Team Case 10

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Hier wird Wissen Wirklichkeit1

Macroeconomics IISummersemester 2004

Prof. Dr.Paul Bernd Spahn

Dipl.-VolkswirtJan Werner

Case Studypresented by

Judit PappOlga Sedova

Alesja StellwagYevgeniya Yarmanova

TheBretton Woods System

and its End

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Contents

1. Historical events preceding the Bretton Woodssystem

2. Establishing of the Bretton Woods system

3. The Bretton Woods chronology

4. Reasons for collapse

5 . Discussion

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1. Historical Events Preceding the BW System1870-1914: Gold standard

Creation of central banking systems as note source andlegal tender Currencies backed by goldLiberalized export and import of goldCollapsed with the beginning of the World War I

3 main problems that led to collapse :(1) adjustment (2) liquidity (3) confidence

1919-1939: Interwar period

a) Floating exchange rates: 1919-1925b) Gold exchange standard: 1926-1931Initiated by Great BritainReturn to the pre-war gold price instead of adoption ahigher gold conversion rate deflationary effect

c) Managed float: 1932-1939

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1. Historical Events Preceding the BW System1930s: Shared experiences of the Great Depression

Deflation and competitive devaluations (beggar -thy-neighbour policies) dropping national income, shrinkingdemand, mass unemployment, decline in world trade

Trade and exchange rate controls

Early 1940s: Developing a new monetary system Acknowledged need for a stable international monetarysystem

A small number of states holding political power easier to negotiateTwo major powers: Great Britain and the U.S.A.Leadership role of the U.S.

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2. Establishing of the Bretton Woods System

In the first three weeks of July 1944,

delegates from 45 nations gathered

at the United Nations Monetary and

Financial Conference in BrettonWoods, New Hampshire.

Goal:

To establish a postwar international monetary systemof convertible currencies, fixed exchange rates andfree trade.But!

Different preferences 2 rival plans

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2. Establishing of the Bretton Woods SystemI. The Keynes Plan: (Great Britain)Goals : - world trade expansion

- international liquidity- protection of the domestic economy from foreign

disturbancesEssence:Focus on adjustment of real economy wide fluctuation bandFocus on world trade expansion and international liquidity

Bancor with nominal value fixed in terms of goldSurplus nations (U.S.A): credit balances earning interestDeficit nations (GB): overdrafts bearing interest to surplusnations

Assigned quota determines the limit on resources to obtain,if over quoted penalties: devaluation, capital control
http://images.google.de/imgres?imgurl=lwi2.wiwi.uni-frankfurt.de/images/flagge_uk_gro%25DF.jpg&imgrefurl=http://lwi2.wiwi.uni-frankfurt.de/publikationen/aobpub.htm&h=198&w=297&sz=18&tbnid=qza2ToDKvkMJ:&tbnh=74&tbnw=111&start=2&prev=/images%3Fq%3Dflagge%2Buk%26hl%3Dde%26lr%3D%26ie%3DUTF-8

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II. The White Plan: (U.S.A)

Goal: Exchange rate stability

Essence:

- Focus on purchasing power of currencies deviations fromparity only in case of fundamental imbalances

- Deficit nations: draw resources by selling their own currencyfor that of other members

- Establishment of stabilizing fond IMF, IBRDPenalties: appropriate domestic policies & exchange controls

Compromise between I and II = BW Agreement
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a) Exchange rate mechanism:Par value system: 35 USD per ounce goldSnake: +/ - 1% wide corridor for exchange rate fluctuations

Adjustable pegObligation to convert only for central banksCurrent account liberalization(capital accounts NOT liberalised)

2 main features:a) Exchange rate mechanismb) Set of institutions to safeguard international monetary

stability

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b) Bretton Woods institutions:IMF

Major functions:1. Regulatory (administering the rules governing

currency values and convertibility)2. Financial (supplying supplementary liquidity)3. Consultative (providing a forum for

cooperation among governments)

IBRD - Fighting poverty- Improving living standards in the developing

countries

ITO GATT WTO

H. D. White &J. M. Keynes, 1946

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Classical gold standard Floating exchange ratesvs.

Exchange rate stability

Long-run price stability

Loss of nationalmonetary authority

Monetary sovereignty

Insulation from foreign shocks

Destabilization and free rider problems

Lack of disciplining effects of fixed exchange rate regimes

Excursus(1):

The Bretton Woods System an attempt to combine the advantages of both systems

Question: Is it theoretically possible?

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Excursus(2): The Inconsistent Trinity: Only 2 of 3following objectives can be achievedsimultaneously

Fixedexchangerates

Free capitalmobility Democraticpolicies aimedtoward fullemployment

YES YES NO = GoldStandard

YES NO YES = BrettonWoods

NO YES YES = 1971- today

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3. The Bretton Woods Chronology

1. The Period of dollar shortage" (1945 -1958):The U.S. serves as a stabilizing force

- The U.S. trade surplus and global liquidity the dollar "gap- Accommodating role of the U.S. foreign aid programs

(i.e. Marshall Plan), and overseas military expenditures (e.g.the Korean War)

- Foreign aid and macroeconomic discipline at home supportsworld economy

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3. The Bretton Woods Chronology2. The Period of dollar glut" (1958 -1971):

The U.S. serves as a destabilizing force- Expansionary domestic (Great Society) and foreign

(Vietnam) policies are financed by inflation

- Key Status of the dollar meant that the U.S. could exportinflation and avoid macroeconomic adjustment

- Confidence crisis: doubtful convertibility of the dollar intogold runs on the gold

- "Nixon shocks" of 1971March 16, 1973 - COLLAPSE

- Switch to flexible exchange rates- End of the official gold price- Gold-peg abolished at peace time

It was clear that it as NOT a temporary break

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4. Reasons for Collapse

1. The Triffin Dilemma :

Relies on the U.S. deficits to avert world liquidity shortage

- After 1958, the U.S. dollar overhang was growing larger thanits gold stock erosion of Americas net reserve position

- To forestall speculation U.S. deficits have to go down liquidity problem

- To forestall liquidity problem U.S. deficits have to grow

Confidence problem

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4. Reasons for Collapse

Attempts to save BW:a) Mid-1960: SDRb) 1961-67: Gold Pool :

U.S.A: 50.00% GB, F, I: 9.26% (each)D: 11.12% CH, B, NL: 3.70% (each)

c) Split market for gold March 1968:Official price: 35 USD / ounce goldPrivate investors: gold price flexible

2. Rigidity of Exchange Rates- Fears of potential world liquidity shortage- Irresistible incentives for speculative currency shifts- Global confidence problem

3. Growing concerns in Europe and Japan about Americas useof its privilege of liability financing

(Exorbitant Privilege C. de Gaule)

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4. Reasons for Collapse4. Inflation- BW assumption of a

stabile economic policyin the U.S.

- After 1965 the U.S.behaviour becameincreasingly destabilizing Inflation Members had to buythe growing surfeit of dollar to defend their pegged rates Accelerating inflation everywhere

Evident incapability of coping with widening of payments imbalances & worsening of confidence

problem (speculators)

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* Ex-Secretary of the State under the U.S. President Roland Reagan

** President of the John M. Olin

Foundation, ex-secretary of the Treasury under PresidentR. Nixon and G. Ford

Wall Street Journal, 3rd February 1998:The IMF is ineffective, unnecessary, and obsolete.George Schulz* & William Simon**

Thank you for your attention!

5. Discussion

Team Case 10

Documents

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