Bretton Woods System Collapse
- The suspension of official convertibility: the right of foreign moentary authorities to
convert official holdings of dollars into primary reserve assets(gold or SDRs)
- Adjustable peg
The gold exchange standard:
- The reserve of a country is made up of a primary reserve asset, gold, and foreign
- If countries have confidence in a foreign currency then they’ll prefer holding reserves in
the foreign currency so that they can make money off of the interest.
- Triffin dilemma: When a country’s currency is being used as the international reserve
currency, that country can either run a deficit in their balance of payments to provide
more US dollars in the system for when people exchange gold for it. This causes the
dollar to become overvalued. Or run a balance of payments surplus so people have
confidence in the dollar. Obviously can’t do both.
- US’s plan was to encourage other countries to hold dollars instead of converting them
into gold when the US’s balance of payments is in deficit and to create a new reserve
asset to supply the increase in liquidity which will be needed when the US balances their
- US were on the path to fixing their balance of payments: inflation was lower than
Europe, earnings on foreign investments were growing rapidly, and part of the deficit
could be explained as the result of financial intermediation.
- Vietnam War caused monetary expansion in the US, even though what they needed for
this plan to work was “belt-tightening”.
- Also, some countries opposed america’s plan and wanted to stick to gold as the primary
reserve asset instead of introducing a new one, the SDR.
Comparions between Gold and SDR
- In an age of inflation, a gold revaluation wouldn’t solve the need for steadily growing
liquidity(SDR could). The cycle would continue, gold accruals would dry up, and US
wouldn’t be able to provide for the exchange of dollars for gold.
- Some advocates of the reinstatement of gold argue that it would restore financial
discipline for governments. However, that’s only present when countries believe they
have no other alternative. When governments began to change prices of gold when they
were in trouble, becomes the same as SDR. - SDRs are cheaper to produce and you don’t need to waste money mining it, plus the
existing gold reserves can be released to be used for better things. SDR potentially
capable of paying a rate of return that competes with currencies so the incentive behind
a reserve currency system will be taken care of.
- Confidence problem present before would be taken care of by the SDR because of the
restrictions on the use of the SDR in portfolio switching operations
- Supply of SDrs can be managed with a view to contributing to stable growth of the world
economy, supply of gold influenced by many things.
- The sudden increases in international liquidity as a result of gold revaluation would have
high inflationary effects.
- The distribution of the seigniorage benefits of the SDR creation would be roughly
neutral, unlike for gold revaluation, where major gold producers (South Africa and Soviet
Union) and the gold hoarders benefited the most while developing countries didn’t gain
Dollar standard advantages:
- Provide an instantaneous solution of the confidence problem
- Resolve the (n-1) problem by allowing the reserve centre’s payments position to adjust
to whatever was required for consistency with the policies chosen by other countries
- Degree of seigniorage that the US would accrue from interest paid on dollar reserves
would be mminimal
- One component of a passive payments policy involves complete sterilization of the
effects of reserve movements on the domestic money supply
Complete sterilization in a fixed exchange rate regime means that the whole
burden of adjustment is avoided by the sterilizing country and thrown onto its
partners; if they also try to sterilize then system becomes unstable.
- There will be times when the center country’s costs get out of line even if they try hard to
resist inflation. Since the US cannot alter the exchange rate themselves other than in a
floating regime, this has to be done by a series of other changes from other countries.
- There may be a cost to the reserve center in losing control of its current account balance
Other than these disadvantages, if the US proved to be stable, the dollar standard addressed
the technical issues well. - The technical issues weren’t the problem, other cuontries didn’t want to put all the power
in the hands of the US.
- Charles Kindleberger suggested that the Federal open Market Committee be extended
into an Atlantic Open Market Committee that includes European and Japanese
• Effective foreign representation would place immense pressure on the US
domestic monetary policy.
- The acceptance of a dollar standard implies some power asymmetry, which existed in
the early post war years but not during this time.
• Leaders didn’t think that requests for conversion of their dollars into gold would
work, would have underminedthe fight against exchange rate changes.
• would have faced everyone with 2 options: either adopting the dollars standard
and breaking up the pegged exchange rate system, or would have caused a
crisis which would have been solved by a revaluation of gold
- the reluctance by the US to subordinate demand managenment policy to external needs
was well founded in such a closed economy, meaning that any effective adjustment
measures had to include a change in exchange rate.
• The adjustable peg alone wouldn’t have been able to devalue the dollar.
If a dollar devaluation wasn’t large enough to convince dollar holders that
no further devaluation would occur, this could have jeopardized the
willingness to continue restraint in converting dollars into gold.
• However, the devaluation necessary for other countries to believe
that no further devaluation would occur would have been larger
than other countries would have accepted, afraid that it would
undermine their competitive position
• So the series of steps the euroepans(including Japan) were taking
to prevent the immediate disintegration of the system led them to
a position where they were forced into a dollar standard.
- Exchange rate flexibility was seen by most to be avoided at all costs
• In their minds related to the failure of the 1930s. • Some believed th