International Financial Management ( MBF 401 )

C.T.-2, Assignment
Group- 6

Submitted To

DEPARTMENT OF MANAGEMENT

TEERTHANKER MAHAVEER INSTITUTE OF MANAGEMENT AND

TECHNOLOGY,

MORADABAD

In Partial Fulfilment of the Requirement of the Degree of Master of Business

Administration (MBA)

SESSION: 2018-2020

TEERTHANKER MAHAVEER UNIVERSITY

MORADABAD

Submitted To: Submitted By:

Dr. Srinivas Shirur Sachin jain (TMG1802054)

Lecturer Paras Jain (TMG1802060)

Breakdown of Bretton Wood System in 1970s

A. Genesis of the crisis.

The United Nations Monetary and Financial Conference was held in July 1944 at the
Mount Washington Hotel in Bretton Woods, New Hampshire, where delegates from
forty-four nations created a new international monetary system known as the Bretton
Woods system. These countries saw the opportunity for a new international system
after World War II that would draw on the lessons of the previous gold standards and
the experience of the Great Depression and provide for post war reconstruction. It was
an unprecedented cooperative effort for nations that had been setting up barriers
between their economies for more than a decade.

They sought to create a system that would not only avoid the rigidity of previous
international monetary systems, but would also address the lack of cooperation among
the countries on those systems. The classic gold standard had been abandoned after
World War I. In the interwar period, governments not only undertook competitive
devaluations but also set up restrictive trade policies that worsened the Great
Depression.

Those at Bretton Woods envisioned an international monetary system that would

ensure exchange rate stability, prevent competitive devaluations, and promote
economic growth. Although all participants agreed on the goals of the new system,
plans to implement them differed. To reach a collective agreement was an enormous
international undertaking. Preparation began more than two years before the
conference, and financial experts held countless bilateral and multilateral meetings to
arrive at a common approach. While the principal responsibility for international
economic policy lies with the Treasury Department in the United States, the Federal
Reserve participated by offering advice and counsel on the new system. The primary
designers of the new system were John Maynard Keynes, adviser to the British
Treasury, and Harry Dexter White, the chief international economist at the Treasury
Department.
Keynes, one of the most influential economists of the time (and arguably still today),
called for the creation of a large institution with the resources and authority to step in
when imbalances occur. This approach was consistent with his belief that public
institutions should be able to intervene in times of crises. The Keynes plan envisioned
a global central bank called the Clearing Union. This bank would issue a new
international currency, the “bancor,” which would be used to settle international
imbalances. Keynes proposed raising funds of $26 million for the Clearing Union.
Each country would receive a limited line of credit that would prevent it from running
a balance of payments deficit, but each country would also be discouraged from
running surpluses by having to remit excess bancor to the Clearing Union. The plan
reflected Keynes’s concerns about the global post war economy. He assumed the
United States would experience another depression, causing other countries to run a
balance-of-payments deficit and forcing them to choose between domestic stability
and exchange rate stability.

White’s plan for a new institution was one of more limited powers and resources. It
reflected the concerns that much of the financial resources of the Clearing Union
envisioned by Keynes would be used to buy American goods, resulting in the United
States holding the majority of bancor. White proposed a new monetary institution
called the Stabilization Fund. Rather than issue a new currency, it would be funded
with a finite pool of national currencies and gold of $5 million that would effectively
limit the supply of reserve credit.

The plan adopted at Bretton Woods resembled the White plan with some concessions
in response to Keynes’s concerns. A clause was added in case a country ran a balance
of payments surplus and its currency became scarce in world trade. The fund could
ration that currency and authorize limited imports from the surplus country. In
addition, the total resources for the fund were raised from $5 million to $8.5 million.

The Mount Washington hotel in rural New Hampshire, meeting place of the Allied
nations for the Bretton Woods Conference . The 730 delegates at Bretton Woods
agreed to establish two new institutions. The International Monetary Fund (IMF)
would monitor exchange rates and lend reserve currencies to nations with balance-of-
payments deficits. The International Bank for Reconstruction and Development, now
known as the World Bank Group, was responsible for providing financial assistance
for the reconstruction after World War II and the economic development of less
developed countries.

The IMF came into formal existence in December 1945, when its first twenty-nine
member countries signed its Articles of Agreement Offsite link. The countries agreed
to keep their currencies fixed but adjustable (within a 1% band) to the dollar, and the
dollar was fixed to gold at $35 an ounce. To this day, when a country joins the IMF, it
receives a quota based on its relative position in the world economy, which
determines how much it contributes to the fund.

In 1958, the Bretton Woods system became fully functional as currencies became
convertible. Countries settled international balances in dollars, and US dollars were
convertible to gold at a fixed exchange rate of $35 an ounce. The United States had
the responsibility of keeping the price of gold fixed and had to adjust the supply of
dollars to maintain confidence in future gold convertibility. The Bretton Woods
system was in place until persistent US balance-of-payments deficits led to foreign-
held dollars exceeding the US gold stock, implying that the United States could not
fulfil its obligation to redeem dollars for gold at the official price. In 1971, President
Richard Nixon ended the dollar’s convertibility to gold.

Though the Bretton Woods conference itself took place over just three weeks, the
preparations for it had been going on for several years. The primary designers of the
Bretton Woods System were the famous British economist John Maynard Keynes and
American Chief International Economist of the U.S. Treasury Department Harry
Dexter White. Keynes’ hope was to establish a powerful global central bank to be
called the Clearing Union and issue a new international reserve currency called the
bancor. White’s plan envisioned a more modest lending fund and a greater role for the
U.S. dollar, rather than the creation of a new currency. In the end, the adopted plan
took ideas from both, leaning more toward White’s plan.

It wasn't until 1958 that the Bretton Woods System became fully functional. Once
implemented, its provisions called for the U.S. dollar to be pegged to the value of
 gold. Moreover, all other currencies in the system were then pegged to the U.S.
dollar’s value. The exchange rate applied at the time set the price of gold at $35 an
ounce.

B. Extent and size of the crisis.

Number of countries having a banking crisis in each year since 1800. The dramatic
feature of this graph is the virtual absence of banking crises during the period of
the Bretton Woods agreement, 1945 to 1971. This analysis is similar to Figure 10.1 in
Reinhart and Rogoff (2009). For more details see the help file for "banking Crises" in
the Ecdat package available from the Comprehensive R Archive Network (CRAN) &
more than 700 delegates of over 40 allied nations were involved in this crisis

C. How many countries were affected?

More than 40 countries were affected. The countries like Belgium, Brazil, China,
Australia, Canada, Egypt, France, Iran, Iraq, New Zealand, South Africa, United
States of America and many more countries were affected.

D. Unique features of the crisis.

Four main features of the Bretton Woods system was as follows.

I. It was a US dollar-based system. Officially, the Bretton Woods system was a gold-
based system which treated all countries symmetrically, and the IMF was charged
with the responsibility to manage this system. In reality, however, it was a US-
dominated system with the US dollar playing the role of the key currency (the
dollar's dominance still continues today). The relationship between the US and other
countries was highly asymmetric. The US, as the center country, provided domestic
price stability which other countries could "import," but did not itself engage in
currency intervention (this is called benign neglect; i.e., the US did not care about
exchange rates, which was desirable). By contrast, all other countries had the
 obligation to intervene in the currency market to fix their exchange rates against the
US dollar.
II. It was an adjustable peg system. This means that exchange rates were normally fixed
but permitted to be adjusted infrequently under certain conditions. As a consequence,
exchange rates were supposed to move in a stepwise fashion. This was an
arrangement to combine exchange rate stability and flexibility, while avoiding
mutually destructive devaluation. Member countries were allowed to adjust "parities"
(exchange rates) when "fundamental disequilibrium" existed. However,
"fundamental disequilibrium" was not clearly defined anywhere. In reality, exchange
rate adjustments were implemented far less often than the builders of the Bretton
Woods system imagined. Germany re-valued twice, the UK devalued once, and
France devalued twice. Japan and Italy did not revise their parities.

III. Capital control was tight. This was a big difference from the Classical Gold Standard
of 1879-1914, when there was free capital mobility. Although the US and Germany
had relatively less capital-account regulations, other countries imposed severe
exchange controls.

IV. Macroeconomic performance was good. In particular, global price stability and high
growth were simultaneously achieved under deepening trade liberalization. In
particular, stability in tradable prices (wholesale prices or WPI) from the mid 1950s
to the late 1960s was almost perfect and globally common. This macroeconomic
achievement was historically unprecedented

E. How was the problem solved?

It can be divided in two parts-

1971-1973 – The agreement collapses

Financial crises during the term of U.S. President Richard Nixon led to the end of the Bretton
Woods system. During these years, the amount of dollars held overseas exceeded the value of
the gold reserves held by the U.S., in Fort Knox and elsewhere. This undermined the premise
of the agreement, namely that the U.S. could still back its dollars with their equivalent value
in gold.

The Balance noted that the financial phenomenon of “stagflation,” inflation during a
recession, struck the U.S. around this time. The U.S. dollar’s use as the global currency
became a cause for concern. Nixon reduced the value of the dollar, cutting it to 1/38 of an
ounce of gold, and then 1/42. With the value falling, people sought to convert their dollars for
gold in anticipation of more changes.

Once Nixon declared the temporary end of convertibility followed by the complete
breakdown of the connection between dollars and gold, the free market became the
determinant of gold prices, which promptly rose. The currency conversion elements of the
Bretton Woods system were now over, though the IMF and World Bank still existed.

1973-present – The World Bank and IMF’s continuing influence

While countries can no longer tie all their currency conversion needs to the U.S. dollar, nor
link that dollar to a fixed amount of gold, the legacy of Bretton Woods continues in the form
of the IMF and World Bank. The IMF still exists as a holder of reserve currencies, and the
World Bank remains as a lender of funds to developing and growing economies, following
the end of its role funding the post war reconstruction of Europe.