bretton woods system
TRANSCRIPT
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Case Study:Bretton Woods System
Introduction to International Relations
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Why does it matter?
Sound IMS is prerequisite for stable world economy
Requirement for growth of world trade and foreign investment
International Monetary System (IMS)
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What is money?◦Any good that is widely accepted in exchange of goods and
services, as well as payment of debts
Three functions of money:1. Medium of exchange – money used for buying and selling
goods and services2. Unit of account – common standard for measuring relative
worth of goods and services3. Store of value – convenient way to store wealth
International Monetary System (IMS)
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1. Liquidity2. Adjustment Mechanism3. Confidence
Requirements for Stable IMS
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Amount of assets (e.g., money) that can be easily available to finance trade
Market liquidity◦ describes how easily an item can be traded for another item, or into the
common currency within an economy
◦ MONEY is the most liquid asset because it is universally recognized and accepted as the common currency
IMS should provide adequate liquidity to finance international transactions
1. Liquidity
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Must specify methods to resolve balance of payment (BOP) disequilibria
BOP◦ All payments between a country and its trading partners
Disequilibria – imbalance
2. Adjustment Mechanism
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Sound IMS should provide confidence in the system
3. Confidence
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1. Era of specie money – precious stones2. Era of political money – paper money3. Classical Gold Standard◦ Why standard? - money acts as a standard measure
and common denomination of trade4. Gold Exchange Standard5. Bretton Woods System6. System of Flexible Rates
History of IMS
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Pre-modern era
Specie money – metal money in circulation◦ coin, money in the form of coins" (as opposed to paper
money or bullion)
Governments had no control over monetary issues (i.e., money flow)
◦ Chronic specie scarcity
1. Era of Specie Money
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18th and 19th century
Financial revolution: Paper money; modern banking, credit instruments
Government started printing money◦ Government acquired extensive control over money
supply
2. Era of Political Money
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Macro-economic variable:◦ Influence economic activities
Government could solve inadequacy of specie money◦ E.g., Gov’t. could fight against deflationary pressure
But this can also create inflationary bias◦ diminish value of currencies◦ instability in IMS
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We want both flexibility in domestic economic policies and stability in IMS
BUT, trade-off between autonomous domestic economic policies and stable monetary order
The way this dilemma was resolved characterizes the subsequent phases in history of IMS
Dilemma:
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1870-1914
Features:1. Central bank of a nation bought and sold gold at a fixed
price2. Citizens could freely export and import gold3. Central bank did not interfere with capital flow4. Fixed exchange rate mechanism for adjusting
international BOP
3. The Classical Gold Standard
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Embodiment of classical liberal economic principles
Very successful IMS
Facilitated growth of world trade and global prosperity
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But at the cost of autonomy in domestic economic policies
Worked well till World War I
Facilitated growth of world trade and global prosperity
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Why did the Classical Gold Standard collapse?
◦ Rise of warfare state◦ Major consequence of WWI: nationalization of IMS◦ States safeguarded their gold supplies, disengaged
from fixed XR◦ Advent of Keynesianism: government should fight
against frequent recession and high unemployment
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Interregnum period
Currency tied to gold, but the return to gold standard was ruled out
Instead of gold, states could use gold-backed currencies such as British sterling
Basically similar to the Classical Gold Standard
4. Gold Exchange Standard
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Only survived a few years. Why?
◦ Rise of welfare state◦ Welfare objectives (e.g., continuous economic growth
and full employment) are more important than stable international monetary order Rise of labor unions
◦ Active intervention in monetary issues
The trade-off…
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Autonomy of domestic economic policies over stable international monetary system!
“Beggar-thy-neighbor policies”, competitive depreciation Great Depression WWII
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Two goals of the Bretton Woods System
1. A world in which governments would have considerable leeway to pursue national economic objectives, yet
2. The monetary order was based on fixed exchange rate to prevent competitive depreciation
In other words, both autonomy and stability!
5. Bretton Woods System
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Creation of the International Monetary Fund (IMF) to supervise the Bretton Woods System
The compromise of domestic autonomy and stability of IMS:
◦ Embedded liberalism
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Embedded Liberalism
◦ “Unlike the economic nationalism of the thirties, it would be liberalistic in character; unlike the liberalism of the gold standard, its liberalism would be predicated upon domestic interventionism.” – John G. Ruggie
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Avoided
1. Subordination of domestic economic activities to the stability of the IMS (key feature of the Classical Gold Standard)
2. The sacrifice of the IMS to the domestic policy autonomy (key character of the interwar period)
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Intended to enable governments to pursue Keynesian growth policies at home, without sacrificing international monetary stability
Also to achieve stable international monetary system, without subordinating autonomy in domestic economic activities
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How the dilemma was solved during the BWS
◦ If a country is suffering temporary BOP disequilibria, IMF would provide medium-term loan to the country
◦ If a country is suffering fundamental BOP disequilibria, the system would permit a country to change its exchange rate
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The key to the system?
◦ American economy dollar◦ Other nations pegged their currencies to the dollar
(system of fixed XR)◦ The US pledged to keep the dollar convertible into gold
at $35 per ounce◦ Dollar was the principal medium of exchange, store of
value, and unit of account
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It was quite successful!
But why did the system collapse?
Triffin dilemma
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Triffin dilemma:
◦ soundness of BWS depended on liquidity and international confidence created by the US economy
◦ Every state wants dollar to rectify their BOP problem◦ But the US can’t print dollars indefinitely inflationary
pressure devalue the worth of dollar◦ People will lose confidence in dollar and in the system
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Triffin dilemma:
◦ To provide liquidity, the US would have to run BOP deficit
◦ US BOP deficit in the long run will undermine confidence in the dollar and the system
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Two basic asymmetries:
1. Role of dollar as providing liquidity US BOP deficit decreased confidence in the system
2. US, not able to devalue the dollar to improve its BOP position
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Collapse of the BWS
◦ August 15, 1971 – Nixon announced that the US will suspend the convertibility of the dollar into gold
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Kingston Conference (1976)
The determination of the par value of a currency is the responsibility of the country
6. System of Flexible Rates
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Briefly discuss:
◦ the importance of international monetary system
◦ trade-off between national autonomy over domestic policies and stability of international monetary system
Activity