Bretton Woods System Collapse.docx

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Paul Cohen

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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 exchange. - 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 deficit. - 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 anything. 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 Disadvantages: - 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 representatives. - • 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
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