Ljubljana University Faculty of Economics International Monetary Systems

UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS
CONTENTS ENDwww.StudsPlanet.com Page 1

1. The Bretton Woods System – Period From 1944 until
1971/73
2. Flexible Exchange Rate System – From 1973 Onwards
CONTENTS AND PURPOSE
 purpose:
 analysis of the forms of international monetary system after
World War II

1. The Bretton Woods System – Period
From 1944 until 1971/73
Creation of the System
process of establishing after-war arrangement was
influenced by:
 economic circumstances in the world at that time
 negative experiences from the interwar period:
 establish a complete arrangement and hence put a stop to instabilities
and economic nationalism
establish a stable
exchange rate
system
ensure additional
international
liquidity
set up a mechanism for
efficient elimination of
balance-of-payments
disequilibria

Creation of the System
 Great Britain’s suggestion:
 new international currency
“bancor”, accepted as
equivalent to gold
 international clearing union
would guarantee automatic
elimination of balance-of-
payments disequilibria
 functioning of the system
similar to the functioning of
the gold standard, but more
flexible
 USA’s suggestion:
 restoration of the gold
exchange standard
 establishment of a special
fund, into which countries
would pay their financial quota
and from which they could
borrow in times of temporary
balance-of-payments
difficulties
 eradication of trade and
payment restrictions
Bretton Woods conference, July 1944:

Basic Elements of the System
Bretton Woods international monetary system reflected
mostly US interests
typical case of a n–1 international monetary system with $
as the N-th currency:
 price of gold fixed at $35 per ounce, convertibility limited to
foreign monetary authorities
 n–1 countries fixed the price of their currencies in terms of dollars
and thus implicitly in terms of gold
countries let an international organization accept decisions
about exchange rates for the first time in history by signing
the IMF statute
N-th currency problem

convertibility of dollars for gold at $35=1 ounce
fixing the par value of each national currency in terms of $
exchange rate could fluctuate within a band of 1 percent
above or below the par value
possibility of changing the par value in case of
fundamental disequilibria

establishment of the International Monetary Fund, based
on a quota and/or drawing rights system of all member
countries:
 each nation was assigned a quota; each was to pay 25% of its
quota in gold or $, and the remainder in its own currency
 a member nation could borrow from the IMF to finance temporary
balance-of-payments deficits:
 restrictions on the amount of borrowing from the IMF
 conditioning
 international liquidity too small for normal functioning of the
world economy

restrictions on international liquid capital flows were
explicitly permitted in the statute to allow nations to
protect their currencies against large destabilizing
international money flows
removal of all restrictions on the current account
transactions:
 a period of transition (article XIV of the IMF statute)

Bretton Woods system turned out to be immensely
asymmetrical, even though it was meant to be a system in
which both groups of countries are responsible for the
elimination of the balance-of-payments disequilibria:
 rare currency principle:
 ongoing balance-of-payments surplus
 member nations could take discriminatory action against imports of
goods and services from a nation with rare currency

central goal of the IMF:
 making a stable exchange rates system come true
 providing borrowing facilities for nations in temporary balance-of-
payments difficulties

Functioning of the System From 1944 – 1959:
Period of the Dollar Shortage
reasons for the dollar shortage:
 enormous world demand for American goods in combination with
very limited export possibilities of other countries and their low
foreign exchange reserves
overcoming the dollar shortage problem:
 Marshall Plan (program of financial aid to Europe, 1948)
 European Payments Union (1950)
 trade and foreign exchange restrictions

Period of the Dollar Shortage
vital changes in the balance-of-payments position of the
USA and Europe:
 improvement in economic growth and balance-of-payments of
Europe and Japan
 worsening of the balance-of-payments of the USA
 redistribution of foreign exchange reserves from the USA into
other parts of the world
role of the IMF in the 1950s:
 passive role at solving the problems of the international economic
agreement

Period of the Dollar Glut
abolition of the European Payments Union and restoration
of convertibility of European currencies:
 exchange rates of the most important currencies relatively stable
 all economically important countries removed exchange
restrictions for current account transactions
 macroeconomic stability, accompanied by high growth rates of
world trade
balance-of-payments adjustment problem, problem of
facilitating international liquidity and problem of
confidence into the system

Period of the Dollar Glut
balance-of-payments adjustment problem:
 increasing balance-of-payments deficit in the USA
 continuing balance-of-payments surpluses in Germany and Japan
 nations with balance-of-payments deficit are under more pressure
than countries with balance-of-payments surplus
 dollar devaluation impossible because of its specific role in the
Bretton Woods monetary system
problem of facilitating international liquidity and problem
of confidence into the system:
 Triffin dillemma

Measures for Protection and Reforms for
Improvement of the Bretton Woods System
Measures for protection:
 Measures of American authorities, focused on reducing the
balance-of-payments deficit:
 Interest Equalization Tax
 Foreign Credit Restraint Program
 Federal Reserve's Regulation Q
 cooperation among countries and central banks of key countries:
 swap arrangements
 gold pool and parallel gold market
 Roosa bonds
 political agreements

Measures for Protection and Reforms for
Improvement of the Bretton Woods System
 IMF measures:
 increase in the member nations quotas
 General Arrangement to Borrow (GAB)
reforms for the improvement of the system:
 creation of a new form of international liquidity – Special
Drawing Rights (SDR), that should enhance the existing
international liquidity (gold and dollars):
 SDRs distributed among member nations proportional to their share
in the IMF quota of all member countries
 a country can use SDR whenever it has balance-of-payments
difficulties and/or wants to increase its international monetary
reserves

Collapse of the System and the Smithsonian
Agreement (1971 – 1973)
dollar not convertible for gold, reduction in American gold
exchange reserves and reduction in coverage of liquid
dollar liabilities of the USA with gold:
 speculative transfers from weak dollar into other currencies
 negative consequences of sterilization of dollar inflows in
countries with strong currencies on inflation
 USA reneged on their obligation to buy and sell dollars for gold at
a fixed price of 35 USD = 1 ounce ⇒ de-iure discontinuation of
convertibility of $ for gold

Smithsonian Agreement (December 1971):
 establish a new group of stable exchange rates (central rates), on
the basis of which a balance-of-payments equilibrium would be
reached again for the most important countries
 elements:
 devaluation of $ of 8,5%, from $35 to $38 an ounce
 revaluation of DEM and ¥ by 17 and 14%
 exchange rate fluctuation band expanded to +/-2,25 percent
 USA discontinued their 10 percent import tariff
 valid only for 14 months, another devaluation of dollar did not
bring confidence into it
Collapse of the System and the Smithsonian
Agreement (1971 – 1973)

Final Assessment of the Functioning of the
Bretton Woods System
inappropriateness of the balance-of-payments adjustment
mechanism and large difficulties with the functioning of
the system of fixed, but adjustable exchange rates
shortage of international liquidity and a built-in systemic
mistake in the form of the Triffin dillemma
importance of international cooperation for successful
functioning of the international monetary system

2. Flexible Exchange Rate System –
From 1973 Onwards
transition to flexible exchange rates system was not
planned or even asked for:
 maintaining the par values of currencies in the increased capital
flow liberalization circumstances required bigger and bigger
interventions of monetary authorities in foreign exchange markets
and more of their cooperation, but monetary authorities did not
want to intervene in the foreign exchange markets anymore

Basic Trends in the Foreign Exchange Rate Regimes After
the Collapse of the Bretton Woods System
smaller and economically more open countries:
 fixing the currency to another currency or a composite of
currencies
 continuation and reinforcing of capital inflow/outflow controls
trends of accelerated development of financial markets and
globalization of international finance
fixing the currency to another currency:
 currency board
 monetary union (Maastricht Agreement)

1973 – 1985: Period of More or Less Pure Floating
of Exchange Rates
failure of the Group 20 work (1972-1974):
 searching for a solution to ensure more international liquidity,
needed for the functioning of the system
 re-establishment of the fixed exchange rates system with new
central rates when the flexible exchange rates will settle down
second amendment to the IMF statute (1976-1978):
 flexible exchange rates system became formally valid with its
ratification in 1978
 member country has to notify the IMF which exchange rate regime
it will implement
 defines the role of the IMF in supervising the functioning of the
international monetary system

of Exchange Rates
 exchange rates fluctuations until the end of 1970s:
 oil shocks
 re-establishment of the fixed exchange rates system unrealistic alternative
 Euro-currency markets became a crucial segment of functioning of the
entire international monetary system
 exchange rates of key world currencies reflected their economic
foundations despite the transition to the flexible exchange rates system:
 willingness for coordination of economic policies
 willingness for accepting the facts that originate in the foreign exchange
market
 willingness and ability for effective usage of capital transactions control
instruments

of Exchange Rates
exchange rates fluctuations in the first half of the 1980s:
 key change in the economic policy of the USA (50% dollar
appreciation relative to other leading world currencies):
 restrictive monetary and expansive fiscal policy
 dollar appreciated mainly as a consequence of quick growth of the
government budget deficit of the USA
 cause for the emergence of debt crisis in developing countries

After 1985: Period of Managed Floating of
Exchange Rates
Plaza and Louvre Agreements (1985-1987):
 $ still too strong; coordinated action needed for its continuing
depreciation
 Plaza Agreement made way for the acceptance of a wide-ranging
program of deregulation and economic liberalization for the
American administration, other countries continued to have
incessant access to the huge American market
 Louvre: exchange rates of the most important currencies around
the right level; continued depreciation of $ not necessary:
 verbal agreement according to which the dollar exchange rate relative
to DEM and yen should fluctuate within a 5 percent band

After 1985: Period of Managed Floating of
Exchange Rates
period of exchange rates instability in the 1990s:
 period of the biggest exchange rates instabilities, and period in
which most exchange rates crises happened ever since the
establishment of the flexible exchange rates system in 1973
 efficiency of intervening in the foreign exchange markets was
crucially reduced in the circumstances of financial globalization
and accelerated capital flows liberalization
 exchange rates instability:
 oscillations in the fluctuations of dollar exchange rates relative to
DEM and yen, the other two important world currencies
 European monetary system crisis in 1992
 exchange rates crises in numerous developing countries and countries
in transition in the period from 1995 onwards

Final Assessment of the Functioning of the
International Monetary System Under flexible
Exchange Rates System
period of flexible exchange rates, in which especially the
European countries were trying to cooperate more with
each other
characteristics:
 currencies of several, especially smaller countries, remained fixed
to another currency or a composite of “main” currencies
 exchange rates fluctuate much more during this period than they
have during the Bretton Woods system, with all the negative
consequences accompanying these fluctuations
 balance-of-payments disequilibria between economically powerful
countries were greater in the 1980s than ever before

Ljubljana University Faculty of Economics International Monetary Systems

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