The Bretton Woods System - Video Tutorials & Practice Problems

Bretton Woods System:Introduction

So after the gold standard was abandoned, a new system was put into place called the Bretton Woods system. So the Bretton Woods system was basically a new try and change up the gold standard. It was an exchange rate system implemented after abandoning the Gold standard and it was used from 1944 to 1973. So you can tell that this one didn't last very long either. So it's named the Bretton Woods because there was a conference in new Hampshire in the Bretton Woods where they had a conference and the U. S. Pledged to buy or sell gold At a fixed rate of $35 an ounce. So the us said that hey we will buy gold from other countries at this price of $35 per ounce. Okay so they set this fixed rate for the exchange rate of dollars to gold. Okay so they were still using gold as basically the basis for the system. So uh countries pledged to buy and sell their currencies at a fixed rate to the dollar. So as the as the dollar fixed itself to the gold countries fix themselves to the dollar right? They thought they were going to buy and sell their currencies at a fixed rate to the dollar. So this was still a fixed exchange rate system. Um so by fixing their rates to the dollar, the exchange rates were also fixed between other countries as well because if you can get £2 for $1.03 pesos for $1. Well you can trade those £2 for three pesos or whatever right? There all fixed to each other. However, unlike the gold standard, no country was willing to exchange, it's paper money for gold, only the U. S. Dollars would be exchangeable for gold. Other countries were not exchanging their money for gold. And even in the US you couldn't go to a bank and redeem your money for gold. It was basically central banks that could redeem the money for gold. Okay. Generally foreign central banks would be the ones that would be redeeming for gold, not just any regular citizen. So from the 1930s to the 1970s, this is actually pretty interesting fact that even I learned about here, it was actually illegal for American citizens to own gold. You could have, you know jewelry or some like rare coins but you weren't allowed to like physically own gold as an investment during this Bretton woods time. Um it was actually illegal to hold gold. So what foreign countries did is they were committed to holding dollar reserves. So they would hold dollar reserves which was basically like holding reserves for for their gold there, right? And the international monetary fund was created to provide loans to central banks that were short of reserves. Okay, so when they didn't have the dollar reserves, the international monetary fund would make those loans to them. So a big thing with these fixed exchange rates is that supply and demand are not at play, right? When we have a fixed exchange rate, we don't have supply and demand. Changing the exchange rate to match the equilibrium, right? And a fixed exchange rate is not necessarily equal to the equilibrium. Remember when we have our graph, it's our standard supply and demand graph, right? And if we're not at equilibrium, well, we're either gonna have a shortage or a a shortage or a surplus, right? If demand is here, supply is here. And let's say this is the exchange rate down here. Well, what's happening? Demand is high, supply is low, right? So there's a shortage. So it depends on where that fixed exchange rate is, whether we're gonna have a shortage or surplus or if it's actually at equilibrium. So this tended to lead to surpluses and shortages of different currencies based on an overvaluation or undervaluation. The I. M. F. Would try and keep up with this. And if they noticed that there was a persistent surplus or shortage, well then they would adjust the fixed exchange rate between the dollar and that currency to make it balance out again. Okay, so that was basically how the system worked. Let's pause here and let's show how the Bretton Woods system basically collapsed afterwards.

Bretton Woods System:Collapse

So there were two main reasons why the Bretton Woods system collapsed. First was that by $1963 the dollars held by foreign central banks exceeded the gold reserves of the United States. Okay so there was more dollars being held in reserves than then the gold to back it up. And that means that if all of those banks went and turned in their dollars to get gold, there wouldn't be enough gold to match all those dollars. This rarely happened though. Central banks rarely redeemed their dollars for gold, but this was the foundation of the system, right? This is why the system tended to work was because of this promise that the us had made to buy the gold at $35 an ounce. And as this gap grew larger and larger, well there was starting to become an uncertainty. The central banks began to doubt the U. S. Would be able to fulfill its promise of redeeming dollars for gold. So that was the first problem with the Bretton woods system was there was just too many dollars for the amount of gold that was in in reserves. Second was that some countries with undervalued currencies were unwilling to revalue their currency. So remember there were these fixed exchange rates and if we were in a situation where there was an undervalued currency like we have in our little graph right here where the demand is greater than the supply because the currency is undervalued, well then the the currency should be valued up to its equilibrium. However, these countries were unwilling to revalue. Right? So this led to an increase in the currency's value would lead to higher prices for their exports. Sorry? So that the reason they didn't want to revalue was if they increase the value of their currency it would lead to higher prices for their exports. And basically firms were pressuring the government saying hey don't let them revalue our currency. So it doesn't hurt our business, right? Because if if the value of the currency goes up, the exports get more expensive than they can't make as many sales overseas. So the firms were basically pressuring the governments not to allow those revaluations. Okay. And this caused bigger and bigger shortages in the in in the currency and causing the governments to print money and inflation to happen. Right? So there was it caused a lot of problems as well. So eventually controlling the fixed rates basically became too difficult. Okay and by 1971 President Richard Nixon abandoned the USS commitment to redeem gold for dollars. And by 1973 the whole system was just abandoned in general. And that's where we got to the system we have today. The managed float system basically supply and demand controls the exchange rates and then the governments might step in at some point. You know if things start to get out of control the government might buy or sell its own currency to try and manage its exchange rate. Okay so that's about it for the Bretton Woods system. Let's go ahead and pause and we'll move on to the next video.