International Relations

What was the Bretton Woods system? Why did it breakdown?

In order to answer properly this question, it is important to establish first the main principles of this international monetary regime and its developments after 1945 and then to analyse the principal factors contributing on the breakdown and the end of this system.

In July 1944 as the World War 2 was still raging, Allies and other capitalist countries gathered in Bretton Woods to cast the foundations of a new international monetary system that would rein the Western financial world until mid of 1970s. The new system had two important elements: created a liberal international trading order and on the other side an international monetary regime. After the experience of the Great Depression and trauma caused to world economy and trade by the World War Two, the Bretton Wood system envisioned a new liberal trading order.

According to this system, Governments were free to pursue their national economic interests but in a fixed monetary order, based on fixed exchange rates, to prevent the undesirable effects of free competition that witnessed during the 1930s (Gilpin, 1987: 131). A main element of the Brent Woods system was the creation of the fixed exchange rates. This emerged on what was called "pegged rate" or "par value" currency regime. As a complete fixed currencies system was disliked by the British, claiming that this would constrain government policies during periods of crisis, floating exchange rates on the other side were discouraging for the Americans remembering the crisis of 1930s. Thus, the compromise was found with the Ð''adjustable peg'. All currencies were made equal to the US dollar and the dollar fixed to gold (Cohen, 2002: 84). The par value then could be changed to the correct Ð''fundamental disequilibrium'. Although being key to the operation of the par value system, disappointingly the Ð''fundamental disequilibrium' "was never spelled out in any detail Ð'- a notorious omission that would come back to haunt the regime in later years" (Cohen, 2002: 85).

In absence of any floating currencies, par values had to be supported by gold reserves or currencies convertible to gold. The institution at the heart of the system, International Monetary Fund (IMF) was to finance any balance Ð'-of-payments deficits and supervise exchange rate adjustments (Gilpin, 1987: 133). Another body created by the system was the International Bank for Reconstruction and Development (IBRD).

The emerging institution was a system of subscription and quotas, largely reflecting U.S preferences. The IMF was provided with a fund, composed of contributions of member countries in gold and their own currencies. When joining the IMF, members were assigned quotas in relation to their economic power, and they were eligible for credits in times of deficits. The credit available was related to the size of the country's quota. The hope was that the IMF would create the right institutional forum for international cooperation on monetary matters. The IMF commenced its financial operations on 1 March 1947.

After World War Two, American hegemony was not based only in its nuclear power, but also on crucial role that dollar had in the international monetary system. But the price paid for exploiting the role of world's banker by USA was the destruction of the system itself (Bretton Woods system) and the transformation of the USA from world's creditor into a debtor nation (Gilpin, 1987: 134).

The system relied on other countries having faith that the dollar would be exchanged for gold at the fixed rate if there was a demand to do so and in the 1950s there was no doubt about this. The USA possessed large amounts of gold as e result of its creditor role played during the First and Second World Wars. Beside this the American dollar was very preferable by states and individuals because of the interests that could be earned on those dollars (O'Brien, Williams, 2004: 226).

A fundamental weakness though was identified by the Belgian-American economist, Robert Triffin as early as 1947. Triffin argued that the gold exchange standard "is flawed by its reliance on the pledge of convertibility of some national currency, such as the dollar, into gold" (Triffin, 1988 cited in Cohen, 2002: 88). By the early 1960s, an ounce of gold was being exchanged for $40 in London, even though the price in the USA was $35. This difference showed that investors knew the dollar was overvalued and that time was running out. By 1967 American gold reserves covered only 30 % of liabilities and as Triffin warned, the deficit was already out of control and the confidence in the system began to collapse (Economides & Wilson, 2001: 78). The major priority of Western governments was to support the value of the dollar, since its collapse would have meant a collapse of their national reserves which were also in dollars.

Even though European and Japanese economies were now much stronger, they were unwilling to revaluate their currencies against US dollar, as this meant that foreign products were cheaper for American consumers and American products were expensive in European and Japanese markets. All this meant a deteriorating trade balance of Americans (O'Brien, Williams, 2004: 231).

By mid 1960s, attempts already begun to establish other sources of liquidity in order to reduce systematic reliance on dollar deficits. The outcome was the Special Drawing Rights (SDR) created in 1967, as a new type of international reserve asset. IMF hoped that the invention of SDR would prevent any future threat of liquidity shortage (Cohen, 2002: 88). In Europe also members of European Economic Community and Britain and Switzerland created the Gold Pool. A network of reciprocal short-term credit facilities (SWAPS) was used in synchronization with an enlarged lending power for the IMF. Also cooperative measures were taken such as the General Arrangements to Borrow. All these instruments were designed to increase confidence in the dollar and to dampen monetary speculation.

The system, despite these severe difficulties and unresolved problems, continued to survive for several more years. According to Cohen the main reason of this survival was political. What he calls an Ð''implicit bargain' that "was struck among three dominant poles of international economy Ð'- the United States, Western Europe and to a less extent, Japan" (Cohen, 1977: 97). Accurately Gilpin notices that "as long as this bargain was sustained and not overly abused, the Bretton Woods system survived" (Gilpin, 1987: 136).

The Americans as the main actor of the system, was accused by other Western countries as trying to shift