External Balance Problem of the United States

1
External Balance Problem of the United States
2
Bretton Woods System

• A system where foreign countries central banks
  pegged their currency against the U.S. dollar.
• U.S. Federal Reserve held the dollar price of
  gold at a constant 35/oz. to allow for a stable
  rate of exchange.
• This allowed foreign central banks to exchange
  their dollars for gold.

3
U.S. the Nth currency Problems

• The U.S. was responsible for holding gold _at_
  35/oz, but gold supplies were not growing fast
  enough.
• Foreign central banks would hold onto dollars,
  since they accumulated interest.
• Good business from an investment point of view.
• Dollar represented international money par
  excellence

4
Confidence Problem

• Central Banks and world economic growth trends
  showed a long-run problem with Bretton Woods.
• Central banks would stop accumulating dollars.
• A feared run on the bank by foreign banks would
  deplete all reserves.

5
Bretton Woods Decline

• 1965-1968 Macroeconomic package
• Government purchases expanded greatly
• Military ( Vietnam)
• Great Society Programs public education and
  urban redevelopment.
• Taxes were never raised.
• There was no offset to the government spending
  that occurred.
• 1966 mid-term election Pres. Johnson avoided
  asking for tax increase, for fear of
  congressional scrutiny on spending.

6
Bretton Woods Fall

• Substantial fiscal expansion policy
• Sharp fall in current accounts surplus
• Rising domestic prices inflation increased
• Monetary policy
• It was contractionary as output expanded
• High interest rates caused Fed. to expand its
  monetary policy, as a remedy.
• Inflation rate was close to 6 per year by the
  end of the 60s

7
Bretton Woods Fall (cont.)

• Speculation of Gold late 1967 and 1968
• The gold bought up on London gold market
• Pushed gold prices up.
• Caused speculation
• Creation of two-tier gold market ( turning point)
• Private market golds price was allowed to
  fluctuate
• Official tier Central banks kept gold at an
  official 35/oz.
• Link severed
• Supply of dollars tied to a fixed market price
  of gold.
• Official price of gold became an arbitrary number
  to balance accounts between among central banks.

8
1970s Recession

• Devaluing the Dollar
• Increase employment
• Balance U.S. current account
• Two options
• Depreciate domestic prices, while increase in
  foreign prices
• OR, depreciate Dollars nominal value against
  foreign currencies

9
U.S. cuts final tie to gold

• Option two choosen depreciating Dollar against
  foreign currencies.
• Multilateral agreement would be needed.
• Foreign currencies are pegged to Dollar, but
  Dollar is fixed to golds set price.
• Many countries were resistant to the idea
• Hurt their import/export competing industries
  with revaluation.
• Nixon arrangement August 1971
• Ended the selling of gold for Dollars.
• Last connection to gold.
• Imposed 10 tax on imports, until trading
  partners agreed to revalue their currency.

10
Dollars Loss of Value 1970's
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11
1971 International agreement

• International exchange rate agreement
• Smithsonian Realignment Dec. 1971
• Dollar was devalued against foreign currencies by
  8.
• The 10 import-surcharge was lifted.
• Gold was raised to a new official price of
  38/oz.
• No significance The U.S. never sold gold for
  Dollars after this arrangement.
• 15 months later Feb. 12, 1973 Mar. 1, 1973
• Speculation attacks against Dollar closed
  exchange markets
• Dollar was devalued 10 more.
• Floating exchange rates
• March 19, 1973 Exchange rates of Japan and most
  European countries were floating against the
  Dollar.
• A temporary fix that has become permanent
  solution for now.