In 1944, representatives from 44 nations met in the New Hampshire resort town of Bretton Woods to lay the foundation for a new international monetary system. The resulting Bretton Woods Agreement was an accord among nations to create a new international monetary system based on the value of the U.S. dollar. The new system was designed to balance the strict discipline of the gold standard with the flexibility that countries needed to deal with temporary domestic monetary difficulties. Let’s now take a brief look at the most important features of that system.
Bretton Woods Agreement
Agreement (1944) among nations to create a new international monetary system based on the value of the U.S. dollar.
Fixed Exchange Rates
The Bretton Woods Agreement incorporated fixed exchange rates by tying the value of the U.S. dollar directly to gold and the value of other currencies to the value of the dollar. The par value of the U.S. dollar was fixed at $35/oz of gold. Other currencies were then given par values against the U.S. dollar instead of gold. For example, the par value of the British pound was established as $2.40/£. Member nations were expected to keep their currencies from deviating more than 1 percent above or below their par values. The Bretton Woods Agreement also improved on the gold standard by extending the right to exchange gold for dollars only to national governments, rather than anyone who demanded it.
The new system also incorporated a degree of built-in flexibility. For example, although competitive currency devaluation was ruled out, large devaluation was allowed under the extreme set of circumstances called fundamental disequilibrium—an economic condition in which a trade deficit causes a permanent negative shift in a country’s balance of payments. In this situation, a nation can devalue its currency more than 10 percent. Yet devaluation under these circumstances should accurately reflect a permanent economic change for the country in question, not temporary misalignments.
Economic condition in which a trade deficit causes a permanent negative shift in a country’s balance of payments.
To provide funding for countries’ efforts toward economic development, the Bretton Woods Agreement created the World Bank—officially called the International Bank for Reconstruction and Development (IBRD). The immediate purpose of the World Bank (www.worldbank.org) was to finance European reconstruction following the Second World War. It later shifted its focus to the general financial needs of developing countries. The World Bank finances many types of economic development projects in Africa, South America, and Southeast Asia. The World Bank also offers funds to countries that are unable to obtain capital from commercial sources for certain projects that are considered too risky. The bank often undertakes projects to develop transportation networks, power facilities, and agricultural and educational programs.