International Financial Architecture
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Essays on International Financial Architecture
Priyvrat Mamgain
2/25/2013
Topic 1: What were the outcomes of the Bretton Woods conference and which factors can account for the agreements reached at that conference? (1200 words)
The Bretton woods conference is a United Nations Monetary and Financial Conference that was organized between 1 and 22 July 1944 at Mount Washington Hotel in Bretton woods, New Hampshire, United States. 730 delegates from 44 nations signed an agreement on the final day of the conference. This agreement went on to become one of the major agreements to govern the monetary relations of independent monetary states. But the obvious question which comes to my mind is why a need for an internationally negotiated monetary order was felt during that period? The reasons were the economic ramifications of the great depression and the concentration of power among a few major economies. Moreover, during the period of the Great depression, the economies engaged in the so called “beggar thy neighbor” policies i.e. competitive devaluation of the currencies by various economies in order to substitute imports with domestic goods and increase the competitiveness of the exports in the international markets. In addition, a number of countries also imposed trade barriers, restricting the recovery of international trade. Hence, the representatives from the major nations gathered at Bretton woods to agree upon a unified rules, procedures and institutions to avoid a repetition of a similar prolonged economic crisis.
The following were the major outcomes of the Bretton woods agreement:
Creation of Par value system, emergence of US dollar as reserve currency
Convertibility of US dollar to gold at a fixed price
Establishment of IMF for international cooperation on monetary matters
Determining the power, functions and organization of the Fund
Establishment of IBRD to finance the recovery of war inflicted nations
The members of the conference believed that stable currency exchange rates were extremely important in order to have a free international trade and a sound recovery from the Great Depression. Reflecting upon the lessons learnt during the crisis, a free floating exchange rate was deemed unsuitable for the global monetary system. Reverting back to the gold-backed fixed exchange rate system also appeared less feasible to the members not only because the amount of gold reserves were insufficient to meet the rising demand of international trade but also because a large amount of gold reserves were in Soviet Union, which would later appear in a Cold War with the US. Hence, the members agreed to peg the national currencies to the US dollar, reflecting the reliability of the dollar and the power of the U.S. This means that the governments had the role to intervene in the forex market to keep the exchange rate in the band of plus/minus 1% of the pegged rate and this also led to the emergence of US dollar as a reserve currency. Bordo (1993) argued that the architects of the Bretton Woods system wanted a set of monetary arrangements that would combine the advantage of the classical gold standard (i.e., exchange rate stability) with the advantage of floating rates (i.e., independence to pursue national full employment policies). Similarly, Cohen argued, in his paper titled Bretton Woods System, that free floating exchange rates encourage destabilizing speculations and competitive depreciation. Nuksee (1944) echoed Cohens argument by adding that in a free floating exchange rate regime, a depreciating currency makes speculators and importers to anticipate a further deprecation, resulting in further decline in currency value. But this explanation is largely contested by
Friedman (1953), who argued that every case of destabilizing speculation Nurkse documented involved a prospective change in government policies that would otherwise have changed the exchange rate-that the market just facilitated movement to the new rate. Moreover, Eichengreen and Sachs (1985) contested the prevalence of beggar-thy-neighbor devaluations in the 1930s. They showed that most devaluations were accompanied with expansionary monetary policies.
Besides, the creation of international institutions such as International Monetary Fund (IMF) and International Bank of Reconstruction and Development (IBRD) were the other outcomes of the conference. The members believed that an establishment of an institution such as IMF can prevent the repeat of currency troubles of the interwar years by providing established procedure for inter-governmental consultation. Negotiators believed that future threats to stability are more likely to emerge from private speculation and IMFs pool of liquidity will be useful in dealing with such situations. The main function of IMF was to establish international monetary cooperation and to provide a multilateral payment system to ensure a smooth transition period. Cohen highlights administering the rules governing currency values and convertibility, supplying supplementary liquidity, and providing a forum for cooperation among governments as the important functions of IMF. The fund had significant powers to influence international monetary system for eg: to decide upon changes in parity, use of multiple exchange rates and even to declare members ineligible to use its resources or even expel members, if required.
On the other hand, IBRD was created with the purpose of providing financial assistance to the nations suffering in the aftermath of the war. According to the data on the website of the World Bank, the Bank financed projects seeking to dam rivers, generate electricity, and improve access to water and sanitation. Following the reconstruction of Europe, the Banks mandate has transitioned to eradicating poverty around the world.
Other factors effecting the agreements reached at the conference:
1. Learning from Depression: Since the conference was held amid the Great Depression, the lessons learnt during and just before the start of depression were fresh in the minds of the member nations. Bordo (1993) highlights the flaw of gold exchange standard, the case against floating exchange rates, and bilateralism as the three major issues dominating the perception of interwar experience. Hudson (2003) argued that the public officials wanted to ensure that the nations are not inclined to isolationism in future, thereby lowering the chances of a similar debacle of the international financial system in the future.
2. Interests of the US: It is