Classic gold standard: 1875-1914
Gold alone is assured of unrestricted coinage
There is a two-way convertibility between gold and national
currencies at a stable ratio
Gold may be freely exported and imported
The gold standard provided a 40 year period of
unprecedented stability of exchange rates which served to
promote international trade (U.S. dollar to pound exchange
rate remained in a $4.84-4.90 range!).
Interwar period: 1915-1944
Trade in gold broke down, and countries started to “cheat.”
Bretton Woods system: 1945-1972
U.S. dollar was pegged to gold at $35.00/oz.
Other major currencies established par values against the
dollar. Deviations of ±1% were allowed, and devaluations
could be negotiated.
The Monetary System
The key role of gold in the Bretton Woods system
was connected to the convertibilty of the U.S dollar
into gold at a fixed price. This meant that the United
States stood ready to sell gold to foreign central
banks, but not to private citizens in exchange for
U.S.dollars at a fixed price of $35 per ounce.
The Bretton Woods system operated on the basis of
a gold exchange standard. Under a gold exchange
standard, countries are expected to redeem their
currencies into convertible currencies ( but not
necessarily in the form of gold itself).
Under Bretton Woods, most central banks kept a
large part of their international reserves in the form of
dollar denominated assets, such as dollar deposits or
U.S. Treasury bills. The dollar became the system’s
main reserve currency, a role it had been chipping
away from the pound sterling ever since World War
Exchange rates were maintained within the narrow
limits allowed by the IMF by means of central bank
intervention in foreign exchange markets.
The U S $ played a predominant role here because it
was used as an intervention currency by foreign
In a nutshell, the Bretton Woods system was an
adjustable peg regime operating under a gold
exchange standard in which most currencies were
convertible into U.S. dollar and the dollar, in turn, was
convertible into gold.
The Economic Experience under Bretton
The generally low levels of international reserves held
by the major foreign industrial countries after the war
and their large trade deficits with the United States
became associated with a massive dollar shortage
abroad and with acute balance-of-payments
difficulties for those countries in the late 1940s and
As a result, most European countries maintained a
range of capital controls throughout the 1950s.
It was not until 1958 that their currencies really
became fully convertible to the dollar.
In the 1950s, the U.S. began to show substantial
deficits on an official reserve settlement basis, a
pattern that persisted and depreciated during the next
The increasing supply of dollars abroad was
accompanied by a rapidly shrinking stock of U.S. gold
In the face of growing purchases of gold on the part
of foreign banks and private citizens, the gold
convertibility of the U.S dollar was threatened.
The Bretton Woods system literally collapsed in
1971. With rampant expectations that an increase in
the dollar price of gold was imminent and that a major
devaluation of the dollar vi-a-vis most other major
currencies was soon forthcoming, the resulting
speculative run on the dollar bacame unsustainable.
In May 1971, in the face of massive short-term capital
inflows associated with speculation against the dollar,
Germany decided to its currency float vis-à-vis the
dollar. The Netherlands followed suit, and
Switzerland and Austria also both revalued their
Early in 1973, the major European currencies and the
Japanese yen started floating vis-a –vis dollar.
The Bretton Woods system operated well while it
lasted. It supported a flourishing regime of
international trade and finance, with stability and
relatively high growth rates, by historical standards,
and with relatively low unemployment and inflation
rates. Given this record, and taking into account that
the period from 1971 to 1973 was not directly
connected to any major war involving the European
industrial countries, the collpse of the Bretton Woods
system appears paradoxical. Nevertheless, its history
shows a number of basic problems.
Why did it( BWS) fail?
The absence of external payments adjustment steps
on the part of the U.S. meant that non-reserve
currencies had the burden of adjustment under BWS.
European countries and Japan had to subjugate their
policy attention toward external balance.
When the supply of dollars in 1970 and 1971
exploded, straining to its limits the internal goals of
price stability in non-reserve currency countries, the
latter reacted by converting dollars into gold,
sterilizing increases in reserves and finally , by letting
their currencies float vis-à-vis the dollar.
The inconsistency of the explosion in international
liquidity with the national policy autonomy and goals
of non-reserve currency countries finally pushed the
Bretton Woods system into collapse.
Broad Real US dollar Index
The Monetary System
Jamaica Agreement (1976)
Central banks were allowed to intervene in the foreign
exchange markets to iron out unwarranted volatilities.
Gold was officially abandoned as an international reserve
asset. Half of the IMF’s gold holdings were returned to the
members and the other half were sold, with proceeds used
to help poor nations.
Non-oil exporting countries and less-developed countries
were given greater access to IMF funds.
Plaza Accord (1985)
G-5 countries (France, Japan, Germany, the U.K., and the
U.S.) agreed that it would be desirable for the U.S. dollar to
Louvre Accord (1987)
G-7 countries (Canada and Italy were added) would
cooperate to achieve greater exchange rate stability.
G-7 countries agreed to more closely consult and coordinate
their macroeconomic policies.
The Monetary System
48 major currencies, such as the U.S. dollar, the Japanese yen,
the Euro, and the British pound are determined largely by
25 countries, including the Czech Republic, Russia, and
Singapore, adopt some forms of “Managed Floating” system.
37 countries do not have their own national currencies!
8 countries, including China, Hong Kong, and Estonia, do have
their own currencies, but they maintain a peg to the U.S. dollar
or the Euro.
The remaining countries have some mixture of fixed and floating
Current Exchange Rate Arrangements
Product of the desire to create a more integrated
Eleven European countries adopted the Euro on
January 1, 1999:
Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, Netherlands, Portugal, and Spain.
The following countries opted out initially:
Denmark, Greece, Sweden, and the U.K.
Greece adopted the Euro in 2002.
Potential benefits and costs of adopting the euro.
Economic and political constraints facing the country.
The potential impact of British adoption of the euro on
the international financial system, including the role of
the U.S. dollar.
The implications for the value of the euro of expanding
the EU to include, e.g., Eastern European countries.
Will the UK (Sweden) join the Euro?
The FX market is a two-tiered market:
Interbank Market (Wholesale)
Accounts for about 82% of FX trading volume—mostly
speculative or arbitrage transactions
About 100-200 international banks worldwide stand ready to
make a market in foreign exchange
Non-bank dealers account for 19% of the interbank market
FX brokers match buy and sell orders but do not carry
inventory and FX specialists
Client Market (Retail)
Accounts for about 18% of FX trading volume
Market participants include international banks, their customers,
non-bank dealers, FX brokers, and central banks
The Foreign Exchange Market