How the Bretton Woods System Established a New International Monetary System
The Bretton Woods Agreement of 1944 created a new international monetary system. It replaced the gold standard with the US dollar as the global currency. In doing so, it established the United States as a dominant force in the global economy. After the agreement was signed, the United States was the only country with the ability to print dollars.
The Bretton Woods Monetary Agreement
The Bretton Woods Agreement was established at a conference held in 1944 with the participation of all Allied nations in World War II. It took place in Bretton Woods, New Hampshire.
Under the agreement, countries committed that their central banks would maintain fixed exchange rates between their currencies and the dollar. If the value of a country’s currency became too weak compared to the dollar, the central bank would buy its currency in foreign exchange markets.
For example, buying the currency would decrease the supply of the currency and raise its price. If the price of the currency became too high, the central bank would print more. This process would increase the supply and lower the price of the currency.
The members of the Bretton Woods system agreed to avoid trade wars. For example, they would not sharply devalue their currencies to boost trade. However, they could adjust their currencies under certain circumstances. For instance, they could take action if foreign direct investments began undermining their economies. They could also adjust the value of their currencies for post-war reconstruction.
Replacement of the Gold Standard
Before Bretton Woods, most countries adhered to the gold standard. This meant that each country pledged to redeem its currency at its value in gold. After Bretton Woods, each member agreed to redeem its currency for US dollars, not gold.
Why the dollar? The United States held three-quarters of the world’s gold supply. No other currency had enough gold to back it as an alternative. The value of the dollar was set at 1/35 of an ounce of gold. Bretton Woods allowed the world to gradually shift from the gold standard to the US dollar standard.
Over time, the dollar became a substitute for gold. As a result, the value of the dollar began to rise compared to other currencies. This discrepancy in value increased the demand for dollars, even though its value in gold remained fixed. This discrepancy in value sowed the seeds for the collapse of the Bretton Woods system three decades later.
Why the Agreement Was Necessary
Until World War I, most countries were on the gold standard. However, they severed the link to gold so they could print the currency needed to pay for the war. This influx of currency caused hyperinflation, as supply overwhelmed demand. After the war, countries returned to the stability of the gold standard.
Hyperinflation caused the value of money to drop significantly, so much so that people in some cases needed wheelbarrows full of cash to buy a single loaf of bread.
Everything was fine until the Great Depression. After the stock market crash of 1929, investors turned to trading commodities. This drove up the price of gold, leading people to exchange their dollars for gold. The Federal Reserve made matters worse by defending the national gold reserves by raising interest rates.
The Bretton Woods system provided countries with more flexibility than a strict adherence to the gold standard. It also offered less volatility than a currency system without a standard at all. A member state still had the ability to change its currency value, if necessary, to correct an “underlying imbalance” in its current account balance, according to the Federal Reserve.
The Role of the International Monetary Fund and the World Bank
The Bretton Woods system could not have functioned without the International Monetary Fund. Member countries needed it to rescue them if the value of their currencies dropped to very low levels. They needed some sort of global central bank from which they could borrow if they needed to adjust the value of their currency and did not have the funds themselves. Otherwise, they would impose trade barriers or raise interest rates.
Decided
Bretton Woods countries did not grant the International Monetary Fund authority as a global central bank. Instead, they agreed to contribute to a fixed pool of national currencies and gold that would be held by the IMF. Then, each member country in the Bretton Woods system had the right to borrow what it needed, within the limits of its contributions. The IMF was also responsible for implementing the Bretton Woods agreement.
The IMF was not designed to print money and influence economies through monetary policies.
Despite its name, the World Bank was not the central bank of the world. At the time of the Bretton Woods agreement, the World Bank was created to lend to European countries devastated by World War II. The purpose of the World Bank has changed to provide loans for economic development projects in emerging countries.
Collapse of the Bretton Woods System
In 1971, the United States experienced massive inflation – a balance between inflation and recession, causing unemployment and low economic growth.
In response to a serious decline in value caused by too much currency in circulation, President Nixon began to devalue the dollar against gold. Nixon devalued the dollar to 1/38 ounce of gold, then to 1/42 ounce.
The devaluation plan failed. It led to a rush on U.S. gold reserves at Fort Knox as people converted their rapidly devaluing dollars into gold. In 1971, Nixon completely severed the dollar’s value from gold. Without price controls, the price of gold quickly rose to $120 per ounce in the free market, leading to the end of the Bretton Woods system.
Frequently Asked Questions
What is the Bretton Woods Agreement?
The Bretton Woods Agreement was a meeting held in 1944 among allied nations, where countries agreed to peg their currencies to the dollar while the dollar was pegged to gold. The agreement came into effect in 1958 but lasted less than 20 years.
What is the gold standard?
The gold standard is a currency measurement system that was in place in the United States until the 1970s, where the value of the dollar was linked to gold. At the time of the Bretton Woods Agreement, the dollar was worth 1/35 ounce of gold.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.
Federal Reserve History. “The Launch of the Bretton Woods System.”
Federal Reserve History. “The Creation of the Bretton Woods System.”
Federal Reserve Bank of St. Louis. “Joint Statement of Experts on the Creation of an International Monetary Fund,” pages 2-3.
U.S. Department of State. “The Bretton Woods Conference, 1944.”
International Monetary Fund. “Book Reviews: A New Global Order.”
IMF Library. “Lessons from the Gold Standard and Bretton Woods.”
Federal Reserve History. “Nixon Ends Convertibility of the U.S. Dollar to Gold and Announces Wage/Price Controls.”
Federal Reserve History. “The Roosevelt Gold Program.”
Federal Reserve History. “The Great Depression.”
Bretton Woods Project. “What are the Bretton Woods Institutions?”
The World Bank. “History.”
Miller Center at the University of Virginia. “Richard Nixon: Domestic Affairs.”
Federal Reserve History. “The Smithsonian Agreement.”
National Mining Association. “History of Gold,” page 7.
Source: https://www.thebalancemoney.com/bretton-woods-system-and-1944-agreement-3306133
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