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Bretton Woods System

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  1. Bretton Woods System

  2. Brief History Representatives of leading nations in Bretton Woods, New Hampshire 1944 • Nations attempted to revive gold standard after World War I • Gold standard was adopted by US in 1919 (1879) • Dropped it 1933 • Returned to it in 1934 • During that year, the US raised the dollar of gold from $20.67 to $35 ounce

  3. Brief History (continued) • By 1932, France and the United States Held more than 70% of gold. • Other countries on gold standard engage in domestic asset sale and raise interest rate. • Worldwide monetary contraction along with New York stock market crash=deep global recession! • Reconstruction, development, and growth of post-war economies become critical. • July 1944, representatives draft and sign the Articles of Agreement of the International Monetary Fund.

  4. Fixed exchange rates against the US dollar and an unvarying dollar price of gold-$35 ounce. • It was a gold exchange standard, with the dollar as its principal reserve currency. • Member countries could sell dollars to the Federal Reserve for gold at the official price. • GOALS • Fix exchange rate to the dollar=>which was tied into gold. • Eliminate uncertainties in international transactions =>to promote the expansion of international trade and investment. What was the Bretton Wood System?

  5. Why did it fail? • Government spending increased (military purchases and other government spending) • No increases in taxes.

  6. London gold market raises red flags. • Speculators began buying gold in anticipation of a rise in dollar price. • Central banks announced the creation of the two-tier system. • This was a TURNING POINT for the BWS, since it made the official price of gold a mythical device for central banks to square accounts among each other. • US entered into a recession in 1970 • Markets believed that to counter the recession, the US had to devalue their currency

  7. Nixon reacts • In 1971, he announces the US would no longer automatically sell gold to foreign banks for USD. • A 10% tax on all imports to the US.

  8. The Smithsonian Agreement • Was drafted in December in 1971. • The USD was devalued against foreign currencies by about 8%. • The 10% tax on imports set by Nixon was removed. • The “official” gold price was raised to $38/ounce.

  9. Aftermath • February 1973, speculative attack on USD forces FOREX to close. • A further 10% depreciation of the USD announced February 12. • FOREX closes again! • Floating of industrialized countries’ dollar EXRA begins (suppose to be a “temporary” response).

  10. Have the potential to cause instability in the global economy. • Current account balance deficits usually occur when domestic private saving is relatively smaller than investment or government deficits. • In theory, countries with CA deficits should have their currencies depreciate relative to the currencies of countries that have CA surplus. This generally increases exports and decreases imports. Sometimes the currencies actually appreciate further increasing the CA deficit. Imbalances of U.S. Current Account

  11. The US current account was relatively balanced until the collapse of the Bretton Woods agreement. • In the mid 1980s the current account deficit ballooned to 3% of GDP. • The Plaza Accord between Germany, France, Japan, the U.S. and U.K. attempted to fix the US current account deficit by depreciation of the dollar relative to the Yen and German Mark through coordinated policy changes • The highest current account deficit was 6% of GDP in 2006 • Currently the CA deficit is hovering around 3-4% because the recession has caused depreciation of the USD and Oil prices are substantially lower. History

  12. Political • Foreign central banks buy dollar assets to keep the dollar relatively high against their currencies in order to boost exports and create jobs. • An example is China keeping their currency low relative to the dollar to maximize exports since Chinese imports will be relatively cheaper. • Oil also aggravates the current account deficit as its price increases. • Relatively low interest rates during the last 10 years has encouraged Americans consume more and save less. Causes

  13. Strong capital inflows from foreign countries have generally kept the dollar from depreciating which would balance the current account deficit. • The US treasury bonds are consider a safe-haven in that investors see treasury bonds as virtually riskless. • Even in recessions countries will flock to the dollar to reduce risk this usually causes appreciation of the dollar relative to foreign currencies. • The savings rate in the US is relatively low. • So as long as foreigners are willing to supply investment money, the current account deficit will remain. Causes(continued)