result economic cooperation was possible between governments in faces of many variables that defined each countries objective. However there were various failures that made the system not to achieve its original objectives. These failures were related to design and management of the system.
Although all members had agreed to the need of global monetary system they largely differed on the design. This gave an opportunity for the US, the most powerful nation at the time to push for its favourable opinion; as a result some key design issues were overlooked. Therefore the IMF could not be sustained leading to the US to assume the position of the IMF. The US later used the system to its self benefit as opposed to the original plan of benefiting all members. However the US later was unable to sustain the system on its own and as it lost credibility. Other nations had also developed themselves hence they ignored the rules of the system which eventually led to the collapse.
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