Why bretton woods system collapsed

First, and most important, the U. This was the main reason that U. Also, a fixed exchange rate system became impractical when the reserve center was unstable. But President Nixon failed to grasp that higher inflation stemmed from U. He pressured Fed Chairman Arthur Burns to hold off raising interest rates in the run-up to the elections, and Burns wound up supporting wage and price controls that were counterproductive.

Second, as international capital mobility proliferated, it became harder to maintain fixed exchange rates as capital flowed out of high inflation countries into ones with low inflation. This situation created problems for European policymakers, especially those in West Germany, Holland and Switzerland, where the primary objective of monetary policy was to keep inflation low, typically at 2 percent or less. Milton Friedman maintained that the shift to flexible exchange rates was desirable because it allowed countries with low inflation to regain control of their money supplies.

For some economists and policymakers, however, the lapse into floating exchange rates meant deficit countries no longer were constrained by their balance of payments. Today, even the most ardent supporters of flexible exchange rates would concede that currency fluctuations have been much greater than expected. Meanwhile, the international financial system has evolved into a hybrid system: The European Monetary Union has a common currency, the euro, which fluctuates freely against the U.

The dollar, in turn, serves as the key reserve currency and numeraire for the system. However, the currency in Asia would fail to experience appreciation if the currency in Asia were pegged a fixed exchange rate to the dollars and other currency. Conversely, a floating exchange rate would create a better international balance. However, some regulations of the exchange rate system is still needed. The Jamaica Monetary system, which was created after the breakdown of the Bretton Woods system and centered on floating exchange rate, has experienced strong turbulence owing to the rapid change of exchange rate.

Second, a successfully designed agreement is also needed to sustain a system. In the case of Bretton Woods as discussed above, the flawed design of Bretton Woods agreement precipitated the uncooperative behavior of its member countries. Therefore, to prevent these detrimental defaults, a restraint mechanism should necessarily be set.

First of all, countries should be given the incentive to cooperative even not under optimal conditions. In other words, although countries during the Bretton Woods system would be better off break the agreement and devalue their currency, they would still choose to cooperate because they would be promised to be compensating for their loss.

In this way, countries are secured against potential loss of compliance, and may cooperate more effectively. Under this circumstance, every country would weigh the cost and benefits more cautiously before making decisions to default in the agreement. This article researches the causes of the collapse of the Bretton Woods system. It comes to the conclusion that structural flaws are the main causes of the breakdown, and puts forward some brief lessons that are useful to ensure a more stable international monetary system.

Therefore, a lesson naturally comes up: a well-designed structure of the system is needed in order to successfully implement it. This article analyses a number of viewpoints of the cause of the breakdown of the Bretton Woods system from various papers and presents a conclusion based on the evaluation of the validity of these views according to the historical context.

This article focuses mainly on qualitative measures and may not include adequate models or graphs. It only explains and evaluates different factors that have led to the breakdown of the Bretton Woods system without plotting them in different graphs to verify the effect. Therefore, further quantitative researches could be done. Further research could focus on mathematical simulations of the effect of different factors on the exchange rates, which clearly shows the significance of each factor.

We would like to express our sincere appreciation to Dr. David C. Shimko of NYU for his valuable suggestions and guidelines for this research program. We would also like to thank CIS for offering us an opportunity to engage in scientific research training.

The Undergraduates Award Library. National Bureau of Economic Research, No. Center on International Cooperation. Home Journals Article. DOI: Abstract The Bretton Woods system was abandoned by the U. Share and Cite:. Jin, Y. American Journal of Industrial and Business Management , 8 , Introduction 1.

As a dominant military and economic power, the US took the leadership away from Britain, which was war torn and losing international influence. The rejected British proposal was to create a mighty settlement union for all countries. Each country was to have an official account at this mechanism, and all balance of payments BOP surpluses and deficits would be recorded and settled through these accounts. This would mean that both surplus and deficit countries bear the responsibility for correcting the imbalance.

However, the US plan, which was actually adopted, was a much weaker revolving fund. Each country would contribute a certain amount "quota" to this fund, and member countries with BOP difficulties would borrow or "purchase" hard currencies from this fund. This meant that only deficit countries would bear the responsibility for correcting the imbalance. The UK was expected to be a deficit country after the war, while the US was expected to be a surplus country.

Later in the s, borrowing countries were required to implement macroeconomic policies to reduce the deficit "conditionality".

The World Bank's initial purpose was to assist the recovery of war-torn Europe and Japan. The World Bank subsequently became an organization to assist developing countries.

One more organization International Trade Organization was also planned but not created at that time. So we now have three sisters. First, 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.

By contrast, all other countries had the obligation to intervene in the currency market to fix their exchange rates against the US dollar. Second, 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 revalued twice, the UK devalued once, and France devalued twice. Japan and Italy did not revise their parities. Third, capital control was tight. This was a big difference from the Classical Gold Standard of , when there was free capital mobility.

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