What was the Bretton Woods Agreement and System?

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Definition:

The Bretton Woods Agreement was a financial agreement negotiated in 1944 in Bretton Woods, New Hampshire, that set the value of the U.S. dollar relative to gold and other currencies relative to the U.S. dollar.

🤔 Understanding the Bretton Woods Agreement

The Bretton Woods Agreement was a financial agreement negotiated in 1944 near the end of World War II. The Allied Nations met in Bretton Woods, New Hampshire, to discuss the international economy. During the negotiations, they agreed to set the value of the U.S. dollar relative to the value of gold and to peg other countries’ currencies to the U.S. dollar. The agreement also established the International Monetary Fund (IMF). The Bretton Woods System remained in place until the United States ended the gold standard in 1971.

Example

Under the Bretton Woods System, every currency involved in the agreement had a known value in U.S. dollars or gold. Any person could convert their foreign currency to dollars, and anyone holding dollars could turn their dollars into gold. According to the agreement, the value of the dollar was set at 1/35th of an ounce of gold. Holders of British pounds could convert them to dollars at a rate of $4.03 to the pound. This made it easy for any person to know what their money was worth compared to other currencies in the agreement.

Takeaway

The Bretton Woods Agreement and System is like making up rules for swapping food with your friends at lunch…

When you eat lunch with your friends, you might want to trade something you brought for something that they brought. Different foods can have different values. You and your friends may agree that you can swap two apples for a bag of chips or one sandwich for a can of soda. The Bretton Woods Agreement and System was similar, codifying rules for exchanging from one currency to another.

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What was the Bretton Woods Agreement and System?

The Bretton Woods Agreement was the result of a series of negotiations among the Allied powers near the end of World War II. In 1944, the nations agreed on how to set up the world’s financial system after the war. The agreement takes its name from Bretton Woods, New Hampshire, where the negotiators met to discuss the plan.

Before the agreement, most nations operated using the gold standard, relating the value of their currency to the cost of gold and allowing those who held the money to convert their cash into gold. The Bretton Woods system modified this somewhat, establishing the U.S. Dollar as the world’s reserve currency and setting its value equal to 1/35th of an ounce of gold. The U.S. maintained gold reserves in the Treasury and other nations pegged the costs of their money to the U.S. dollar. The goal was to make it easy to convert from any currency to the dollar, which had a known value in gold. This helped facilitate the exchange of currencies.

The agreement also established significant international organizations like the World Bank and the International Monetary Fund.

Though the deal was made in 1944, it didn’t fully go into effect until 1958. The agreement helped stabilize the values of the currencies involved, and the IMF received contributions from member nations that it could lend to countries that required additional funds.

The deal collapsed in the early 1970s as the United States reduced the value of the dollar to 1/42nd of an ounce of gold. Eventually, President Nixon suspended the convertibility of the dollar to gold, removing the United States from the gold standard entirely.

Though the Bretton Woods system broke down with this change, the institutions it created remain an essential part of the international economy to this day.

What were the main objectives of the Bretton Woods system?

The Bretton Woods system sought to accomplish a few goals.

The first goal was to create a monetary system more flexible than the gold standard. The gold standard makes it difficult or impossible for governments to adjust the value of their currency based on their country’s economic needs and forces central banks to hold vast reserves of the metal.

Another goal was to prevent governments from devaluing their currencies to compete with other countries in the import and export markets. The new system aimed to establish fixed exchange rates between the monies involved.

Third, the agreement sought to encourage economic growth among the member nations through a combination of stabilizing currency values, fostering international trade, and establishing bodies like the World Bank and International Monetary Fund to help countries grow their economies.

What were the features of the Bretton Woods System?

One of the primary features of the Bretton Woods System was a set conversion between currencies and the U.S. dollar and the U.S. dollar and gold. The value of the dollar was set at 1/35th of an ounce. The values of other currencies were pegged to the U.S. dollar. Those who held other currencies covered by the agreement always knew how many dollars they could receive for their British pounds or French francs.

The value of a currency in comparison to the dollar could only change slightly. More substantial changes required international approval.

The agreement also established the International Monetary Fund, which is tasked with tracking exchange rates, maintaining international reserves currencies, and lending money to countries that require extra funds to maintain their exchange rates. It also created the World Bank, which aimed to help rebuild the global economy after World War II and assist underdeveloped countries with growing their productivity.

Who signed the Bretton Woods agreement?

Forty-four countries sent delegations to the Bretton Woods conference to negotiate the Bretton Woods System. Each of those 44 countries later signed the agreement.

The countries that signed the agreement were:

  • Australia
  • Belgium
  • Bolivia
  • Brazil
  • British Raj
  • Canada
  • Chile
  • China
  • Colombia
  • Costa Rica
  • Cuba
  • Czechoslovakia
  • Dominican Republic
  • Ecuador
  • Egypt
  • El Salvador
  • Ethiopia
  • France
  • Greece
  • Guatemala
  • Haiti
  • Honduras
  • Iceland
  • Iran
  • Iraq
  • Liberia
  • Luxembourg
  • Mexico
  • Netherlands
  • New Zealand
  • Nicaragua
  • Norway
  • Panama
  • Paraguay
  • Peru
  • Philippines
  • Poland
  • South Africa
  • Soviet Union
  • United Kingdom
  • United States
  • Uruguay
  • Venezuela
  • Yugoslavia

What were the benefits of Bretton Woods currency pegging?

Stability and predictability were the benefits of currency pegging under Bretton Woods.

The agreement limited how much the value of a currency could change, forcing it to stay within a small band. Someone who had four British pounds knew that those pounds were worth about one dollar.

Under a system where currencies float freely, four pounds could be worth one dollar one month, two dollars the next, and 50 cents the month after that. Constantly changing currency values can make it hard for governments and businesses to plan for and handle international trade. Setting a fixed conversion value made it far easier for organizations to predict their costs, regardless of where they did business and what currency they used.

What was the impact of the Bretton Woods System?

The Bretton Woods System failed to stand the test of time, but it has had far-reaching effects that are felt to this day.

The stability and predictability it offered helped restore confidence in the international economic system after World War II. This helped create an economic boom that lasted through the 1950s and 1960s.

The cooperation among governments also helped encourage globalization as it fostered international trade and made currency conversion much more predictable.

The agreement also established the World Bank and International Monetary Fund, which continue to play a significant role in the world economy, offering loans to nations that need assistance growing their economies.

What institutions did the Bretton Woods Agreement create?

The Bretton Woods Agreement established two major world institutions: the International Monetary Fund and the World Bank.

International Monetary Fund

The International Monetary Fund (IMF) today includes 189 countries that work together to encourage growth, international trade, and the reduction of poverty. The IMF states that its primary goal is “to ensure the stability of the international monetary system.”

It accomplishes this goal using a three-pronged approach.

First, it monitors the world economy and the policies of each of its member nations. It highlights issues that it finds in countries’ policies and risks to global stability.

Second, the IMF offers loans to nations that need help stabilizing their currencies, paying for imports, or otherwise encouraging growth.

Third, the IMF works with less-developed nations to help them modernize their economic systems and train people to implement policies that encourage growth.

The World Bank

The World Bank helps developing countries by offering low or no-interest loans and grants to developing nations. It helps borrowers to take on projects focusing on things like education, infrastructure, developing the private business sector, agriculture, and managing natural resources. It also participates in knowledge sharing efforts to help countries improve their economic systems.

The World Bank has two goals that it aims to accomplish by 2030.

  • Reducing poverty by improving the economic standing of those who currently earn less than $2 per day
  • Shrinking inequality by providing aid to people in the bottom 40% of income in each nation

Why did the Bretton Woods System collapse?

The Bretton Woods System collapsed in the early 1970s when President Richard Nixon suspended the convertibility of the U.S. dollar to gold.

The system collapsed for a few reasons.

One is that a surplus of the U.S. dollar caused by increasing foreign investment, aid, and American spending caused the number of dollars in circulation to outpace the amount of gold the U.S. government held in reserve.

As the oversupply of the dollar increased, people who held dollars worried that the government would have to cut the value of the dollar in comparison to gold. This led to a run on gold, which was part of President Nixon’s reasoning for suspending the dollar’s convertibility.

The economic upheaval of the early 1970s, including rising unemployment and stagflation, also encouraged the U.S. government to alter its currency’s value, which helped lead to the collapse of the Bretton Woods system.

What replaced the Bretton Woods system?

When the Bretton Woods system collapsed, countries became free to set the value of their currencies as they wished. Most countries remain members of the IMF, which forbids nations from returning to the gold standard.

Today, many nations allow the value of their currency to float freely in comparison to other currencies. Other governments peg their currency’s value to a reserve currency such as the U.S. dollar or the Euro or the value of a basket of multiple currencies.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

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© 2022 Robinhood. All rights reserved.