Macroeconomics II

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The Bretton Woods System and its End

• Macroeconomics II
• Summersemester 2004
• Prof. Dr.
• Paul Bernd Spahn
• Dipl.-Volkswirt
• Jan Werner
• Case Study
• presented by
• Judit Papp
• Olga Sedova
• Alesja Stellwag
• Yevgeniya Yarmanova

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Contents

• Historical events preceding the Bretton Woods
  system
• Establishing of the Bretton Woods system
• The Bretton Woods chronology
• Reasons for collapse
• 5 . Discussion

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1. Historical Events Preceding the BW System

• 1870-1914 Gold standard
• Creation of central banking systems as note
  source and legal tender
• Currencies backed by gold
• Liberalized export and import of gold
• Collapsed with the beginning of the World War I
• 3 main problems that led to collapse (1)
  adjustment (2) liquidity (3)
  confidence
• 1919-1939 Interwar period
• a) Floating exchange rates 1919-1925
• b) Gold exchange standard 1926-1931
• Initiated by Great Britain
• Return to the pre-war gold price instead of
  adoption a higher gold conversion rate ?
  deflationary effect
• c) Managed float 1932-1939

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1. Historical Events Preceding the BW System

• 1930s Shared experiences of the Great Depression
• Deflation and competitive devaluations
  (beggar-thy-neighbour policies) ? dropping
  national income, shrinking demand, mass
  unemployment, decline in world trade
• Trade and exchange rate controls
• Early 1940s Developing a new monetary system
• Acknowledged need for a stable international
  monetary system
• A small number of states holding political power
  ? easier to negotiate
• Two major powers Great Britain and the U.S.A.
• Leadership role of the U.S.

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2. Establishing of the Bretton Woods System

• In the first three weeks of July 1944,
• delegates from 45 nations gathered
• at the United Nations Monetary and
• Financial Conference in Bretton
• Woods, New Hampshire.

Goal To establish a postwar international
monetary system of convertible currencies, fixed
exchange rates and free trade.
But! Different preferences
2 rival plans
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2. Establishing of the Bretton Woods System

• I. The Keynes Plan (Great Britain)
• Goals - world trade expansion
• - international liquidity
• - protection of the domestic economy from
  foreign
• disturbances
• Essence
• Focus on adjustment of real economy ? wide
  fluctuation band
• Focus on world trade expansion and international
  liquidity
• Bancor with nominal value fixed in terms of
  gold
• Surplus nations (U.S.A) credit balances earning
  interest
• Deficit nations (GB) overdrafts bearing interest
  to surplus nations
• Assigned quota determines the limit on resources
  to obtain, if over quoted ? penalties
  devaluation, capital control

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2. Establishing of the Bretton Woods System

• II. The White Plan (U.S.A)
• Goal Exchange rate stability
• Essence
• Focus on purchasing power of currencies ?
  deviations from parity only in case of
  fundamental imbalances
• Deficit nations draw resources by selling their
  own currency for that of other members
• Establishment of stabilizing fond ? IMF, IBRD
• Penalties appropriate domestic policies
  exchange controls

Compromise between I and II BW Agreement
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2. Establishing of the Bretton Woods System
2 main features a) Exchange rate mechanism b)
Set of institutions to safeguard international
monetary stability

• a) Exchange rate mechanism
• Par value system 35 USD per ounce gold
• Snake /- 1 wide corridor for exchange rate
  fluctuations
• Adjustable peg
• Obligation to convert only for central banks
• Current account liberalization (capital accounts
  NOT liberalised)

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2. Establishing of the Bretton Woods System

• b) Bretton Woods institutions
• IMFMajor functions1. Regulatory (administering
  the rules governing currency values and
  convertibility)2. Financial (supplying
  supplementary liquidity)3. Consultative
  (providing a forum for cooperation among
  governments)

IBRD - Fighting poverty - Improving living
standards in the developing countries
ITO ? GATT ? WTO
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2. Establishing of the Bretton Woods System
Excursus(1)
Classical gold standard
Floating exchange rates
vs.

• ? Monetary sovereignty
• Insulation from foreign shocks
• Destabilization and free rider problems
• Lack of disciplining effects of fixed
  exchange rate regimes

• ? Exchange rate stability
• Long-run price stability
• ? Loss of national monetary authority

The Bretton Woods System an attempt to combine
the advantages of both systems
Question Is it theoretically possible?
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2. Establishing of the Bretton Woods System
Excursus(2)
The Inconsistent Trinity Only 2 of 3 following
objectives can be achieved simultaneously
Fixed exchange rates Free capital mobility Democratic policies aimed toward full employment
YES YES NO Gold Standard
YES NO YES Bretton Woods
NO YES YES 1971- today
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3. The Bretton Woods Chronology

• The Period of dollar shortage" (1945-1958)
• The U.S. serves as a stabilizing force
• The U.S. trade surplus and global liquidity the
  dollar "gap
• Accommodating role of the U.S. foreign aid
  programs (i.e. Marshall Plan), and
  overseas military expenditures (e.g. the Korean
  War)
• Foreign aid and macroeconomic discipline at home
  supports world economy

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3. The Bretton Woods Chronology

• 2. The Period of dollar glut" (1958-1971)
• The U.S. serves as a destabilizing force
• Expansionary domestic (Great Society) and foreign
  (Vietnam) policies are financed by inflation
• Key Status of the dollar meant that the U.S.
  could export inflation and avoid macroeconomic
  adjustment
• Confidence crisis doubtful convertibility of the
  dollar into gold ? runs on the gold
• "Nixon shocks" of 1971

March 16, 1973 - COLLAPSE - Switch to flexible
exchange rates - End of the official gold
price - Gold-peg abolished at peace time
It was clear that it as NOT a temporary break
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4. Reasons for Collapse

• The Triffin Dilemma
• Relies on the U.S. deficits to avert world
  liquidity shortage
• After 1958, the U.S. dollar overhang was growing
  larger than its gold stock ? erosion of Americas
  net reserve position
• - To forestall speculation ? U.S. deficits have
  to go down? liquidity problem
• To forestall liquidity problem ? U.S. deficits
  have to grow
• Confidence problem

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4. Reasons for Collapse

• Attempts to save BW
• Mid-1960 SDR
• b) 1961-67 Gold Pool
• U.S.A 50.00 GB, F, I 9.26 (each)
• D 11.12 CH, B, NL 3.70 (each)
• c) Split market for gold March 1968
• Official price 35 USD / ounce gold
• Private investors gold price flexible
• 2. Rigidity of Exchange Rates
• Fears of potential world liquidity shortage
• Irresistible incentives for speculative currency
  shifts
• Global confidence problem
• 3. Growing concerns in Europe and Japan about
  Americas use of its privilege of liability
  financing
• (Exorbitant Privilege C. de Gaule)

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4. Reasons for Collapse

• 4. Inflation
• BW assumption of a stabile economic policy in the
  U.S.
• After 1965 the U.S. behaviour became
  increasingly destabilizing
• ? Inflation
• ? Members had to buy the growing surfeit of
  dollar to defend their pegged rates

? Accelerating inflation everywhere Evident
incapability of coping with widening of payments
imbalances worsening of confidence problem
(speculators)
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5. Discussion
Wall Street Journal, 3rd February 1998 The IMF
is ineffective, unnecessary, and
obsolete. George Schulz William Simon

• Ex-Secretary of the State under
• the U.S. President Roland Reagan
• President of the John M. Olin
• Foundation, ex-secretary of
• the Treasury under President
• R. Nixon and G. Ford

Thank you for your attention!