Friday, August 28, 2009

Bretton Woods System

In 1944 under UN, a monetary conference held at Bretton Woods USA. The purpose of this conference was to devise international finance and monetary system. In this conference, two plans were presented as Keynes Plan and White Plan. Keynes Plan proposed to establish a clearing house which will be entrusted with powers to issue some international reserve currency. While the White Plan proposed to establish an “International Fund” which will perform following three main functions.

1. It will be a pool of international reserves.

2. IT will assist in the removal of balance of payment deficit.

3. It will determine and maintain exchange rates between currencies.

The White Plan was approved. In this respect three institutions were setup (1) IMF (2) IBRD (3) ITO. IMF would deal with international monetary issues, like reserve currency, exchange rate determination and removal of deficit in balance of payments.

Under Bretton Woods System (BWS) it was decided that international liquidity or international reserves will be consisting or Pound, Dollar and Gold. Each country will have to represent the par value of its currency either in pound dollar or gold. Above all, in this system, the dollar and gold were convertible, because Federal Reserve System of America will sell the gold at the rate of 1 ounce of gold against $35. The rate of exchange once determined remained fixed. This is the reason that BWS is accorded as a system of fixed change rate. To meet deficit in balance of payments, if it occurred the members of IMF could borrow from IMF under difference rights of facilities.

Causes of Failure of Bretton Woods System:

Following are the reasons which led to the fall of Bretton Woods System.

1. Defective Economic Policies of US:

In Bretton Woods System US dollar was like a king without crown. Therefore, there was a need that dollar could remain a scarce currency. But same could not happen. Rather there was a glut of dollar all over the world. US spent lavishly in Viet-Nam war and the same was the situation in case of space-race expenditure. In this way, the US deficits in budget went on mounting. With this the supply of dollars increased heavily. More properly, the world had to see the era of “Dollar shortage to Dollar Glut”. The currency which was an international currency, failed to maintain itself, and confidence in dollars decreased.

2. Increase in Unofficial Price of Gold:

As we have mentioned above that dollar was convertible into gold at the official price of 35 dollars equal to one ounce of gold. But because of increased supply of dollars such rate could not be maintained. In 1969 the office price of gold went to $200 per ounce in the markets of Zuriche, Franfurt, London and New-York etc. The Speculators of gold anticipated that in future the open market price of gold would increase. Hence, they started purchasing of gold against dollars. In addition to individuals, the governments particularly France started accumulating gold. France was sure of collapse of Bretton Woods System and the Gold Standard may take over. With this the breeches occurred in Bretton Woods System.

3. Insufficient Sources of IMF:

As we mentioned earlier that abundance of dollars reduced the value of dollars, while the economic adversity of Britain led to dethrone British pound. Above all the price of gold went on increasing in the world markets, which led to the accumulation of gold with individuals and governments. This show that all the components of BWS i-e gold, dollar and pound had to face certain complications. In such situation a need was realized to entrance world’s liquidity. Therefore, SDRs were issued and quotas of SDRs were fixed for the members of IMF. Against such SDRs a country can borrow from IMF and with such borrowings the deficits can be removed. In addition to SDRs IMF provided loans to its member countries under different facilities to finance deficit, in their balance of payments. But inspite of all such measures, the balance of payments position of poor countries could not improve. The deficits of under-developed countries went worst while those of developed countries went on improving. The Bretton Woods System increased international inequalities, rather reducing them. The under-developed countries were found demanding for more resources to meet their deficits. But it could not happen due to insufficient sources of IMF.

4. Fixed Exchange Rate:

We have mentioned above that Bretton Woods System was the representative of fixed exchange rate where the value of each currency in dollar or in pound remained fixed. The country faced deficit in its balance of payments had to make the payments in the form of gold or it had to devalue its currency. Because of devaluation, the prices of exports would fall, while the prices of imports would rise. In this way the deficit could be removed through increasing the exports and the decreasing the imports. But the mechanism which was in operation at the international level did not help to increase exports of the poor countries as their exports were agriculture in nature where as their imports did o decrease even they were expensive. In such circumstances, the deficits of the poor countries went on increasing rather decreasing. The loans or drawing rights of the poor countries with IMF were very meagre. The major share of such drawings was taken away by the rich countries which had the greater subscription in IMF. The poor countries had to pay heavy interest against ordinary drawing rights and special drawing rights. They had to meet the conditions of IMF. Simply the adjustment process attached with Bretton Woods System always led to promote the demand for dollars, where as the dollars remained short as far as under-developed countries are concerned. Consequently the deficit of under-developed countries went on mounting. The governments of under-developed countries always wished to maintain the exchange rate once it was settled. Accordingly artificial rate of exchange was attempted to be maintained. As a result the exchange rate in the open market happened to be different from that of official exchange rate. In this way, the un-optimal resource allocation, unreal exports, un-optional levels of outputs, destabilizing speculation and multiple exchange rates were observed. In such circumstances, eth international monetary arrangements went on aggravating and Bretton Woods System lost its efficacy.

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