How did the Bretton Woods system change exchange rates?

1 Fixed but adjustable rates

Under the Bretton Woods system, each country agreed to peg its currency to the US dollar, which in turn was convertible to gold at a fixed rate of $35 per ounce. This meant that exchange rates were fixed but could be adjusted if a country faced a persistent imbalance in its balance of payments. For example, if a country had a large trade deficit, it could devalue its currency to make its exports cheaper and imports more expensive, thus correcting the imbalance. However, such adjustments required the approval of the International Monetary Fund (IMF), which was created to oversee the system and provide loans to countries in need.

2 Dollar shortage and surplus

One of the main problems of the Bretton Woods system was the asymmetry between the US and the rest of the world. The US was the dominant economic and military power after the war, and its currency was the main reserve and trade currency. This created a high demand for dollars, but also a shortage of dollars in other countries, especially in Europe and Japan, which needed to rebuild their economies and pay for their imports. To alleviate this problem, the US provided aid and loans to its allies, such as the Marshall Plan and the World Bank. However, this also led to a surplus of dollars in the global market, which eroded the confidence in the dollar's value and gold convertibility.

3 Speculation and crisis

As the US economy grew and faced inflationary pressures, it became harder for the US to maintain the fixed gold-dollar exchange rate. The US started to run a balance of payments deficit, which meant that it had to sell its gold reserves to meet the demand for dollars from other countries. This raised doubts about the US's ability and willingness to defend the gold parity, and encouraged speculation against the dollar. In response, some countries, such as France and Germany, decided to convert their dollar holdings into gold or other currencies, creating a run on the US gold reserves. This triggered a series of currency crises in the 1960s and 1970s, which undermined the stability and credibility of the system.

4 Flexible and floating rates

The Bretton Woods system effectively ended in 1971, when President Nixon suspended the convertibility of the dollar into gold, in what is known as the Nixon shock. This marked the beginning of a new era of flexible and floating exchange rates, where currencies are determined by market forces of supply and demand, rather than by fixed rules or interventions. This allowed countries to have more autonomy and flexibility in their monetary and fiscal policies, but also exposed them to more volatility and uncertainty in the exchange rate markets. The IMF and the World Bank continued to play important roles in providing financial assistance and advice to countries, especially to developing and emerging economies.

5 Legacy and lessons

The Bretton Woods system had a lasting impact on the global economy and governance. It fostered a period of unprecedented growth, trade, and cooperation among countries, as well as a sense of shared responsibility and solidarity. It also laid the foundations for the development of other international institutions and agreements, such as the General Agreement on Tariffs and Trade (GATT), the European Economic Community (EEC), and the Group of Seven (G7). However, the system also revealed the limitations and challenges of managing exchange rates in a complex and dynamic world. It showed the need for balance and adjustment between national interests and global objectives, as well as between stability and flexibility.

6 Here’s what else to consider

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