The Bretton Woods System and Its Role for Forex Market
If at least some of the following words: “fixed exchange rate”, “fluctuations of the foreign exchange rate”, “pegged currencies”, “IMF” and “Smithsonian Agreement” do not sound like abracadabra to you, but, on the contrary, seem quite familiar, perhaps you must have heard about the Bretton Woods system then. And even you see the above-mentioned terms first in a lifetime, and out of the collocation “the Bretton Woods system” you know only the word “system”, still the information below will be useful for you. We all live in a world where Foreign exchange is a very important and frequent thing, and each of us tackles the necessity to deal with foreign currencies – most often for our private purposes, like travelling abroad or paying for foreign goods. However, only some of us connect Forex not with the physical exchange of money only, but rather with making profit on the Forex market.
Trading currencies in the Forex market and existence of the Forex Market itself became possible thanks to some global financial reforms that took place in the XX century. These reforms resulted in establishing the floating currency exchange rate regime, which made trading currencies against one another possible. However, there were three major landmarks in the history of Forex, and the Bretton Woods system is one of them. So, in order to get a deep understanding of what Forex is, let’s have a closer look at these landmarks.
On the whole, the history of Foreign exchange can be subdivided into three large periods:
- Before the Bretton Woods system;
- The Bretton Woods system itself;
- After the Bretton Woods system.
So, let’s start the ball rolling. After we have answered the following questions, we will have a full picture of Bretton Woods system, its role and significance for the Foreign exchange.
The Foreign exchange before the Bretton Woods system
In fact, the notion of Foreign exchange was not very developed in the times before theBretton Woods system (XIX – early XX centuries). The matter is that the world economy was not very mobile at those times, especially in comparison to today. The reason of this was the level of science and technology development. Development of transport was quite poor, that didn’t allow quick cross-border capital movements. At that time, the value of the national paper currency was defined depending on the gold reserves of a certain country. That is, the more gold a country had in its reserves, the more powerful and valuable its currency was considered. This system was called The Gold Standard. The pound sterling was the leading currency at that time, because it was the most backed up with gold. As a result, England became very influential and authoritative country in the currency market at that time.
That was a period of a certain economic stability. The Gold Standard became the domineering economic system in the world. However, it wasn’t absolutely flawless, and over time its faults began to show themselves.
By the end of the XIX century the world economy started developing rapidly – that was for a large part thanks to the technological and scientific progress. The world has never faced such tempos of development before. Certainly, currency exchange rates were affected, too – national currencies could devaluate and revaluate in a boom-bust regime. Inflation could replace economic growth on the instant, because it often turned out that the supply of paper money in a certain local country did not always to correspond to the gold cover of this country, and nobody could be made responsible for that. Moreover, gold production was not sufficient to meet the demands of international trade and investment. By the time of World War I governments began to control imports and exports in order to compensate blockades of the war period. This led to the manipulation of currencies for the purpose of shaping foreign trade.
What is more, most countries governments in the 1930s were keen on such practice as currency devaluations to increase the competitiveness of a national’s export products to reduce balance of payments deficits — which resulted in falling country’s incomes, shrinking demand, mass unemployment, and an overall downturn in world trade. Trade in the 1930s became largely limited to currency blocs. Currency blocks were the groups of nations that used an equivalent currency, for example the “Sterling Area” of the British Empire. In particular, the British Empire created their own economic block to shut out the US goods, since they were realizing that they could no longer compete with the US industry. These blocs held back the international flow of capital and investment opportunities from foreign country. This strategy dramatically worsened the international economic situation.
This ongoing volatility of the Golden Standard system and the lack of universal rules regulating currency relations were highly inconvenient for the most governments.
Then the Great Depression came. Though the Great Depression of the 1930s is notion referring to the USA economy for the most part, its experience was very painful for the entire world. In fact, it led to led to a breakdown of the international financial system and a worldwide economic depression. The Gold Standard collapsed entirely during the Great Depression that generated a chaos.
Source: http://www.forexreview.org/bretton-woods-system/
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