BRETTON WOODS AND INTERNATIONAL FINANCE

After World War II, the world’s financial and trading system needed to be redesigned.

A new international economic structure was created at Bretton Woods, N.H., in 1944.
This post-war economic system was based on free trade, laissez-faire, capitalism, and liberal economic theories.  This is called the Liberal International Economic Order.

Globalization has been a result of this approach.

Bretton Woods created the International Monetary Fund and the International Bank for Reconstruction and Development became the World Bank

Bretton Woods System: 1944 - 1971

“In July 1944, forty-four states allied in war against the Axis powers met in the New Hampshire resort community of Bretton Woods.  Their purpose was to devise new rules and institutions to govern international trade and monetary relations after World War II.”  A brief description of the Bretton Woods System, is then given by Kegley and Wittkopf. (World Politics, 8^th Ed., pp. 248 - 249).  This analysis is then continued on pages 261 to 288.

The planners wanted to avoid a return to protectionism (each country going it alone), which had plagued the world after World War I and may have contributed to the outbreak of World War II.  A system of relatively free trade and economic liberalism was to prevail.   Pound sterling and the dollar were the dominant currencies at the time.  A system of fixed exchange rates between major currencies was created. 

When national economies got into trouble because of imbalances in their international trade and finance balances, the International Monetary Fund (IMF) was created to lend them money until their currencies and trade patterns stabilized or were readjusted.  Since much of Europe was damaged during WWII, an International Bank for Reconstruction and Development was created to lend money to Europe for rebuilding its infrastructures and economies.  These loans were intended to “prime the pump” of economic recovery.  The United States, which funded most of these loans, expected to profit by a) selling most of the goods the Europeans would buy with the funds received and b) the overall increase in trade that revived European economies would generate.   European recovery would also diminish the threat of communist revolution that prolonged economic turmoil might engender.  It was a win-win situation for all.

This system worked well until 1971 when the global burden became intolerable for the domestic U.S. economy.  The U.S. economy was growing in absolute terms, but its relative position of dominance was declining.  Especially our military commitments throughout the world were eating into our balance of payments.

Floating Exchange Rates

In 1971, President Richard Nixon de-linked the dollar from gold.  He would no longer exchange $32 for an ounce of gold.  The stable value of the dollar to gold was broken and with it the fixed system of exchange rates.  The dollar would float in value depending on market forces.  The underlying domestic economy of the United States and the faith that foreign exchange traders put into the value of the dollar would henceforth determine the value of the dollar on the market.

It may be difficult for students to accept but money is a commodity just like copper or pork belly futures.  Money can be bought and sold.  One can exchange one currency into another not only as a tourist and need to convert dollars into euros to buy a meal at a small bistro in Bordeaux, but also as a speculator who wants to make a profit out of currency fluctuations from one day to another.  This kind of trading in currencies is called arbitrage.  In late 2007, “the volume of arbitrage traders routinely exceeds $2 trillion daily,” according to Kegley (12^th ed., p. 261).

“As a result of increasing cross-over capital flows, the global financial market has become increasingly interconnected.  This has made imperative the need for a reliable system of money exchange across borders to cope with the broad array of fluctuating national currencies.  The daily turnover on the global currency markets often is greater now than the global stock of official foreign exchange reserves, and this has practically eliminated the capacity of government central banks to influence exchange rates by buying and selling currency in those markets.” (Kegley, World Politics, 12^th Ed, p. 261).

The central governments of so-called sovereign states and their central banks have lost control over the value of their own currency on the global currency markets.  Think about the implications of that statement.

Global Monetary System

            International Monetary Fund (IMF) seeks to stabilize exchange rates

            World Bank makes loans to Global South countries

            Central Banks of States manage financial systems of states.

            Currencies are the mediums of exchange within a countries.

            Exchange Rates allow one currency to be converted into another.

            Arbitrage is trading and profiting in currencies. (Trading dollars for yen or euros.)

            International Loans and International Debt is growing.

            Finance Capitalism is the general term for the world financial system based on private ownership.

            Direct Foreign Investment is money invested by multinational corporations in a foreign country.

            Foreign Aid is usually money granted or loaned by one country’s central government to another country.