The Bretton Woods
system
Nations attempted to revive
the gold standard following World War I, but it collapsed entirely
during the Great Depression of the 1930s. Some economists said
adherence to the gold standard had prevented monetary authorities
from expanding the money supply rapidly enough to revive economic
activity. In any event, representatives of most of the world's
leading nations met at Bretton Woods, New Hampshire, in 1944 to
create a new international monetary system. Because the United
States at the time accounted for over half of the world's
manufacturing capacity and held most of the world's gold, the
leaders decided to tie world currencies to the dollar, which, in
turn, they agreed should be convertible into gold at $35 per ounce.
Under the Bretton Woods system,
central banks of countries other than the United States were given
the task of maintaining fixed exchange rates between their
currencies and the dollar. They did this by intervening in foreign
exchange markets. If a country's currency was too high relative to
the dollar, its central bank would sell its currency in exchange for
dollars, 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.
The Bretton Woods system lasted
until 1971. By that time, inflation in the United States and
a growing American trade deficit were undermining the value of the
dollar. Americans urged Germany and Japan, both of which had
favorable payments balances, to appreciate their currencies. But
those nations were reluctant to take that step, since raising the
value of their currencies would increases prices for their goods and
hurt their exports. Finally, the United States abandoned the fixed
value of the dollar and allowed it to "float" -- that is,
to fluctuate against other currencies. The dollar promptly fell.
World leaders sought to revive the Bretton Woods system with the
so-called Smithsonian Agreement in 1971, but the effort failed. By
1973, the United States and other nations agreed to allow exchange
rates to float.
Economists call the resulting system
a "managed float regime," meaning that even though
exchange rates for most currencies float, central banks still
intervene to prevent sharp changes. As in 1971, countries with large
trade surpluses often sell their own currencies in an effort to
prevent them from appreciating (and thereby hurting exports). By the
same token, countries with large deficits often buy their own
currencies in order to prevent depreciation, which raises domestic
prices. But there are limits to what can be accomplished through
intervention, especially for countries with large trade deficits.
Eventually, a country that intervenes to support its currency may
deplete its international reserves, making it unable to continue
buttressing the currency and potentially leaving it unable to meet
its international obligations.
[economics.about.com/od/foreigntrade/a/bretton_woods.htm]
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