Bretton-Woods-System

The Bretton Woods system was a post–World War II monetary order that limited exchange rate fluctuations to a certain range relative to the U.S. dollar.

Function of the New Monetary Order

In 1944, representatives of 44 nations met in Bretton Woods, New Hampshire, to discuss the international monetary system after World War II—which was still ongoing at the time. The goal of the conference was to avoid repeating the competitive currency devaluations and protectionist import restrictions that had contributed to the collapse of the prewar order and ultimately to the outbreak of World War II itself.

The Bretton Woods Conference resulted in two major decisions for the international monetary system:

1. Fixed Exchange Rates to the U.S. Dollar

Participating nations committed to maintaining a fixed exchange rate between their currency and the U.S. dollar.The U.S. Federal Reserve, in turn, had to sell gold to foreign central banks at a fixed price of 35 USD per ounce (31.1 grams) to stabilize their currencies.

To maintain the fixed exchange rate, central banks intervened when imbalances occurred:

• If a currency appreciated, the central bank printed more of its currency to lower its value.

• If a currency depreciated, the central bank bought its own currency using foreign reserves to strengthen it.

Fluctuation bands of ±1 percent were allowed.

2. Creation of the International Monetary Fund (IMF)

The IMF was established to oversee and guarantee the functioning of the new monetary system.

Collapse of Bretton Woods

The fixed exchange rates between the countries and the U.S. required frequent adjustments.

By 1971, U.S. President Richard Nixon feared that American gold reserves were no longer sufficient to cover the number of dollars in circulation. The U.S. money supply had expanded massively due to the Vietnam War and large social spending programs.

Doubts also grew abroad about whether the U.S. could still back its currency with gold. France was especially suspicious and even sent its navy to retrieve its gold reserves stored at Fort Knox.

Following a rush on America’s gold reserves, Nixon suspended the dollar’s convertibility into gold—ending the fixed gold price.

In December 1971, the Smithsonian Agreement attempted to reestablish fixed exchange rates. But by January 1973, heavy speculation forced the Swiss National Bank to abandon its interventions. The same happened to the Deutsche Mark. After repeated efforts to support the dollar, Germany finally allowed the D-Mark to float freely in March 1973. Other countries followed.

By March 1973, the fixed exchange rate system had collapsed.

The Deutsche Mark as the New Anchor

After the collapse, the D-Mark repeatedly came under appreciation pressure. Following a small initial revaluation in 1969, more U.S. dollars continued to flow into Germany in the years after.

The Bundesbank could no longer resist the upward pressure. On March 2, 1973, the German government released the Bundesbank from its obligation to intervene, and the next day the D-Mark–dollar exchange rate was allowed to float freely.

With the market now able to determine the price, the U.S. dollar fell by more than nine percent against the Deutsche Mark within weeks. Other countries followed, and the Bretton Woods agreement was effectively finished.

After the Collapse: A New Era of Exchange Rate Policy

After 1973, each country could once again freely choose its exchange rate regime:

• Some countries pegged their currencies to another currency or a basket of goods,

• Others, like Germany, allowed the exchange rate to be determined by the free market.

  
  

Western European nations established the European Monetary System (EMS) with semi-fixed exchange rates and flexible fluctuation bands. Due to its stability, the Deutsche Mark became the anchor currency, eventually leading to the creation of the euro.

Most industrialized countries adopted floating exchange rates.

However, many East Asian and Latin American developing and emerging economies maintained fixed exchange rates to the U.S. dollar—often with problematic consequences.

For example:

• Argentina was forced to abandon its dollar peg after its 2001 sovereign default.

• Similar crises struck Mexico, Russia, and South Korea in the late 1990s.