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Bretton Woods Agreement

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Understanding Bretton Woods Agreement

The Bretton Woods Agreement is considered a historic event for its economic implications. Although it’s no longer in force, it has created some of the world’s most significant financial bodies. The agreement has also become a popular point of discussion among economists, politicians and world history. It is the fruit of different factors that have affected almost every country and its fallout is considered one of the greatest lessons in economics.

Background and Precursor of Events

Two events in the past help materialize the event in Bretton Woods: World War II and Great Depression. These two events have affected countries around the world economically and early adjustments that appeared to work only worsened the situation. The Great Depression during the 30s happened because countries and states started the “beggar thy neighbor” scheme. Through this scheme richer countries adjusted their currency so that poorer countries would be able to handle payment deficits faster. While this could help poorer countries, its long term effect has worldwide implications. The Great Depression is a period of massive unemployment, national income is slowly depleting and world trade has become limited. The latter factor was due to isolationism which was still considered an economically viable option for various countries and states during that time. This is also the same for World War II but this affected USA the most since they took the leadership role in rebuilding. They provided monetary assistance to war-ravaged countries and the massive money required to rebuild from WWII took its toll on US economy.

To prevent another Great Depression, 44 countries – all part of the allied nations met in Bretton Woods, New Hampshire in July 1944. They laid out an agreement that would suggest a solution to increasing problem of monetary relations.

Meeting in Bretton Woods

For three weeks, leaders from 44 countries tried to establish rules on economic inter-country relations. Specifically, they met to determine how countries would conduct monetary relations with each other. This is considered a tall order even in its time because of the recently concluded World War II and countries are still in the process of reconstruction.

After three weeks, countries were able to agree to practically reorganize the countries’ currency value. With the leadership of USA, gold standard was instituted. This fact was also pushed by the “pegged rate” or value of the country’s currency in relation to gold. The US Dollar was used as the standard currency. Aside from the leading country during the meeting, USA also has 80% of the world’s gold reserve. This gives them the capability to handle gold standard against the US Dollar. The agreed pegged rate for gold standard is $35 per ounce. The gold reserve of countries will determine their trading capability based on their gold reserve. There’s also a separate agreement that would allow countries to buy gold from USA at the same price. This would naturally change the value of a country as long as they buy gold from USA.

Establishment of IMF

Bretton Woods is also known for the establishment of IMF or the International Monetary Fund. Although it’s already part of World Bank Group, it still exists as a regulating body. During its formal establishment in 1845, the IMF is the regulating body that would enforce the agreements in Bretton Woods especially in ensuring countries will follow their par value and would not deviate beyond 1% parity. The IMF is also in charge of determining a country’s par value. As indicated, countries could purchase gold at $35 per once to increase their value. They can’t just declare they have significantly improve – they have to get the approval of IMF first as only the IMF can declare their par value.

Problems with Bretton Agreement

The Bretton Woods Agreement can be heralded as a contract that will allow countries to prosper without limitation. On paper, it’s an impressive contract but the actual repercussions have been problematic for US and other major countries. One of the biggest reasons why this contract caused some world economic problems is that the $35 per once is a 1935 value. By the time Bretton Woods Agreement is implemented in 1946, the value of gold increased. This was taken advantage by other counties and although US can handle such purchases, it did not give them at least leverage on the transaction.

Another reason for the downfall of Bretton Agreement was the presumption that gold production could handle the demand. Even at $35 an ounce, USA is confident that it can handle the demand because there is production. Unfortunately, production is not as extensive anymore which placed them in an economic disadvantage.

The full effects of the disadvantages of Bretton Woods Agreement were felt during the Vietnam War during the 70s. USA was printing money more than its gold reserve as money is spent to aid the war and for international relations. It was only in 1971 that the US currency is no longer attached to gold. This event is known as the “Nixon Shock” because this decision was made without any consultation with the IMF. This led to adjustments in other countries and the floating currency status started in March 1976.

Bretton Woods Agreement Quotes (5)

At the 1944 Bretton Woods Monetary Conference, the United States persuaded the nations of the world to back their currencies with dollars instead of gold. Since the United States pledged to exchange an ounce of gold for every 35 dollars, and it owned 80 percent of the world's gold, the arrangement was widely accepted.

However, 40 years of monetary inflation brought about by Keynesian money managers at the Federal Reserve caused the pegged price of gold to be severely undervalued. This mismatch led to what became known as the "gold drain," a mass run by foreign governments, led by France in 1965, to redeem U.S. Federal Reserve Notes for gold. Given the opportunity to buy gold at the 1932 price, foreign governments were quickly depleting U.S. reserves.

— Peter Schiff; How an Economy Grows and Why It Crashes

The new system was essentially the gold-exchange standard of the 1920s but with the dollar rudely displacing the British pound as one of the “key currencies.” Now the dollar, valued at 1/35 of a gold ounce, was to be the only key currency. The other difference from the 1920s was that the dollar was no longer redeemable in gold to American citizens; instead, the 1930’s system was continued, with the dollar redeemable in gold only to foreign governments and their Central Banks. No private individuals, only governments, were to be allowed the privilege of redeeming dollars in the world gold currency. [...] Since the dollar was artificially undervalued and most other currencies overvalued in 1945, the dollar was made scarce, and the world suffered from a so-called dollar shortage, which the American taxpayer was supposed to be obligated to make up by foreign aid. In short, the export surplus enjoyed by the undervalued American dollar was to be partly financed by the hapless American taxpayer in the form of foreign aid.

— Murray Rothbard; What Has Government Done to Our Money?

As the 1950s and 1960s wore on, the United States became more and more inflationist, both absolutely and relatively to Japan and Western Europe. [...] But Europe did have the legal option of redeeming dollars in gold at $35 an ounce. And as the dollar became increasingly overvalued in terms of hard money currencies and gold, European governments began more and more to exercise that option.

— Murray Rothbard; What Has Government Done to Our Money?

In 1944, just as World War II was about to end, a meeting of international banking leaders was held at a resort in Bretton Woods, New Hampshire—the United Nations Monetary and Financial Conference. This conference resulted in the creation of the International Monetary Fund (IMF) and the World Bank. While popular perception is that these two agencies were created for the good of the world, they have actually resulted in a lot of harm—foremost of which is the spread of a flat monetary system throughout the world.

— Robert Kiyosaki; Rich Dad's Conspiracy of The Rich

1944: The Bretton Woods Agreement was made. This international currency agreement created the World Bank and the International Monetary Fund (IMF). The agreement replicated the Federal Reserve System globally and, in effect, installed the U.S. dollar as the reserve currency of the world. Basically, while the world was involved in a world war, the world's bankers were hard at work changing the world. This meant that all currencies worldwide were now essentially backed by the U.S. dollar, which was pegged to gold. As long as the U.S. dollar was backed by gold, the world economy would be stable.

— Robert Kiyosaki; Rich Dad's Conspiracy of The Rich
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