Question

What are the reasons of the collapse of the Bretton Woods system and what exchange rate system followed it

Answer 1

Many European countries had BOP surpluses by the end of the 1950's and the US was running counterpart deficit. It was essential for the United States to maintain this deficit for the continued economic expansion, as it was the only way that the growth of international reserves could be sustained in the absence of any other reserve assets including gold.

Such assumption resulted in an almost humiliating accumulation of reserves due to the large-scale inflow to that nation of foreign funds. France experienced an unprecedented outflow of funds in particular, and the French Government enforced stringent currency restrictions to defend Franc. But in the end, storm could only be weathered after Mark's upward rejustment and Franc 's downward adjustment.

The adjustment through quantitative controls was opposed due to possible distortion of the allocation of resources and reduction in economic efficiency. In these circumstances, the countries adopted a policy of wait-and-see rather than taking decisive and swift action for BOP adjustments. The undue wait has contributed to a deterioration of the BOP crisis's maladjustment and development.

Triffin had exposed serious inbuilt contradictions in the system as early as 1960. It is often referred to as the 'Triffin dilemma' i.e. either the U.S. corrected its deficit and created a liquidity shortage or the BOP deficit continued to run. The latter option could only cause a crisis of confidence. The existence of this dilemma demonstrated clearly that the system was inherently unstable and destined to collapse.

As the euro-dollar economy evolved in the late 1950s, highly flexible short-term capital expanded rapidly. Owing to strong dollar competition, the expected shifts in par value culminated in large-scale investment money. It has led to the speculative movements of capital from the United States to other surplus countries like Germany, Japan and Switzerland. These large-scale movements of capital were bound to have a destabilizing effect on both the exchange rate and the adjustments to the BOP.

The Bretton Woods Agreement and System created a collective international currency exchange regime that lasted from the mid-1940s to the early 1970s. The Bretton Woods System required a currency peg to the U.S. dollar that was in turn tied to the gold price. The Bretton Woods System collapsed in the 1970s but created a lasting influence on international currency exchange and trade through development of IMF and World Bank