A simple analysis on the Bretton woods system

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  Introduction
  The span of the distance between the Bretton woods system collapse time and present time is about 40 years. During this period of time, the international exchange rate system has transformed from gold - dollar standard into multiple exchange rate arrangement system which gives priority to floating exchange rate. However, due to the blemishes of Floating exchange rate system, further reform of the international monetary system has became more and more imminently.Based on above circumstance, it is indispensable to retrospect the Bretton woods system and implement a simple analysis on it, thus, providing theoretical and practical significance for the prospect of further reform of the international monetary system. This essay will implement a simple analysis on The Bretton Woods system from brief introduction of the Bretton woods system、the operating mechanism of the Bretton woods system、the benefits and cost of fixed exchange rates under the Bretton woods system、the reasons of the Bretton woods system collapse、and the enlightenments for further reform of the international monetary system.
  Brief introduction of the Bretton woods system
  In December 1945, 29 countries representatives which attended the Bretton woods meeting signed the Bretton woods agreement, symbolizing the formal establishment of the international financial order after the war .The main contents of the Bretton woods system consists of four parts. The first part is the dollar linked to the gold directly, the convertibility of per ounce of gold is 35dollars.The second part is other member states should peg their currencies to the dollars, that is, to maintain a fixed exchange rate with the dollars. The third part is that member states can counsel the international monetary affairs together and obtain credit support via establishing the International Monetary Fund(IMF).The last part is to cancel the foreign exchange control of current account.
  The operating mechanism of the Bretton woods system
  The operating mechanism of the Bretton woods system can be simply generalized as ‘two hooks’ and ‘two channels of regulating the balance of payments’.
  1)‘Two hooks’:i)The first hook is that the dollar pegs to the gold. It is mainly manifested in two aspects. One aspect is each member states should confirm the official price of gold, that is, per ounce of gold is equal to 35dollars. Another aspect is the U.S. government should agree that each member states could always exchange dollars with U.S. for gold according to the above official price in gold. Based on this, the dollar could link with gold directly. ii)The second hook is currencies of other member states are pegged to the dollar. To be specific, currencies of other member states maintain fixed price parity with dollar to establish a relatively fixed exchange rate relationship with dollar.   2)‘Two channels of regulating the balance of payments’: i) The first channel is to regulate the balance of payments via IMF. The deficit member states could obtain loan of IMF to make up the deficit. Each member states has the right to obtain ordinary loan of IMF to cope with temporary current- account. ii)The second channel is to regulate the balance of payments via exchange rate adjustment. Each member state can change its currency parity when there is a fundamental imbalance in international payments .However, the adjustment should be acquire the approval of IMF if adjusting scope exceeds 10% up and down of parity.
  In short, based on the operating mechanism, an international monetary system which is centered on dollar is established.
  The benefits and cost of fixed exchange rate system under the Bretton woods system
  To be more exact, the fixed exchange rate system under the Bretton woods system is an adjustable fixed exchange rate system,that is, national monetary authorities of member states maintain the real exchange rate in a small scope via foreign currencies intervention or domestic economic policy measures. In addition to, according to Mint Par Theory、purchasing power parity theory and Keynes’s interest parity theory, the essence of the fixed exchange rate system is monetary consideration among different currencies based on its own value.
  1)The benefits of fixed exchange rate system. i)The fixed exchange rate system make fluctuation range of exchange rate be limited within a certain range,thus,reducing risk of exchange rate fluctuation. It is conducive to promoting the development of international trade.The volume indices increased from 300 in 1950 to 1635 in1973.It indicates that the fixed exchange rate system makes a great contribution to the rapid development of world trade. ii) From the perspective of economic fundamentals, the fixed exchange rate system can not only increase policymakers’ credit of pledging to maintain low、stable inflation but also reduce the frequency of speculation. iii) The fixed exchange rate system is conducive to stable development of world economy. It will impose limits on domestic monetary policy and reduce the uncertainty of exchange rate volatility. Based on this, the world economy enters a stable development track. Just as Maddison described: The world economy in 1950-1973,the world GDP per capita increased by 3% each year. iv) The fixed exchange rate system is beneficial to guard against ’irresponsible’ government policies. The fixed exchange rate system can confine the government to use inflation tax as a source of income, thus, limiting the ability of policymakers to make up for the deficit via seigniorage.   2)The cost of fixed exchange rate system under the Bretton woods system. i)Fixed exchange rate system can barely play the role to adjust the economic leverage of the balance of payments. Fixed exchange rate system will make one country unable to achieve the balance of international payments in the event of a balance of payments deficit. Instead, it will often cause a large number of outflows of domestic foreign exchange and gold, thus, making a significant decline in international reserves. ii)Fixed exchange rate system is easy to damage the internal economic equilibrium. For instance, in the event of a country’s balance of payments deficit, in order to keep domestic currency off devaluation, the country would need to implement tighten monetary policy or fiscal policy. However, these policies will restrain domestic economic growth and increase unemployment rate. iii)Fixed exchange rate system will make the internal value and external value of currency disconnect, thus, affecting internal and external equilibrium at the same time. Due to fixed exchange rate system determines legal parity and upper and lower scope, the exchange rate is not always exact to reflect the real purchase power of currency between the two countries.
  The reasons of the Bretton woods system collapse
  The operation of the Bretton woods system promoted the great development of world economy after World war II via operation mechanism and unique benefits of fixed exchange rate system. However, the Bretton woods system fell apart in 1973.The reasons of the Bretton woods system collapse are as following:
  1)The internal contradiction of system. According to ‘Triffin dilemma’, the collapse of the Bretton woods system is ascribe to the inherent contradiction of system itself. On the one hand, dollar is not only the store currencies but also pay off means of each member states. On the other hand, the international payment deficits and budget deficits of U.S will take a toll on the dollar credit.
  2)The incompatibility between international intervention and domestic interests. On the one hand, U.S assumes the responsibilities of managing world monetary system and the monetary policy of U.S has become the world’s monetary policy. On the other hand, many member states use the international system to make self-serving. This free-rider behavior undermines the effectiveness of the Bretton woods system virtually.
  3)The high cost. In the early time of the Bretton wood system, U.S can still achieve benefits from maintaining the stability of the system via its powerful economic entities and less dependence on the international economy. However, with the deterioration of trade status and chronic deficit of U.S, Europe and Japan began to concern the excessive supply of dollar will result in inflation and currency turbulence. Finally, the world foreign exchange market was in a mess.   The enlightenments for further reform of the international monetary system
  Based on the above elaboration, there are several enlightenments for further reform of the international monetary system.
  1)The ideal of Fixed exchange rate often deviates from the reality. Fixed exchange rate system has ever been the ideal pursuit of the international monetary system. However, due to lots of asymmetries, it is often tough to achieve. The asymmetry of the gold nature and dollar made fixed exchange rate system struggle on the verge of collapse.
  2)Strengthening the Regional monetary cooperation will be conducive to the stability of international monetary system. Economies of the periphery countries are often affected by inflation or deflation because of spillover effects of economic policy of core countries. Under the condition of increasing globalization of financial and economy, to strengthen regional monetary cooperation and economic integration is conducive to resist the external impact effectively.
  3)A counterweight to the nation’s economic power in the system is the key to the stability of international monetary system. In the view of the stability of the international monetary system, economies difference between the core and peripheral countries is objective but it should be restricted reasonably.
  4)Reforming the existing reserve currency system which is dominated by the dollar. Moreover, restructuring and increasing the number of international financial institutions with multiple levels. What is more, to establish a multi-level global financial safety net.
  Conclusion
  This essay comprehensively expounded the Bretton woods system from brief introduction、the operating mechanism、the benefits and cost of fixed exchange rates、the collapse reasons、and the enlightenments for further reform of the international monetary system. Although the Bretton woods system has fell apart for about 40years,a simple analysis on itself ,especially, on its operating mechanism、the benefits and cost of fixed exchange rates、the reasons of collapse will undoubtedly provide a useful lesson to further reform of the international monetary system. It can be confirmed that further reform of the international monetary system could not be separated with withdrawing the simple analysis of the Bretton woods system.What is more, further reform of the international monetary system needs deep global cooperation and balanced development of world economy. Based on the rational grasp on the Bretton woods system, further reform of the international monetary system will be achieved finally.
  References:
  [1]Dooley,M.P.,
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