The thrust of an ideal international monetary system is anchored on three fundamental principles, namely: liquidity, adjustability and confidence. Liquidity implies adequate supply of monetary reserves of the preferred exchange base to sustain the growth of international trade and investment. Adjustability refers to operational measures that ensure the restoration of Balance of Payment (BOP) equilibrium, in event of distortions. Confidence in this context arises from the established measures to safeguard against systemic crisis/collapse (Eun and Resnick, 2009). All three principles weight equal importance in maintaining a functional, uniform international monetary system, such that an operational monetary system/ arrangement showing weakness in one or more of these three principles may perhaps fall under severe pressure, as seen in the development of the international monetary system from 1875 till date. For instance, the demise of the classical gold system in 1914 is traced to liquidity pressure. The adjustable peg system (Bretton Woods, 1944 to 1973) is largely attributed to weakness in the exchange base (US dollar) adjustability amongst other factors. The floating system has been associated with high volatility indicating a weakness in preventing systemic crises.
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The recent financial crises (from the Mexican crisis of 1994 to the current Greek debt crisis) and the rapid evolution in the world financial system have intensified the call for a revisit of the Bretton Wood agreement of 1944. Together with the pervasive volatility in the global financial system, under the current exchange rate agreement, a sound argument for the revival of Bretton Woods II is inferable, based on the historic stability enjoyed under the previous system. However, the success or otherwise of a reviewed Bretton Woods system is substantially dependent on the degree of modification to the core weakness – adjustability and confidence, observed in the earlier system. These core weaknesses form the basis of our discussion, and attempt to suggest an ideal framework for a new Bretton Woods system (Bretton Woods II) underway.
This paper reviews the Background (Objectives and features) of Bretton Woods’s agreement, the achievement of the system, its failures and reasons for its demise. We also attempt to clarify the rationale behind the recent call for a revised Bretton Woods and we suggest the obstacles that could impede a successful implementation of a new Bretton Woods system.
BACKGROUND AND OBJECTIVES OF BRETTON WOODS
The Bretton Woods fixed exchange rate system, was established as an international monetary framework after World War II. Watts (2008) argued that the primary focus was to come up with a currency system less rigid than the Gold Standard while providing similar stability. The Bretton Woods international monetary system became effective in July 1944, with the signing of the International Monetary Fund (IMF) agreement in the United States of America (US), Bretton Woods, New Hampshire. This period also marked the end of the World War II. Proponents of the system – H. D. White and J. M. Keynes, envisaged the need to; create an international reserve asset for payments and settlement (different from the earlier Gold Standard) for international transactions, promote consultation and collaboration on international monetary problems, arrange a pool where member countries would make contributions as well as give loans to member countries in need due to recurring balance of payment deficits. These rationale and agreement of Bretton Woods also formed the basis for the creation of the International Bank for Reconstruction and Development (IBRD) also referred to as World Bank, and the launching of the International Monetary Fund (IMF) in 1945, with the responsibility of financing individual national development projects and the conduct of International monetary policies.
Besides, the design of the Bretton Woods system was also instituted as a need for a departure from the weaknesses of the former Classical Gold Standard system. These weaknesses include: the cost associated with movement of gold in the execution of international trade transactions, the two way convertibility between gold and national currency, inadequate regulatory mechanisms – the Gold system was of greater benefit to countries that produced gold at the expense of the world economy, the inability to match the supply of gold with the world’s increasing need for liquidity amongst other factors. The objectives of the Bretton Woods system among others therefore include:
Promotion of international monetary cooperation by establishing global monitoring agencies that supervise, collaborate and consult on monetary problems (Dammasch, 2001?).
Foreign exchange Intervention: Central Banks of countries other than the US were given the task of maintaining fixed exchange rates between their currencies and the dollar. If a country’s currency was too high relative to the dollar, its Central Bank would sell its currency in exchange for dollar, thereby driving down the value of its currency. Conversely, if the value of a country’s money was too low, the country would buy its own currency; thereby driving up the price to ensures exchange rate stability and avoids competitive exchange depreciation. (U.S Department of State, 2010?)
To eliminate foreign exchange restrictions and create an efficient system of payments for multilateral trade (Dammasch, 2001?).
To this end, the key features of the Bretton Woods system are categorized under three broad caption namely; Monetary policy conduct, exchange base currency and external and internal imbalances. We summarize these features below:
Monetary policy conduct
The International Monetary Fund was created and given full responsibility of conducting international monetary policies.
Exchange rates for other currencies were allowed to fluctuate within ±1 percent of their adopted values, with each member in charge of maintaining its exchange rate within the range.
Exchange Base Currency
The US dollar was officially pegged to gold at $35 per ounce, while other currencies established a par value in relation to the dollar.
The US dollar ($) replaced Gold as the reserve currency and was the only currency that was fully convertible to Gold. Unlike in the gold standard system where other currencies were fully convertible to Gold. Thus the Bretton woods system can be described as a “Dollar-Based Gold-Exchange Standard”. (Eun and Resnick, 2009).
External / Internal Imbalances
Under this system, member countries were permitted to change the par value of their currencies only in event of “fundamental imbalances” – temporary imbalances of payments, subject to meeting the requirements of IMF.
The United States was instituted to run Balance-of-Payment (B.O.P) deficit under this system in other to ensure the supply of reserves (Dollars).
ACHIEVEMENTS OF THE BRETTON WOODS SYSTEM
Although, the Bretton Woods system collapsed in the early 1970s, there is no doubt that its establishment made a significant and lasting impact to the world economy. The establishment of the system was influenced by the perceived accomplishment of the Gold standard before the First World War It therefore became an attempt to reinstate the stability in the Gold standard without its deflationary bias and inability to adapt to prevailing and changing circumstances. Hence while it was a system of fixed exchange rate, it provided for rates to be adjusted under circumstances of ‘fundamental disequilibrium’ (Robinson College Working Group, 1999). Thus the establishment of a pegged exchange rate system of international finance restored confidence in the world economy and subsequently an astonishing boom in the post war years. Eichengreen and Kenen (1994) reported that industrial production in Western Europe rose significantly by nearly 10 percent between 1945 and 1951.
The introduction of capital account convertibility in 1959 also influenced the mobility of short-term funds across borders especially in Europe thereby rapidly increasing international portfolio investment and expanding world trade. It is also noteworthy to say that the Base Exchange currency provided enough liquidity to fuel the expansion.
The Bretton Woods system established two strategic institutions i.e. the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) also referred to as World Bank. These two organizations still remain relevant forces in the world economy today long after the demise of the system that introduced them (Addison Wiggin, 2006). The creation of IMF facilitated international world trade expansion thereby promoting and sustaining high levels of employment and real income.
Furthermore, the IMF, which was formed amongst many reasons to ensure exchange rate stability, was able to reduce foreign exchange restrictions among member countries by designing payment systems for multilateral trade. Moreover, member countries with balance of payment disequilibrium have had opportunity to fix such problems with the financial arrangement provided by the IMF.
Likewise, the World Bank has solely become the most significant source of financial assistance to crumbling economies especially the developing nations with an average of $16 billion annual loans disbursed to member countries in need.
THE REASONS FOR THE DEMISE OF BRETTON WOODS
Despite the achievement of Bretton Woods in the 1950s and early 1960s, the international financial system came under severe pressure brought by increased capital mobility as it became convenient for investors to move capital to and from a country in anticipation of a possible devaluation. Therefore, the release of information of a possible devaluation could trigger a crisis. Weaker currency countries became unwilling to participate in exchange rate devaluation to correct balance of payment anomalies thereby giving rise to international monetary system rigidity and friction in the foreign exchange markets in the late 1960s.
Also, the design of the whole Bretton Woods system was hinged on the political, economic and military strength of the United States (Eichengreen and Kenen, 1994) and hence made US the burden carrier of the whole system. However, as the recovery of other industrial countries became visible, the United State under Kennedy administration sought a revised arrangement with a balance partnership in the area of responsibility sharing with other industrial countries (apparently, the US was losing its influence on the system). This raised uncertainties about the future of Bretton Woods as warned by Triffin (1960)
Moreover, the emergence of the third world countries and the involvement of developing countries in the late 1950s and early 1960s were not anticipated by the system since they were not part of the original plan in the 1944 conference. The need to integrate them properly became an issue the Bretton Woods system had to deal with.
More importantly, a significant weakness in the Bretton Woods, according to Robinson College Working Group (1999), was its inability to provide for low-key adjustments in exchange rates as relative costs changed. This was evident in several balance of payment crises in the 1960s. Although the crises were not systemic but revealed the danger of relying on US balance of payment deficits to meet the global need for reserves (Triffin, 1960). This danger was exposed in 1971 when the US administration closed the gold window in an attempt to correct the exchange rate. Several later attempts to correct the imbalance in the exchange rate lowered the confidence in the dollar. A further devaluation was made by the US in 1973 but met a weak support as the foreign exchange market had little confidence in the fixed exchange rate system. Eichengreen and Kenen (1994) argue that this led to speculation against the dollar as European central banks pulled out of the foreign exchange market leaving the dollar to float. This marked the official end of the pegged exchange rate system of Bretton Woods.
THE CASE FOR A NEW BRETTON WOODS
Every international financial frameworks in the past evolved in response to prevailing economic circumstances of its times. In fact, major international financial architectures were developed as a result of one major economic down turn or the other. For instance, Eichengreen and Kenen (1994) argued that the devastating depression of the 1930s and the ruinous effect of the World War II gave birth to Bretton Woods Conference of 1944 which introduced fixed exchange rate regime. Similarly, the substantial pressure on fixed exchange rate regime, brought by increased capital mobility in the 1960s led to the collapse of the Bretton woods system of exchange rate and ushered in a new monetary order, this time a floating exchange rate regime. It is therefore not surprising , in lieu of the turmoil the global economy is going through to see world leaders advocating for the reintroduction for Bretton Woods as a replacement for the current exchange rate arrangements.
The campaign for a new Bretton Woods has come from several regions, leaders and policy makers but not limited to the following:
In September 2008, French President, Nicolas Sarkozy, opined that a new Bretton woods must be reconstructed from the scratch based on his perceived high volatility in the exchange rates of major currencies of the world. His call was repeated in January 2010 at the Economic World Summit.
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In October 2008, British Prime Minister, Gordon Brown, advocated for a new international financial architecture emphasizing on the continuation of globalization and free trade rather than the initial strategy of the system: a fixed exchange rate system. He also continued his call in March 2009, requesting for a reform and granting of extended power to international financial corporations like IMF. This is believed, according to him, to have the support of President Obama of the United States of America.
In March 2009, Dr. Zhou Xiaochuan, the governor of the People’s Bank of China, embraced the proposition of John Maynard Keynes, which advocated for a centrally managed global reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”. Bearing the difficulty of getting a suitable global reserve currency in mind, he advocated for a gradual shift to Special Drawing Rights (SDRs) as a substitute.
An NGO, Choike, campaigned for the establishment of ‘international permanent and binding mechanisms control over capital flows’.
Italian Economics Minister, Giulio Tremonti, called for the overhauling of the dollar as the base currency of a new Bretton Wood system.
It is worth mentioning that the call for a new Bretton Woods system has been on since the mid 1990s with the complexities of the Mexican financial crisis created by the fear of contagion effect on other emerging markets. Bordo (1995) observed that the problems associated with floating exchange rate system since the abandonment of bretton woods include high transactions cost for businesses, excess volatility, and prolonged misalignment of the exchange rates of major currencies. Eichengreen and Kenen (1994) also based their call for a new Bretton Woods system on the aforementioned problems of floating rate system. He further suggests that a more managed system based on co-ordinated monetary and fiscal policy and exchange rate target zones will revive the record of stable and rapid growth, low interest rates, and relatively low inflation of the Bretton Woods regime.
In more recent times however, the world has witnessed massive financial blows ranging from the subprime mortgage crisis in the US to the Greek sovereign debt crisis. More than before, these crises have exposed the problems of excess volatility, and high transaction costs for businesses. The time relationship between floating rate system and deregulation of financial sector opened way for a more interconnected global system i.e. globalization. This explains why the current financial crises became a global phenomenon rather than a regional problem.
It has therefore become apparent that a need to forestall a global recession of the magnitude of the recent crisis and a need to devise an early warning signalling system in a more regulated international financial environment is responsible for the call for a new Bretton Woods system in the last two years. Hall and Eaglesham (2008) consider this as the basis for backing a new Bretton Woods by the British and French government. They claim Britain and France want a better resourced International Monetary Fund to be watchman and carry out early warning functions for the global financial system.
Furthermore, the fear of persistent volatility in currency is heightened by the dollar carry trade which has poured money into the emerging markets. Dr. Zhu Min of the People’s Bank of China maintained that such international rate parity discrepancy may soon trigger huge volatility with some unpredictable consequences if there is a mass withdrawal of funds from the emerging market (Tett, 2010). Also, Simon Derrick of Bank of New York Mellon in Watts (2008) contends that extreme volatility in foreign exchange market clearly has a huge potential to do damage to investors who are not properly hedged and to people who are trying to forecast budgets. Hence the need for a system with more controls on the foreign exchange market.
The free market global economy has been blamed for the failures of financial markets and financial institutions all over the world and since a global consensus on individual national regulations may be difficult to achieve, many political economists have also come to terms with and have suggested the need to go back to Bretton Woods with some modifications that will cope with the changing world.
Interestingly, one of the possible reasons for a renewed call for Bretton Woods system could be the shift by the world industrialised nations from their commitments to poverty alleviation in poor countries. The commitment of G8 countries to fighting extreme poverty in poor countries has suffered setback because of the need to bail out their financial institutions and stabilize their local economies. According to Otsch (2009), the same mainstream politicians who gave tax holiday to financial investors, legislated to allow high-risk financial transactions in their economies and even had to divert tax payers’ monies into stabilizing the financial system after the bust, are now interested in a system that fosters international cooperation instead of destructive competition among national economies.
POTENTIAL BARRIERS TO THE RE-INTRODUCTION OF A NEW BRETTON WOODS SYSTEM
The maintenance of stable exchange rate achieved during the first Bretton Woods system could be attributed not only to the agreement finalised by Bretton Woods conference alone, but of two other exceptional factors resulting from the second World War (Eichengreen and Flandreau, 1997). They argued that one of such factors was the limited international capital mobility through capital controls. At that time, this control was effective because of restrictions on international banking legislated in response to the Great depression and international bond markets were yet to recover from the sovereign defaults of the 1930s.
Besides, there was a singular and common need for growth resulting from post war reconstruction and catch-ups. Countries were more concerned on how to stimulate rapid growth in their economies having lost almost a decade as a result of the depression. Under these circumstances, countries felt little need to engage in discretionary monetary and fiscal policies that might have undermined the currency pegs.
In view of these considerations, a re-introduction of a new Bretton Woods in present times might prove challenging. With the proliferation of various financial instruments, the impact of rapid development by emerging markets, the rising powers of the eastern world and the diffusion of global economic power, as opposed to the original system where the US denominated the world economy, a number of challenges could be highlighted.
First, the political drive for economic cooperation and global consensus is less compelling now than it was at the wake of Bretton Woods Conference of 1944. It is crucial to note that for reforms in international monetary system to work, countries have to unanimously agree on terms and objectives as regards their national economic policies and outcomes. However, this is currently absent and maybe difficult to attain in the pursuit of a new Bretton Woods. Each country is more concerned with the safety and growth of its national economic and political sovereignty. In the words of former Managing Director of IMF, Michel Camdessus -“countries must make a greater effort to understand the economic policies of other countries and that they must listen to the judgement of others about their own national policies. It also means that they must take a more enlightened view of their own national interests, recognizing that it is in their own self-interest to take the interests of other countries into account.” (Dammasch, 2001?)
Secondly, globalization has in the last few decades increased capital mobility. This was said to have culminated into the collapse of the original Bretton Woods system. Due to lesser restrictions on capital control, and with other currencies being pegged to the US dollar, the result was massive pressure on the dollar which eventually led to the fall of the Bretton Woods system. However, with the present deregulation of the financial markets and the free flow of capital, reverting to a fixed exchange rate system will be a herculean task.
Thirdly, the domination of the Bretton Woods institutions i.e. the IMF and World Bank, by western powers poses a challenge in the area of support from the emerging markets. Currently the US has about 17 per cent of the Fund, the European Union 32 per cent, altogether constituting about 50 per cent of the total voting rights (Wolf 2008). With such level of authority, emerging economies like China, India, Brazil, South Africa, etc might find it unattractive to participate. A new agenda for a Bretton Woods that works must recognise the potentials of rising economies.
Lastly, power shift from the West to East is certainly going to impact on the governance of a new bretton woods. Rachman (2008) argued that the original bretton woods was basically formed by the US and UK being the world economic giants at that time. Obviously there are many more countries namely the G7, G8, G20 and so on competing to take on the wheel of power as opposed to the past. Such power tussles if not amicably resolved would cause a serious impediment towards the creation of a new system.
The recent events in the global financial and economic system have exposed how deficiently the financial system was structured over the last 50 years. The rise of a lucrative market economy and its domino (risky) effect in the foreign exchange market, stock and other financial market, commodity markets, etc has triggered a global depression that has raised an increased determination for a change to a new version of Bretton Woods Systems. Nonetheless, any system that must meet the demand of a much developed financial world must consider crisis management, institutional reforms, and financial regulation and must be capable of predicting the future directions of markets with a strong purpose of preventing systemic crisis. As mentioned earlier, the success or otherwise of any re-invented Bretton Woods system is hinged on the fundamental principles of adjustability and confidence.
Finally however, considering the obstacles to a re-introduction of a new Bretton Woods, the different circumstance(s) that culminated into Bretton Woods Agreement in 1944 and the protracted nature of the recent crises, a new Bretton Woods may be far-fetched.