Bretton Woods Institutions Joycelyn T Damaso Background Bretton

Bretton Woods Institutions Joycelyn T. Damaso

Background: Bretton Woods With the world at war, participants from each of the Allied countries convened on July 1, 1944 in Bretton Woods, New Hampshire to create a new international monetary system. The breakdown of the inter-war gold standard, and the mutually destructive economic policies that followed, convinced leaders that a new set of cooperative monetary and trade arrangements was a prerequisite for world peace and prosperity. 2

Background: Bretton Woods The outcome of the conference, known as the Bretton Woods Agreement, included the creation of an adjustable peg exchange rate system (termed the par value system) and the establishment of two international organizations (the IMF and the IBRD) that were created in the hopes of maintaining economic cooperation among the participating countries. The ITO (International Trade Organization) was also part of the original Bretton Woods plan. Its’ charter was never ratified, though GATT (and more recently the WTO) subsumed some of its original goals. 3

The IMF would create a stable climate for international trade by harmonizing its members' monetary policies, and maintaining exchange stability. It would be able to provide temporary financial assistance to countries encountering difficulties with their balance of payments. The World Bank, on the other hand, would serve to improve the capacity of countries to trade by lending money to warravaged and impoverished countries for reconstruction and development projects 4

What are the Bretton Woods Institutions? The World Bank and its sister organization, the International Monetary Fund, were created at Bretton Woods New Hampshire in 1944. Together they are referred to as the Bretton Woods Institutions or BWIs.

The World Bank Originally created primarily to finance the reconstruction of war-torn Europe, the World Bank has become the primary financier of development projects in the Third World. It has also become the Third World's largest creditor. Together the countries of the Third World owe the World Bank more than US$160 billion. 6

Why is the World Bank in Need of Reform? The World Bank's failure to achieve its primary mission of poverty alleviation is now acknowledged at the most senior levels of the Bank itself, as well as by the Canadian Auditor General. Evidence of project and portfoli failures have led to increasing calls for a comprehensive review of the World Bank and the IMF, the most recent call coming from the countries of the G-7 in the communique from their 1994 Naples summit. The fundamental reform of the Bretton Woods Institutions (BWIs) is urgently needed. 7

What is the International Monetary Fund? The IMF's original mandate sets forth three main objectives: To promote international monetary cooperation; To facilitate the expansion of international trade; To promote exchange rate stability. The IMF achieves these objectives by advising member countries on their economic policies and by providing conditional assistance to member countries experiencing balance of payments problems. 8

The IMF often escapes close scrutiny by groups who tend to focus their advocacy efforts on the World Bank. Yet, the IMF has played a very significant, if not more important, role in exacerbating the impoverishment of developing countries. Critics argue that the IMF has strayed far from its original mandate of providing member countries with funds to alleviate short-term balance of payments crises and stabilizing exchange-rates. The IMF is increasingly under attack for its inappropriate role in exacerbating the economic crisis in Africa during the 1980 s and for the fiasco 9 surrounding Mexico's recent collapse.

International Trade Organization The Bretton Woods Conference of 1944 recognized the need for a comparable international institution for trade (the later proposed International Trade Organization, ITO) to complement the International Monetary Fund and the World Bank. Probably because Bretton Woods was attended only by representatives of finance ministries and not by representatives of trade ministries, an agreement covering trade was not negotiated there 10

A Preparatory Committee was established in February 1946, and met for the first time in London in October 1946 to work on the charter of an international organization for trade; the work was continued from April to November 1947. At the same time, the negotiations on the General Agreement on Tariffs and Trade (GATT) in Geneva advanced well and by October 1947 an agreement was reached: on October 30, 1947 eight of the twenty-three countries that had negotiated the GATT signed the "Protocol of Provisional Application of the General Agreement on Tariffs and Trade 11

The IMF and the World Bank How Do They Differ?

If you have difficulty distinguishing the World Bank from the International Monetary Fund, you are not alone. Most people have only the vaguest idea of what these institutions do, and very few people indeed could, if pressed on the point, say why and how they differ. Even John Maynard Keynes, a founding father of the two institutions and considered by many the most brilliant economist of the twentieth century, admitted at the inaugural meeting of the International Monetary Fund that he was confused by the names: he thought the Fund should be called a bank, and the Bank should be called a fund. Confusion has reigned ever since. 13

Similarities between them do little to resolve the confusion. Superficially the Bank and IMF exhibit many common characteristics. Both are in a sense owned and directed by the governments of member nations. The People's Republic of China, by far the most populous state on earth, is a member, as is the world's largest industrial power (the United States). In fact, virtually every country on earth is a member of both institutions. Both institutions concern themselves with economic issues and concentrate their efforts on broadening and strengthening the economies of their member nations. 14

What's really happen after the World Wide War ? What is the aim of the Bretton Woods Institution? System? 15

CONTENTS AND PURPOSE 1. The Bretton Woods System – Period From 1944 until 1971/73 2. Flexible Exchange Rate System – From 1973 Onwards ? purpose: ü analysis of the forms of international monetary system after World War II

1. The Bretton Woods System – Period From 1944 until 1971/73 Creation of the System process of establishing after-war arrangement was influenced by: economic circumstances in the world at that time negative experiences from the interwar period: • establish a complete arrangement and hence put a stop to instabilities and economic nationalism establish a stable exchange rate system ensure additional international liquidity set up a mechanism for efficient elimination of balance-of-payments disequilibria

Creation of the System ? Bretton Woods conference, July 1944: Great Britain’s suggestion: new international currency “bancor”, accepted as equivalent to gold international clearing union would guarantee automatic elimination of balance-ofpayments disequilibria functioning of the system similar to the functioning of the gold standard, but more flexible USA’s suggestion: restoration of the gold exchange standard establishment of a special fund, into which countries would pay their financial quota and from which they could borrow in times of temporary balance-ofpayments difficulties eradication of trade and payment restrictions International Finance © Mojmir Mrak

Basic Elements of the System Bretton Woods international monetary system reflected mostly US interests typical case of a n– 1 international monetary system with $ as the N-th currency: price of gold fixed at $35 per ounce, convertibility limited to foreign monetary authorities n– 1 countries fixed the price of their currencies in terms of dollars and thus implicitly in terms of gold countries let an international organization accept decisions about exchange rates for the first time in history by signing the IMF statute N-th currency problem

Basic Elements of the System convertibility of dollars for gold at $35=1 ounce fixing the par value of each national currency in terms of $ exchange rate could fluctuate within a band of 1 percent above or below the par value possibility of changing the par value in case of fundamental disequilibria

Basic Elements of the System establishment of the International Monetary Fund, based on a quota and/or drawing rights system of all member countries: each nation was assigned a quota; each was to pay 25% of its quota in gold or $, and the remainder in its own currency a member nation could borrow from the IMF to finance temporary balance-of-payments deficits: • restrictions on the amount of borrowing from the IMF • conditioning international liquidity too small for normal functioning of the world economy

Basic Elements of the System restrictions on international liquid capital flows were explicitly permitted in the statute to allow nations to protect their currencies against large destabilizing international money flows removal of all restrictions on the current account transactions: a period of transition (article XIV of the IMF statute)

Basic Elements of the System Bretton Woods system turned out to be immensely asymmetrical, even though it was meant to be a system in which both groups of countries are responsible for the elimination of the balance-of-payments disequilibria: rare currency principle: • ongoing balance-of-payments surplus • member nations could take discriminatory action against imports of goods and services from a nation with rare currency

Basic Elements of the System central goal of the IMF: making a stable exchange rates system come true providing borrowing facilities for nations in temporary balance-of-payments difficulties

Functioning of the System From 1944 – 1959: Period of the Dollar Shortage ? reasons for the dollar shortage: ü enormous world demand for American goods in combination with very limited export possibilities of other countries and their low foreign exchange reserves ? overcoming the dollar shortage problem: ü Marshall Plan (program of financial aid to Europe, 1948) ü European Payments Union (1950) ü trade and foreign exchange restrictions

Functioning of the System From 1944 – 1959: Period of the Dollar Shortage ? vital changes in the balance-of-payments position of the USA and Europe: ü improvement in economic growth and balance-of-payments of Europe and Japan ü worsening of the balance-of-payments of the USA ü redistribution of foreign exchange reserves from the USA into other parts of the world ? role of the IMF in the 1950 s: ü passive role at solving the problems of the international economic agreement

Functioning of the System From 1959 – 1971: Period of the Dollar Glut ? abolition of the European Payments Union and restoration of convertibility of European currencies: ü exchange rates of the most important currencies relatively stable ü all economically important countries removed exchange restrictions for current account transactions ü macroeconomic stability, accompanied by high growth rates of world trade ? balance-of-payments adjustment problem, problem of facilitating international liquidity and problem of confidence into the system

Functioning of the System From 1959 – 1971: Period of the Dollar Glut balance-of-payments adjustment problem: increasing balance-of-payments deficit in the USA continuing balance-of-payments surpluses in Germany and Japan nations with balance-of-payments deficit are under more pressure than countries with balance-of-payments surplus dollar devaluation impossible because of its specific role in the Bretton Woods monetary system problem of facilitating international liquidity and problem of confidence into the system: Triffin dillemma

Measures for Protection and Reforms for Improvement of the Bretton Woods System Measures for protection: Measures of American authorities, focused on reducing the balance-of-payments deficit: • Interest Equalization Tax • Foreign Credit Restraint Program • Federal Reserve's Regulation Q cooperation among countries and central banks of key countries: • • swap arrangements gold pool and parallel gold market Roosa bonds political agreements

Measures for Protection and Reforms for Improvement of the Bretton Woods System IMF measures: • increase in the member nations quotas • General Arrangement to Borrow (GAB) ? reforms for the improvement of the system: ü creation of a new form of international liquidity – Special Drawing Rights (SDR), that should enhance the existing international liquidity (gold and dollars): Ø SDRs distributed among member nations proportional to their share in the IMF quota of all member countries Ø a country can use SDR whenever it has balance-of-payments difficulties and/or wants to increase its international monetary reserves

Collapse of the System and the Smithsonian Agreement (1971 – 1973) dollar not convertible for gold, reduction in American gold exchange reserves and reduction in coverage of liquid dollar liabilities of the USA with gold: speculative transfers from weak dollar into other currencies negative consequences of sterilization of dollar inflows in countries with strong currencies on inflation USA reneged on their obligation to buy and sell dollars for gold at a fixed price of 35 USD = 1 ounce de-iure discontinuation of convertibility of $ for gold

Collapse of the System and the Smithsonian Agreement (1971 – 1973) Smithsonian Agreement (December 1971): establish a new group of stable exchange rates (central rates), on the basis of which a balance-of-payments equilibrium would be reached again for the most important countries elements: • • devaluation of $ of 8, 5%, from $35 to $38 an ounce revaluation of DEM and ¥ by 17 and 14% exchange rate fluctuation band expanded to +/-2, 25 percent USA discontinued their 10 percent import tariff valid only for 14 months, another devaluation of dollar did not bring confidence into it

Final Assessment of the Functioning of the Bretton Woods System inappropriateness of the balance-of-payments adjustment mechanism and large difficulties with the functioning of the system of fixed, but adjustable exchange rates shortage of international liquidity and a built-in systemic mistake in the form of the Triffin dillemma importance of international cooperation for successful functioning of the international monetary system

2. Flexible Exchange Rate System – From 1973 Onwards transition to flexible exchange rates system was not planned or even asked for: maintaining the par values of currencies in the increased capital flow liberalization circumstances required bigger and bigger interventions of monetary authorities in foreign exchange markets and more of their cooperation, but monetary authorities did not want to intervene in the foreign exchange markets anymore

Basic Trends in the Foreign Exchange Rate Regimes After the Collapse of the Bretton Woods System smaller and economically more open countries: fixing the currency to another currency or a composite of currencies continuation and reinforcing of capital inflow/outflow controls trends of accelerated development of financial markets and globalization of international finance fixing the currency to another currency: currency board monetary union (Maastricht Agreement)

1973 – 1985: Period of More or Less Pure Floating of Exchange Rates failure of the Group 20 work (1972 -1974): searching for a solution to ensure more international liquidity, needed for the functioning of the system re-establishment of the fixed exchange rates system with new central rates when the flexible exchange rates will settle down second amendment to the IMF statute (1976 -1978): flexible exchange rates system became formally valid with its ratification in 1978 member country has to notify the IMF which exchange rate regime it will implement defines the role of the IMF in supervising the functioning of the international monetary system

1973 – 1985: Period of More or Less Pure Floating of Exchange Rates exchange rates fluctuations until the end of 1970 s: oil shocks re-establishment of the fixed exchange rates system unrealistic alternative Euro-currency markets became a crucial segment of functioning of the entire international monetary system exchange rates of key world currencies reflected their economic foundations despite the transition to the flexible exchange rates system: • willingness for coordination of economic policies • willingness for accepting the facts that originate in the foreign exchange market • willingness and ability for effective usage of capital transactions control instruments

1973 – 1985: Period of More or Less Pure Floating of Exchange Rates exchange rates fluctuations in the first half of the 1980 s: key change in the economic policy of the USA (50% dollar appreciation relative to other leading world currencies): • restrictive monetary and expansive fiscal policy • dollar appreciated mainly as a consequence of quick growth of the government budget deficit of the USA • cause for the emergence of debt crisis in developing countries

After 1985: Period of Managed Floating of Exchange Rates Plaza and Louvre Agreements (1985 -1987): $ still too strong; coordinated action needed for its continuing depreciation Plaza Agreement made way for the acceptance of a wide-ranging program of deregulation and economic liberalization for the American administration, other countries continued to have incessant access to the huge American market Louvre: exchange rates of the most important currencies around the right level; continued depreciation of $ not necessary: • verbal agreement according to which the dollar exchange rate relative to DEM and yen should fluctuate within a 5 percent band

After 1985: Period of Managed Floating of Exchange Rates period of exchange rates instability in the 1990 s: period of the biggest exchange rates instabilities, and period in which most exchange rates crises happened ever since the establishment of the flexible exchange rates system in 1973 efficiency of intervening in the foreign exchange markets was crucially reduced in the circumstances of financial globalization and accelerated capital flows liberalization exchange rates instability: • oscillations in the fluctuations of dollar exchange rates relative to DEM and yen, the other two important world currencies • European monetary system crisis in 1992 • exchange rates crises in numerous developing countries and countries in transition in the period from 1995 onwards

Final Assessment of the Functioning of the International Monetary System Under flexible Exchange Rates System period of flexible exchange rates, in which especially the European countries were trying to cooperate more with each other characteristics: currencies of several, especially smaller countries, remained fixed to another currency or a composite of “main” currencies exchange rates fluctuate much more during this period than they have during the Bretton Woods system, with all the negative consequences accompanying these fluctuations balance-of-payments disequilibria between economically powerful countries were greater in the 1980 s than ever before

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