The Bretton Woods Agreement established the International Monetary Fund (IMF) as the agency to regulate the fixed exchange rates and enforce the rules of the international monetary system. At the time of its formation, the IMF (www.imf.org) had just 29 members—today 185 countries belong. Included among the main purposes of the IMF are:4
■ Promoting international monetary cooperation.
■ Facilitating expansion and balanced growth of international trade.
■ Promoting exchange stability, maintaining orderly exchange arrangements, and avoiding competitive exchange devaluation.
■ Making the resources of the fund temporarily available to members.
■ Shortening the duration and lessening the degree of disequilibrium in the international balance of payments of member nations.
SPECIAL DRAWING RIGHT (SDR)
World financial reserves of dollars and gold grew scarce in the 1960s, at a time when the activities of the IMF demanded greater amounts of dollars and gold. The IMF reacted by creating what is called a special drawing right (SDR)—an IMF asset whose value is based on a weighted “basket” of four currencies, including the U.S. dollar, European Union euro, Japanese yen, and British pound. Figure 10.4 shows the “weight” each currency contributes to the overall value of the SDR. The value of the SDR is set daily and changes with increases and declines in the values of its underlying currencies. Today there are more than 21 billion SDRs in existence worth about $29 billion (1 SDR equals about $1.56).5 The significance of the SDR is that it is the unit of account for the IMF. Each nation is assigned a quota based on the size of its economy when it enters the IMF. Payment of this quota by each nation provides the IMF with the funds it needs to make short-term loans to members.
special drawing right (SDR)
IMF asset whose value is based on a “weighted basket” of four currencies.
Collapse of the Bretton Woods Agreement
The system developed at Bretton Woods worked quite well for about 20 years—an era that boasted unparalleled stability in exchange rates. But in the 1960s the Bretton Woods system began to falter. The main problem was that the United States was experiencing a trade deficit (imports were exceeding exports) and a budget deficit (expenses were outstripping revenues). Governments that were holding dollars began to doubt that the U.S. government had an adequate amount of gold reserves to redeem all its paper currency held outside the country. When they began demanding gold in exchange for dollars, a large sell-off of dollars on world financial markets followed.