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Bretton Woods Agreement

Bretton Woods Agreement

Summary of Bretton Woods Agreement

The product of an international conference on monetary and economic affairs held at the end of World War II, from which resulted the International Monetary Fund and the World Bank; the term is used most commonly in reference to a program for world monetary affairs that emerged from the conference and remained in effect until 1971. In the summer of 1944, a conference of monetary and economic experts of the Allied powers was held at Bretton Woods, New Hampshire, to devise a plan for postwar reconstruction and economic stability. At this conference it was agreed that the U.S. dollar would serve as the principal trading and clearing currency, with a value equal to 1/35 ounce of gold; nations adhering to the agreement were obliged to establish a par value for their currencies in terms of dollars or gold. The International Monetary Fund was established to ensure exchange rate stability and facilitate resolution of payment imbalances among members. Each member of the fund pledged to maintain the relationship of its currency to the dollar within 1 percent of the established par; hence, if the market value of the local currency rose more than 1 percent over its par relationship to the dollar, the central bank of the affected nation would sell dollars and buy the local currency. Under this arrangement, any national currency might fluctuate within a range of 2 percent (1 percent either way) against its predetermined dollar value without central bank intervention. The system, under International Monetary Fund supervision, provided that chronic exchange rate aberrations against the dollar would be accommodated by a change in the par value of affected currency against the dollar, i.e., devaluation (for those currencies persistently weak against the dollar) or revaluation (where the national currency has been undervalued against the dollar); such changes in par values were to be made only after consultation with the IMF.

In those cases where the par rate was to be revised by more than 10 percent, advance IMF approval was required, although this rule was ignored by some members.

Inasmuch as the U.S. dollar was the standard against which other currencies were valued, disturbances in the American economy profoundly affected the world monetary system. Expansionary monetary policies in the United States, caused by deficit spending to finance the Vietnam War and social programs, coupled with significant balance of payment deficits, generated concern about America’s capacity to redeem dollars for gold at the prescribed rate of thirty-five dollars per ounce. This concern animated massive conversions of dollars into gold by foreign central banks, threatening U.S. gold reserves. In order to avoid depletion of American official gold stocks, President Richard Nixon suspended redemption of dollars for gold on August 15, 1971.

The act of suspending official conversion of dollars into gold upon demand served to break the link between the dollar and gold; in so doing, the value of the dollar was undefined. The absence of a precise value for the dollar, which was the standard for all other trading currencies, resulted in widespread disorder in exchange markets, with attendant fluctuation of currency values.

An effort was made to resurrect the Bretton Woods system in a conference held by the International Monetary Fund at the Smithsonian Institution in Washington in December 1971. At this meeting it was decided to widen the bank around the dollar from 1 percent to 2.25 percent in either direction, thereby permitting any currency to fluctuate as much as 4.5 percent from its par value against the dollar without central bank intervention. In addition, the dollar was devalued by 8.5 percent against gold.

The expanding monetary crisis was not deflected by the so-called Smithsonian Agreement. By the winter of 1973 the situation had deteriorated to the point where a further devaluation of the dollar, this time by an additional 11.5 percent, was deemed essential.

The February 1973 devaluation of the dollar did not provide the relief anticipated by monetary experts, and most nations abandoned efforts to maintain the fixed exchange rate scheme fundamental to the Bretton Woods agreement, preferring instead to permit their currencies to float freely in the market.

(Main Author: William J. Miller)

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