The Imf And The Bretton Woods Agreements The international financial system has been radically altered since the worldwide depression of the late 1920s and early 1930s. This change is due in large part to the inception of the International Monetary Fund (IMF) and its subsequent control over the international financial system. In this paper I will examine the extensive role of the Bretton Woods system of exchange rates and the gold standard. Additionally, I will examine the role that the IMF has taken on since the demise of the gold standard. To begin, we must examine the circumstances that surround the creation of the IMF, who the actors are and what each of their roles are as member countries.
The IMF was created as a result of the worldwide market collapse that took place initially in October of 1929. The domino effect that took place when the first market crashed was seen to be a situation so severe that world powers felt that drastic measures needed to be taken to ensure that this was the last global financial crisis that the world would face. Its creation in 1944 was the beginning of a new era for the international financial system. The creation of the IMF occurred at Bretton Woods along with the World Bank and the system of fixed exchange rates and the gold standard for currency. Under this system, the US dollar was tied to gold by a United States government commitment to buy it at $35.00 and ounce and sell to central banks at the same price (excluding handling and other charges).
Other participating countries maintained the exchange values of their currencies at prices which were almost fixed in terms of the dollar (the values fluctuate normally not more than one percent on either side of their parities), with the result that exchange rates were almost universally fixed. Other governments carried out their commitments by selling internationally acceptable liquid resources when there was an excess demand for foreign currencies in terms of their own currencies, and by buying liquid resources when there was an excess supply. What constituted internationally acceptable resources for this purpose were gold, and other liquid assets denominated in key or reserve currencies, principally US dollars or UK pounds sterling. The IMF was to ensure that these standards were being followed as well as being the lender for temporary deficits, and balance of payment problems. Each member country contributed a predefined amount, or quotas, of national currencies and gold. This quota also determines the voting power on the IMF and the amount of resources that they may draw on from the Fund.
Designed to foster monetary cooperation, the IMF sought to enforce strict rules of behaviour in a world based on the gold standard and fixed currency-exchange rates. The Fund had, in theory, strict rules regarding how much to lend and when it was to be repaid. In reality, however, the Fund had discretion to waive any normal limitations. In 1961 with the advent of the General Arrangements to Borrow (GAB), the Fund increased its ability to lend through arrangements to borrow from 10 major industrial countries. At the time, these agreements had enabled the IMF to have and additional $6 billion at its disposal. The Gold Standard, in theory, functioned to limit the ability of governments to issue currency at will, hence decreasing the purchasing power of money.
It existed before the Bretton Woods agreement, but was suspended for reasons that we will see later. If, for example, the US dollar were defined as equal to 1/20 of an ounce of gold, then the number of dollars that the United States could issue would be constrained by its holdings of gold reserves. Moreover, if the UK defined its currency, the pound sterling, as 5/20 of an ounce of gold, the fixed exchange rate between the US and the UK, quite obviously would be $5 USD=1 sterling. One specific problem with specie standards (that is a currency convertible into a standardised unit of a non-monetary commodity) is that the value of money is only as valuable as the specie backing it. When worldwide gold production was low in the 1870s and 1880s, the money supply grew slowly, leading to a general deflation.
This situation changed radically in the 1890s following the discovery of gold in Alaska and in South Africa. The result was rapid money growth and inflation up until the outbreak of World War I. Furthermore, linking currencies to gold did not totally restrain governments from manipulating the value of their currencies. First, in order to finance expenditures by printing money, governments would frequently suspend the gold standard during times of war. Second, even without officially abandoning gold, some nations periodically redefined the value of their currencies in terms of gold. Instead of allowing for gold or foreign reserves to be consistently depleted, the countries would choose instead to devalue their currencies.
It might seem, by this previous line of argument that countries had no real restrictions on their behaviour when it came to currencies, since they could devalue them at will. However, there was a serious price to pay for devaluation. Should a country threaten to devalue its currency, a speculative attack on that countrys currency would surely follow as investors attempted to rid themselves of that currency. Such countries would ultimately lose large amounts of reserves. This is exactly what occurred in the UK in 1966 and 1967.
Confidence in the value of the pound sterling crashed and the subsequent loss of gold reserves amounted to 28 million ounces. In one day alone (November 17, 1967) the British government lost reserves valued at over $1 billion. On August 15, 1971, in the midst of a major international monetary crisis, President Richard M. Nixon announced a new policy suspending indefinitely the U.S.’s commitment to redeem gold for dollars. This commitment was the lynchpin of the international monetary system in which the U.S.
dollar served as the key currency by which the value of other currencies would be determined. Nixon’s decision to break the link between the dollar and gold effectively pulled the rug out from under the other world currencies, forcing them to re-determine their values, and thus forcing devaluation of the dollar. This event is generally regarded as marking the demise of the system of fixed exchange rates. The fall of the Bretton Woods system represents an important transitional stage in the history of international economic relations. It represents a change from a hegemonic system dominated by the U.S. intended to lay the foundation for an open, competitive world economy to the current system of floating exchange rates and expanding global capitalism.
The Fall of the Bretton Woods System President Nixon’s announcement in 1971 and then the subsequent collapse of the system in 1973 were hardly spontaneous occurrences. The fall of Bretton Woods was simply the culmination of a chain of economic and political developments that were quite predictable. From flaws in the design of the system that made it inherently unstable, to the spin-off of international capital markets that exploited its weaknesses, the collapse of Bretton Woods was inevitable. Because of the U.S. pledge to back dollars with gold, the stability of the system was based on the ratio of foreign-held dollars to the value of gold held by the United States.
If the amount of foreign dollars exceeded the amount of U.S. gold, the U.S. could not pay all of its claimants without changing the price of gold. So as the ratio of foreign dollars to U.S. gold increased, so did pressure to devalue the dollar. As such, the stability of the system was gauged by the U.S.
balance of payments. Considering this, confidence in the dollar became an essential element of the Bretton Woods system. The decade following the signing Bretton Woods agreement would see the U.S. balance of payments shift from surplus to deficit, producing new pressures on the system. From 1948 to 1958, several new and significant features surfaced in the international system. These features included development of new institutions for economic cooperation, dramatic economic growth in Europe, rising U.S. military spending, U.S.
foreign aid to the Third World, and the emergence of U.S.-based multinational corporations (MNCs). These new additions to the international landscape helped to generate the stability and prosperity that gave nations the confidence to participate in this liberal system. But at the same time, each factor contributed to an outflow of dollars, pushing the U.S. balance of payments in the direction of larger deficits, meaning more dollars abroad and more potential claimants on U.S. gold, thereby destabilizing the system.
The balance of payments difficulties posed a unique problem for the United States. As the hegemon of the system, the U.S. had an obligation to provide economic and military security for itself, its allies, and the system. In the 1960s U.S. leaders faced the dilemma of trying to solve the balance of payments problem while still fulfilling the country’s responsibilities as hegemon. The initial deficits of the 1950s, which were created through military and economic aid, were actually seen as beneficial at the time in that they helped close the gap with the still economically weak Europeans.
By the end of the 1950s, Europe had recovered and the deficit became a problem. Before 1958 and 1959, large surpluses in goods and services and investment income had helped to offset the costs of providing foreign aid, military expenditures abroad, and private overseas investment. When the U.S. surpluses suddenly shrank, the payments deficit became even wider. Clearly the burden of hegemony was taking its toll on the United States. One of President John F.
Kennedy’s economic advisers warned, [we] will not be able to sustain in the 1960s a world position without solving the balance of payments problem. This assessment proved to be accurate as U.S. efforts to meet its global responsibilities further damaged its balance of payments, undermining its ability to act as hegemon. The increase in U.S. deficits meant money was leaving the country and as such, it had to go somewhere.
This is evidenced by the surpluses experienced by Japan and Western European countries, such as West Germany, which were growing rapidly. The surpluses, combined with the U.S. deficit, meant decreasing liquidity in the world economy, as the U.S., in its role as central banker to the world, had supplied much of the liquidity from its reserve assets, mainly gold. To remedy this situation, a devaluation of the dollar would have been seemingly appropriate. However, the U.S.
could not devalue the dollar without horribly upsetting the other currencies of the world. Another way to help correct the disequilibrium in world payments would have been to have surplus countries like Germany and Japan revalue their currencies, effectively devaluing the dollar in the process. Because these countries were persistently reluctant to change their own rates, the payments imbalances increased until a breaking point was reached in 1971. The fact that the surplus countries did not wish to revalue their currencies emphasizes an important flaw in the design of the Bretton Woods system. Orin Kirshner writes, It was becoming uncomfortably clear that a system of fixed exchange rates, in which gold and the dollar..were the main components, was rather asymmetrical in its pressures for adjustment.
The deficit countries were under pressure to adjust when they ran out of reserves and had to go to the [IMF] or to the central bankers for aid; but there were no similar pressures on the creditors to reduce their surpluses. Another interesting development that played a large part in the breakdown of the Bretton Woods system is the Eurodollar phenomenon. The Eurodollar, or Eurocurrency (other currencies were also involved), market was a by-product of the large-scale accumulation of dollars in foreign banks following the shift from a dollar shortage (U.S. payment surplus) to a dollar surplus (U.S. payments deficit) in 1957-1958. It was then that London bankers decided to lend these dollars out, rather than return them to the U.S. (which would have helped to stabilize the situation by improving the U.S.
balance of payments). Thus, Lairson says, was born the Eurodollar..market — essentially an unregulated money supply. When the U.S. government acted in 1963 to address this problem by enacting the interest equalization tax to slow the outflow of dollars for loans, U.S. banks then opened o …