bret ton woods system[1]

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    Brettonwoods System

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    Brettonwoods SystemEvolved in response to the dire necessity

    of:

    i) Stability of Exchange Rate &

    ii) Availability of adequate InternationalReserves.

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    J uly 1, 1944 Brettonwoods Agreement.

    Fixed Parity of global currencies againstUS $.

    U.S. fixed gold parity as $ 35 for oneounce of gold.

    U.S.A undertaken free convertibility of U.S. dollar for gold.

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    G lobal currencies backed by U.S. gold ascollateral.

    + or 1% fluctuation band allowed.

    Values of other currencies fixed in U.S. $official parity.

    Exchange rate maintained within 1percent on either side of official parity.

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    T his required U.S. to maintain gold backing its$ currency.

    Other member countries to maintain $

    reserves.

    Allowed a revision of 10 percent within a year of initial selection of the exchange rate.

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    The Articles of Agreements requires IMF memberscountries to :

    1.Promote international monetary co-operation

    2.Facilitate the growth of trade3.Promote exchange rate stability4.Establish a system of multilateral payments5.Create reserve base.

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    ACT IVIT IES OF I M F

    Surveillance process of monitoring &consultation handled by I M F.

    Financial assistance of different kinds.

    For ensuring adequate reserves flow

    maintaining Exchange Rate stability &avoiding competitive depreciation of currencies.

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    Special Drawing Rights (SDRs)

    Created in 1969.

    T o augment world liquidity.

    T aking into account shortage of $ and goldsupply in response to increase world trade /other global transactions & consequentshortage of world liquidity.

    SDRs allocation to members in proportion totheir contribution to funds.

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    W hat is SDRs ?

    SDRs => Not currency => Not claim onI M F => is sanction of credit limit tomember countries.

    Is potential claim on freely usable

    currencies of I M F members.

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    H olders of SDRs can obtain these currencies inexchange for their SDRs in two ways:

    i) T hrough arrangement of voluntaryexchanges between member countries.

    ii) An arrangement by I M F fordesignatingmembers with strong external positions topurchase SDRs from members with weakexternal positions.

    Deficit countries can use them to purchasestronger currencies which can be used to payoff B.O.P. debts.

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    Brettonwoodssystem

    ended in 1973

    B y 1973 many countries moved to flexible exchange rates.

    Break-down of

    Brettonwoods system

    G eneral Force Specific Forces

    French Policy Reactionto dominance of $

    Tiffin's paradoxcontinuing and growingU.S. deficits growingreserve requirements.

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    H uge Deficit in U.S. BOP => loss of confidencein U.S. $.

    H olland & G ermany came out of fixed rate parity.

    Central Banks met at Smithsonian Institute onDecember 17 & 18, 1971 to resolve the crisis.

    U.S.A revised the gold parity against $ as $38 per ounce of gold.

    Currency fluctuation band widened from 1% to 2.25%and for some currencies 4.50%.

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    Prospects of the International FinancialSystem.

    T he International Financial Systemevolves in response to the environment itserves.

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    I. 1914 1918 => 1944 1973

    T he shift from classical G old Standard to theStandard adopted at Brettonwoods came inresponse to

    i) Beggar-thy-neighbour, cut-throatcompetition.ii) Protectionist exchange rate policies competitive devaluations during thedepression and W orld war.

    In reaction to the above environment thesystem chosen was characterised by extremerigidity of exchange rates.

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    II. 1960s 1970s

    Oil shocks of the 1960s and the early 1970s.

    Rigidity of Brettonwoods System did notprovide adjustment needed between oil usingand oil producing countries.

    In response to the above environment, thesystem of flexible exchange rate has emerged.

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    III. Since 1980s

    T he environment emerged subsequently wascharacterised by:

    i. G rowing financial & economicinterdependence.

    ii. Financial deregulation & growth in trade.

    iii. Massive structural imbalances of trade &fiscal deficits.

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    In response to the above scenario, the

    unfettered flexibility of the 1970s & early 1980s

    was replaced by the more co-operative

    arrangements of Plaza Agreement and Louvre

    Accord.

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    IV. W here do we go from here ?

    A broad answer to this question can bediscovered from review of the followingchallenging questions:

    a) T he T hird W orld Debt Problem.&

    b) T he shift from U.S. economic hegemony toa shared U.S. J apanese European balanceof Economic Power.

    T he review of the above two burning issuessuggest the possible direction of theInternational Finance System.