International Bank for Reconstruction and Development
The agreement made no provisions for international creation of reserves. New gold production was assumed to be sufficient. In the event of structural disequilibria, it was expected that there would be national solutions, for example, an adjustment in the value of the currency or an improvement by other means of a country’s competitive position. The IMF was left with few means, however, to encourage such national solutions.
It had been recognized in 1944 that the new system could only commence after a return to normalcy following the disruption of World War II. It was expected that after a brief transition period of no more than five years, the international economy would recover and the system would enter into operation.
To promote the growth of world trade and to finance the postwar reconstruction of Europe, the planners at Bretton Woods created another institution, the International Bank for Reconstruction and Development (IBRD), now the most important agency of the World Bank Group. The IBRD had an authorized capitalization of $10 billion and was expected to make loans of its own funds to underwrite private loans and to issue securities to raise new funds to make possible a speedy postwar recovery. The IBRD was to be a specialized agency of the United Nations charged with making loans for economic development purposes.
Bretton Woods – Fixed exchange rates
The Bretton Woods system sought to secure the advantages of the gold standard without its disadvantages. Thus, a compromise was sought between the polar alternatives of either freely floating or irrevocably fixed rates—an arrangement that might gain the advantages of both without suffering the disadvantages of either while retaining the right to revise currency values on occasion as circumstances warranted.
The rules of Bretton Woods, set forth in the articles of agreement of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), provided for a system of fixed exchange rates. The rules further sought to encourage an open system by committing members to the convertibility of their respective currencies into other currencies and to free trade.
What emerged was the “pegged rate” currency regime. Members were required to establish a parity of their national currencies in terms of gold (a “peg”) and to maintain exchange rates within plus or minus 1% of parity (a “band”) by intervening in their foreign exchange markets (that is, buying or selling foreign money).
In theory the reserve currency would be the bancor, suggested by John Maynard Keynes; however, the United States objected and their request was granted, making the “reserve currency” the U.S. dollar. This meant that other countries would peg their currencies to the U.S. dollar, and—once convertibility was restored—would buy and sell U.S. dollars to keep market exchange rates within plus or minus 1% of parity. Thus, the U.S. dollar took over the role that gold had played under the gold standard in the international financial system. (Rogue Nation, 2003, Clyde Prestowitz)
Meanwhile, to bolster faith in the dollar, the U.S. agreed separately to link the dollar to gold at the rate of $35 per ounce of gold. At this rate, foreign governments and central banks were able to exchange dollars for gold. Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar, itself convertible into gold, and above all, “as good as gold”. The U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. As the world’s key currency, most international transactions were denominated in US dollars.
The U.S. dollar was the currency with the most purchasing power and it was the only currency that was backed by gold. Additionally, all European nations that had been involved in World War II were highly in debt and transferred large amounts of gold into the United States, a fact that contributed to the supremacy of the United States. Thus, the U.S. dollar was strongly appreciated in the rest of the world and therefore became the key currency of the Bretton Woods system.
Member countries could only change their par value with IMF approval, which was contingent on IMF determination that its balance of payments was in a “fundamental disequilibrium”.
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