A new worldwide monetary system was established with the signing of the Bretton Woods agreement in 1944. It supplanted the gold standard with the dollar as the primary medium of exchange used around the world. The United States of America became the preeminent economic power in the world as a result of this action. Following the signing of the agreement, the United States was the only nation that retained the ability to create new dollars. As part of the accord, the World Bank and the International Monetary Fund (IMF) were established as entities with the support of the United States that would oversee the new system.
Key Takeaways
- The establishment of the Bretton Woods system led to several nations deciding to peg their currencies to the dollar of the United States.
- As a result, the value of the dollar was fixed to that of gold, and the United States economy grew to dominate that of the rest of the world.
- The United States was the only country that had the ability to manufacture the currency that was accepted everywhere, and as a result, countries had greater leeway than they did under the previous gold standard.
- As soon as the dollar was no longer linked to the value of gold, it was able to establish itself as the monetary standard, which led to other countries linking their currencies to the dollar.
The accord reached Bretton Woods
At a conference held in 1944, all of the Allied nations that had participated in World War II came together to construct the Bretton Woods agreement. It was held in Bretton Woods, which is located in New Hampshire. As part of the agreement, countries guaranteed that their respective central banks would keep the exchange rates between their currencies and the dollar at a constant level. If the value of a country's currency dropped to an unacceptable level in comparison to the dollar, the central bank would buy up as much of that country's currency as possible on the foreign exchange markets. Buying currency would reduce the available supply of currency, hence driving up the price of currency. If the price of a currency rose to an unacceptable level, the central bank would issue more of it. This printing process would result in an increase in the supply, which would, in turn, result in a decrease in the price of the currency. The participants in the Bretton Woods system came to an agreement to prevent trade wars. As an illustration, they would not devalue their currencies for the sole purpose of boosting commerce. However, they could control the value of their currencies under specific circumstances. For instance, they may take action if it became apparent that foreign direct investment was causing economic instability in their countries. They might even change the values of their currencies in order to rebuild after the war.Putting an End to the Gold Standard
Prior to the establishment of Bretton Woods, the majority of nations used the gold standard. This meant that every nation gave a guarantee that they would exchange their money for the equivalent value in gold. Following Bretton Woods, all of the members came to an agreement that their currencies could only be redeemed for dollars, not gold. Why dollars? The United States was responsible for the custody of three-quarters of the world's gold reserves. No other currency has the backing of sufficient gold to serve as a viable alternative. When measured in terms of gold, one dollar was equal to one-thirtieth of an ounce. The world was able to gradually shift from using gold as its standard currency to using the United States dollar, thanks to Bretton Woods. The value of gold was gradually supplanted by the dollar as time went on. As a direct consequence of this, the value of the dollar began to rise in comparison to the values of other currencies. Even though the value of a dollar, when measured in gold, did not change, the move led to an increase in demand for dollars. This disparity in value sowed the seed that would eventually lead to the downfall of the Bretton Woods system thirty years later.Why It Was Necessary to Come to an Agreement
Up until the start of World War I, the majority of countries used the gold standard. In spite of this, they severed their ties to gold so that they could generate the currency necessary to pay for the costs of their war. Hyperinflation was the direct result of this influx of currency because the supply of money exceeded the demand for it. After the war, many nations decided it was best to stick to the tried-and-true gold standard. As a result of hyperinflation, the value of money plummeted to such an extent that individuals, in certain instances, needed wheelbarrows worth of cash merely to purchase a single loaf of bread. Everything was going swimmingly until the Great Depression. Following the collapse of the stock market in 1929, investors shifted their focus to the trade of commodities. It caused the price of gold to rise, which led to an increase in the number of people exchanging their dollars for gold. 8 In order to protect the nation's gold reserve, the Federal Reserve raised interest rates, which made the situation even more difficult. The tight adherence to the gold standard was replaced by the Bretton Woods system, which provided governments with more flexibility. Additionally, it offered lower levels of volatility in comparison to a monetary system that had no standards at all. According to what was highlighted by the Federal Reserve, a member nation could still change the value of its currency if it deemed it necessary to address a "fundamental imbalance" in the country's current account balance.The Part Played by the International Monetary Fund and the World Bank
Without the International Monetary Fund, the Bretton Woods system could never have been successful. Ten of the member countries were dependent on it as a safety net in case the value of their currencies fell too far. If they needed to modify the value of their currency but did not have the cash themselves, they would need some form of global central bank that they could borrow from. In the event that this did not occur, they threatened to erect trade barriers or increase interest rates. The countries that participated in the Bretton Woods monetary arrangement came to the conclusion that the IMF should not have the authority of a global central bank. Instead, they came to an agreement to make regular contributions to a pool of national currencies and gold that would be kept by the International Monetary Fund (IMF). After that, every nation that was a part of the Bretton Woods system had the ability to borrow whatever amount it needed, as long as it stayed within the boundaries of its contributions. The International Monetary Fund was also in charge of upholding the terms of the Bretton Woods accord. The International Monetary Fund was not established to engage in money printing or to exert influence over economies through monetary policy. Despite its name, the Globe Bank was not the central bank of any country in the world. The World Bank was established during the time of the Bretton Woods agreement in order to provide financial assistance to the nations of Europe that had been ravaged by World War II. The World Bank's mission shifted to one of providing financial assistance to developing market countries with the aim of implementing economic development initiatives.The Destruction of the Bretton Woods System
The United States of America had severe stagflation in 1971. Stagflation is a mix of inflation and recession that results in low economic growth and high unemployment. In order to combat a potentially catastrophic decline in value brought on by an abundance of cash in circulation, President Richard Nixon initiated a process to devalue the dollar relative to gold. The value of the dollar was reduced to 1/38 of an ounce of gold by President Nixon and then to 1/42 of an ounce later on. The effort to devalue the currency was unsuccessful. People promptly exchanged their dollars, which were rapidly losing value, for gold, which caused a rush on the United States gold reserves held at Fort Knox. Nixon decoupled the value of the dollar from its relationship to gold completely in 1971. The Bretton Woods system came to an end when gold on the free market reached a price of $120 per ounce very soon after price controls were removed.Questions That Are Typically Asked (FAQs)
The Bretton Woods Agreement was an agreement that...
A summit of the Allied nations took place in 1944 under the auspices of the Bretton Woods Agreement. At this meeting, the nations decided to peg their currencies to the dollar while also keeping the currency linked to gold. 1958 marked the beginning of the agreement's term. However, it was terminated after fewer than 20 years.Where can I find the benchmark of excellence?
The United States of America maintained a monetary measuring system known as the gold standard until the 1970s. Under this system, the value of the dollar was pegged to the price of gold. One dollar was equal to a value of 1/35 of an ounce of gold during the time that the Bretton Woods Agreement was in effect.