Question

Brief description of the contents, limitations and causes of the collapse of the Bretton Woods system.

Answer 1

Bretton Woods System is a system of monetary management system established to set up rules for financial and commercial relations between countries such as United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. It was obligated to the countries to maintain their exchange rates within 1% by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments . Such was the monetary policy set up in the different countries.

However there were certain limitations or shortcomings of the Bretton Woods System:

There were big restrictions on capital movement throughout the years of Bretton Woods as well as the fact that parities were only adjusted after speculative and financial crises.

One more short coming in this aspect was the pressure that Bretton Woods put on the United States, because US was not willing to supply the amount of gold which the rest of the world demanded.

There were also structural problem in this system. Over time the world economy grew and needed more liquidity, which meant that US had to maintain increasing trade deficits.US failed in this aspect. Thus US did not have the control to set up the exchange rate of the dollar with that of the other currencies. Changing the value of dollar in terms of gold has no real effect, because the values of other currencies were pegged to the dollar. This problem would not have existed if most of other currencies were pegged to gold. However, none of these currencies were pegged to gold because they were not convertible into gold with the limited supply of gold.

The economy had to face the collapse of the Bretton Woods System because when the Vietnam War hiked in 1965, it brought about domestic inflation in US .There were other issues related to it which may be discussed as:

• The Symmetry Problem: This problem insisted between countries of deficit and surplus countries or between other countries and USA . The burden of payment imbalances adjustment fell sharply on the deficit countries, not following to that mention in the Bretton Woods System Agreement.
• Triffin Dilemma: The United States cleared its deficit and created a liquidity shortage or it continued to run the deficit of its balance of payment. The latter alternative could only cause the crisis of confidence. This point clearly brings into picture that the system was breathing its last stages.
• Long run adjustment problem: No country can undergo deficit in balance of payments for a longer period of time. But the Bretton Woods did not allow the use of direct controls over the foreign transactions.

Thus there were many reasons which encouraged the collapse of the Bretton Woods System.