Lecture 20
THE BRETTON WOODS SYSTEM

1. Origins

• 44 countries met in Bretton Woods, New Hampshire in July 1944
• Formed the IMF and the World Bank

2. System of fixed exchange rates

• Each country had a fixed exchange rate vs the $
• The dollar price of gold was $35/oz
• Member countries held gold and dollar assets as reserves
• Member countries could buy gold from the Fed for dollars

3. External adjustment

3.1 IMF lending facilities

• Each member country is assigned a quota
• IMF conditionality, in case of heavy borrowing

3.2 Adjustable parities

• In case of "fundamental diseqbm", devaluation permitted
• Speculative capital flows
• Balance-of-payments crisis

4. The collapse of the Bretton Woods system

• Expansionary fiscal policies in the U.S. associated with Vietnam War
  • Inflation in the U.S.
  • Current account surplus fell

• Expansionary monetary policy
  • Higher inflation
  • The market expected dollar price of gold to go up
• Massive gold sales by the Fed and other central banks

• Two-tier gold market announced
• Market price and official price

• Tax increase (contractionary fiscal policy)
• Too late; inflationary expectations had built in
• Inflation continued to rise

• The U.S. current account went into deficit
• The market expected a devaluation of the $ vs DM
• The German central bank bought large amounts of dollars
• German money supply increased

• Nixon announced that the U.S. would no longer sell gold at $35/oz
• 10% tax on imports until (N1) currencies were revalued

• The Smithsonian Agreement
  • $ was devalued
  • 10% import surcharge was removed
  • Official gold price raised to $38/oz

• High U.S. current account deficit
• Market expected further devaluation of the $
• Capital outflow from the U.S. into Germany

• Massive speculative attack on the $
• Another 10% devaluation of the $
• Not enough; speculative outflow continued

• Floating exchange rates

5. Role of dollar?

• Other countries had to revalue their currencies to correct U.S. BP deficit