The Significance of the Bretton Wood System for the International Political Economy, Essay Example

Question: The Bretton Wood System (BWS) marked a before and after in how the world understands the monetary system. Please explain the meaning and significance of the Bretton Woods System for the monetary system as well as the reasons and consequences of its collapse. Further, make sure you elaborate on the significant Post- Bretton Woods arrangements.

The Bretton Woods System (will be referred to as the System from hereon) was designed to be the postwar international monetary system. Organizations that are meant to operate on a global scope were developed and established to accomplish the goals that the System is designed to perform. Helleinner claims, “The Bretton Woods negotiators, under the American leadership, explicitly opposed to a return to the open, liberal, global economic system” (4). Helleinner pointed out that the key players in the global economy during those years were strongly committed to a restrictive international monetary system. The US did not use capital controls. However, US were still supportive of the use of capital controls abroad (Helleiner 4). In addition, the US demand and supply shocks have impacts on inflation in G7 countries (Dibooglu 84). There are also claims that the IMF and the WB did not operate according to how they are meant to handle (Mikessel 404). The point is that the decisions of the dominating authorities in the System, and the logic of the System itself contributed to the collapse. Take note that the System itself has inherent flaws that created the impasse that, in turn, guide to how the imbalances halted the System from operating.

When the System was established, it was the most politically and economically influential countries of the world shaped the history of international political economy under this System. The ascendancy of the US as the authority of global economic behavior is attributed to the impact of the interwar period in the global economy. In the 1950s, the US has essentially uncontrolled capital and a good market (Dooley, Folkerts-Landau, and Garber 307). Europe and Japan were the emerging peripheries. However, there is an integral systemic error that made it impossible for the US to maintain the stability that it promised the global economy.

The economic circumstances in the 1940s called for the necessity to develop a new system to adopt (UCSD). The conception of the System was due to efforts to address the economic circumstances at that time (UCSD). The instabilities and economic nationalism were the main problems that need immediate attention. A new arrangement needs was then discussed, and new arrangement would be the basis of the System. The provision was meant to establish a fixed exchange rate system. This provision was also reached to secure additional international liquidity. In addition, the provision was meant to set up a mechanism for efficient elimination of balance-of-payments disequilibria.

International organizations, such as the IMF, were also established as one of the major elements of the System. The IMF was established to give funds to nations with deficits in their balance-of-payment records or current accounts (UCSD). Devaluations were also approved. The resources of the IMF came from the fund paid for by member nations. A quota was set for each member nation. This quota determines the contribution of a member country as well as the amount of fund a country can borrow. Large loans were quite restrictive under the watch of IMF’s policies. If IMF deems that a country is in “fundamental disequilibrium”, devaluations can occur. Also, nations believed to provide countries with sufficient flexibility to obtain an external balance. External balance refers to a condition where the current account of a nation is not too positive or not too negative. A financial crisis can happen is there is a loss. This is because nations may not lend funds to countries with deficits as the former thinks that the latter has no capacity to pay the debt. On the other hand, if there is an excess, protectionism may occur. Foreign pressure to other countries with surplus records may also face being pressured by other countries. In other words, the IMF provided hopes for countries with deficit records. During these times, the war barely tore US apart, while the war left most European countries in absolute devastation. Under the System, the European countries became indebted to US as the European countries borrowed funds from the latter to rebuild the nation (Mrak).

The System was meant to free international trade that was closed during the interwar years due to protectionism (UCSD). In the 1944 meeting, Britain and US were the two key players that have their own interests. Their differences of interests reflect on the terms each of these nations wants to design the system (Skidelsky). Great Britain suggests that the balance-of-payments disequilibrium can be eliminated through establishing a new international currency. This new international currency was to be accepted as equivalent to gold. Britain proposes a way that somehow functions similar to the gold standard. Conversely, the US proposed that the balance-of-payments disequilibria can be eliminated through establishing a special fund and restoring the gold exchange standard. US also propose a system that eradicates trade and payment restrictions (Skidelsky).

Often averted flows of financial assets across nations (UCSD). This is to prevent abrupt changes in the financial accounts that are the probable cause of the difficulty of balance-of-payments. Note that the proponents view trade as all beneficial to economies. Therefore, the System encouraged the flows of such trade. Gradually, the currencies were made convertible among member nations to further boost trade among nations. Under this new international monetary system where exchange rates are fixed, all member nations, except the US, have failed economic policies for internal balance. Internal balance refers to the macroeconomic goals to achieve full employment and achieve stability. Full employment means normal production and stability means low inflation. Increased prices may result from over-employment and decreased prices may result from under-employment. Volatile prices may appear when there is shifting aggregate demand and production. The redistribution of income from creditors to debtors may occur in case unexpected inflation happens. This situation makes planning for the future a difficult task (Mrak).

The member nations utilized fiscal policy as tools for maintaining an internal balance (Mrak). This policy includes taxes or government policies. Borrowing funds from the IMF is the essential tool that these countries apply for achieving an external balance. These countries may also restrict financial asset flows, as well as allow periodic changes in the exchange rates. Fiscal policy is crucial when the internal balance happens when production at potential output will equal the aggregate demands. The aggregate demand can be increased through government purchases. This also lifts the outputs over its full employment level. Decreasing the tax can also cause these effects. A revaluation should happen to have the internal balance restored. Fiscal policy also plays a vital role in case external balance happens when attains a certain value. The aggregate demand, income, and output can expand when government purchases are increased. This also happens when the taxes are decreased. In such a situation, decrease happens to the current accounts. Devaluation should occur in order to obtain the external balance restored (Mrak). Devaluations were expected to occur only infrequently under the new System, but the political factors that came into play triggered the collapse of this system – a collapse that is inevitable since the system has inherent errors (Mrak).

In the 1960s, US shifted its priorities from price stability to full employment (Niehans 177).  The policy makers in the US chose to respond to domestic policy objectives over responding to the international monetary system. The incipient speculative pressure crashed the System to the ground. In the late 1960s, there were sets of restraints on the par value system that, once and for all, lead to the collapse of the System. This collapse was triggered when the major industrial countries shifted their competitive positions, wherein Europe and Japan wielded decisive influence (Hooke 25). There is a possibility that market confidence may have occupied a pivotal position in the disintegration of the System (Chen and Lai 449). Chen and Lai utilizes a model of financial crisis wherein a scale of small speculators. These could make a decision on their market confidence as well as their trading positions. The Triffin Dilemma defines that nature of the challenges surrounding the facilitation of international liquidity and the problem of confidence to the system. Note that the System does not allow devaluation of the System’s key currency. Nevertheless, the American economy needs to endure, and that lead the US to devise mechanisms to do so. The US needs to reduce its balance-of-payment deficit. Nonetheless, everything failed due to lack of cooperation of key countries. In sum, the mechanisms to regulate balance-of-payments are not suitable. The system of fixed, but adjustable exchange rates failed to work. There is also a lack of international liquidity. Moreover, the Triffin Dilemma is a proof that there exists a built-in systemic mistake. There is also the lack of international cooperation to make the international monetary system work. All of these boiled down to imbalances in US, which is the primary cause of the disintegration of the System.

The establishment of the Smithsonian Agreement in December 1971 marked the impending demise of the System and the emergence of a new arrangement (Mrak). This agreement aims at establishing a new group of stable exchange rates, wherein a balance-of-payments equilibrium would be achieved again for the most important countries. The Smithsonian Agreement, which had been in effect from 1971 to 1973, resulted to devaluation of dollars of 8.5%, from $35 to $38 an ounce (Mrak). There is also a devaluation of DEM and Yen by 17% and 14%. In addition, there was an expansion of exchange rate fluctuation band to more or less 2.25%. Also, the United States discontinued their 10% import tariff. However, valid only for fourteen months, another devaluation of dollar did not bring confidence into it. A flexible exchange rate system followed, which had been in effect from 1973 onwards (Mrak). The transition into this system was unplanned and uncalled for. Major interventions and cooperation of monetary authorities were necessary to maintain the par values of currencies in the increased capital flow liberalization circumstances (Mrak).

There are basic trends that emerged in the Post-Bretton Woods arrangements. There were smaller and economically open countries, wherein the currency is fixed to another currency (Mrak). There are also trends of accelerated expansion of financial markets, as well as globalization of international finance. The period from 1973 to 1985 is defined as a period of more or less pure floating of exchange rates. Within this period, the Group 20 failed to search for a solution to secure more international liquidity, which is needed to keep the system functioning (Mrak). It was also in this period when the IMF statute was amended for the second time. This amendment allowed for the formal validity of flexible exchange rates (Mrak). In the period of flexible exchange rate, European countries tried to cooperate more with each other. Under this system, the currencies of several countries remained fixed to another country (Mrak). Compared to the period where the Bretton Wood System is in effect, exchange rates fluctuates much more.

Works Cited

Chen, Chih-huan and Lai, Ching-chong. “An Interpretation of the Collapsing Process of the Bretton Woods System.” Open Economies Review, 21.3 (2010): 449-463.

Dibooglu, Selhattin. “Inflation under the Bretton Woods system: The spillover effects of U.S. expansionary policies.” Atlantic Economic Journal, 27.1 (1999): 74-85.

Dooley, Michael, Folkerts-Landau, David and Garber, Peter. “The Revived Bretton Woods System.” International Journal of Finance & Economics, 9.4 (2004): 307-313.

Helleiner, Eric. States and The Re-emergence of Global Finance:  From Bretton Woods to the 1990s.Cornell, UP: Ithica, 1994.

Hooke, Augustus. The international monetary fund: Its evolution, organization, and activities. 2d ed. IMF Pamphlet Series no. 37. Washington, D.C., 1982.

Mikesell, Raymond Frech. “Bretton Woods–Original Intentions and Current Problems.” Contemporary Economic Policy, 18.4 (2000): 404-414.

Mrak, Mojmir. “Chapter 10: International Monetary System after World War II.” University of Ljuljyana Website. Web. 27 November 2012.

Niehans, Jurg. “How to Fill an Empty Shell.” American Economic Review, 66.2 (1976): 177-185.

Skidelsky, Robert. John Maynard Keynes: A Biography: Fighting for Britain, 1937-1946. London: Macmillan, 2000.

UCSD. “Bretton Woods System, 1945-1973.” University of California San Diego Website. Web. 27 November 2012.