Most traded currencies[3]

[14]
Currency distribution of reported FX market turnover

Ran ISO 4217 code  % daily share

Currency
k (Symbol) (April 2010)
1  United States dollar USD ($) 84.9%
2  Euro EUR (€) 39.1%
3  Japanese yen JPY (¥) 19.0%
4  Pound sterling GBP (£) 12.9%
5  Australian dollar AUD ($) 7.6%

6  Swiss franc CHF (Fr) 6.4%

7  Canadian dollar CAD ($) 5.3%

8  Hong Kong dollar HKD ($) 2.4%
9  Swedish krona SEK (kr) 2.2%
10  New Zealand dollar NZD ($) 1.6%
Other Currencies 18.6%
Total[notes 1] 200%

Top 10 currency traders [6]

% of overall volume, May 2010

Ran Market
Name
k share
1  Deutsche Bank 18.06%

2  UBS AG 11.30%

3  Barclays Capital 11.08%

4  Citi 7.69%
 Royal Bank of
5 6.50%
Scotland
6  JPMorgan 6.35%
7  HSBC 4.55%

8  Credit Suisse 4.44%

9  Goldman Sachs 4.28%

10  Morgan Stanley 2.91%
Main foreign exchange market turnover, 1988–2007, measured in billions of USD.

Significance

Foreign exchange risk is the level of uncertainty that a company must manage for changes
in foreign exchange rates, that will adversely affect the money the company receives for
goods and services over a period of time.
For example, a company sells goods to a foreign company. They ship the goods today, but
will not receive payment for several days, weeks or months. During this grace period, the
exchange rates fluctuate. At the time of settlement, when the foreign company pays the
domestic company for the goods, the rates may have traveled to a level that is less than
what the company contemplated. As a result, the company may suffer a loss or the profits
may erode.
To minimize or manage the risk, companies enter into contracts to buy foreign currency at a
specified rate. This allows the companies to minimize the uncertainty of the risk, so that
they can price their products accordingly.

The meaning of Foreign Exchange

Foreign Exchange is the system or process of converting one national currency into another and of
transferring the ownership of money from one country to another country

What is the meaning of Exchange Rate?

The rates applied by the Bank for converting foreign currency into Indian rupees and vice versa are
known as exchange rates. In other words, exchange rate is the rate at which one currency can be
exchanged for another.

What are the systems of quoting Exchange Rates?

There are two systems of quoting exchange rates:

i.Direct Quotation: Where the price of foreign currency is quoted in terms of home or local currency. In this
system variable units of home currency equivalent to a fixed unit of foreign currency is quoted

For Example US Dollar 1 = Rs 43.50

ii. Indirect Quotation: Where exchange rates are quoted in terms of variable units of foreign currency as
equivalent to a fixed number of units of home currency.
For Example US Dollar 2.30 = Rs. 100

Till 01.08.1993 banks in India were required to quote all the rates on indirect basis. From 02.08.1993
banks are quoting rates on direct basis only

 Size
About $4 trillion a day flows through the global foreign exchange market. The currency exchanges
are closed only for a 24-hour period over the weekend.
 Location
Currencies are traded over-the-counter in the foreign exchange market, rather than on exchanges
such as the New York Stock Exchange. Banks or other businesses that exchange currencies for
travelers rely on this trading to set their daily exchange rates. International traders can lock in
exchange rates when contracts are signed.

Swift
SWIFT is the Society for Worldwide Interbank Financial Telecommunication, a member-owned cooperative through
which the financial world conducts its business operations with speed, certainty and confidence. More than 9,000
banking organisations, securities institutions and corporate customers in 209 countries trust us every day to
exchange millions of standardised financial messages.

Our role is two-fold. We provide the proprietary communications platform, products and services that allow our
customers to connect and exchange financial information securely and reliably. We also act as the catalyst that
brings the financial community together to work collaboratively to shape market practice, define standards and
consider solutions to issues of mutual interest.

SWIFT enables its customers to automate and standardise financial transactions, thereby lowering costs, reducing
operational risk and eliminating inefficiencies from their operations. By using SWIFT customers can also create new
business opportunities and revenue streams.

The Society for Worldwide Interbank Financial Telecommunication ("SWIFT") operates a

worldwide financial messaging networkwhich exchanges messages between banks and other financial
institutions. SWIFT also markets software and services to financial institutions, much of it for use on the
SWIFTNet Network, and ISO 9362 bank identifier codes (BICs) are popularly known as "SWIFT codes".

The majority of international interbank messages use the SWIFT network. As of September 2010, SWIFT
linked 9,000+ financial institutions in 209 countries.[1] SWIFT transports financial messages in a highly
secure way, but does not hold accounts for its members and does not perform any form
of clearing or settlement.
SWIFT does not facilitate funds transfer, rather, it sends payment orders, which must be settled via
correspondent accounts that the institutions have with each other. Each financial institution, to exchange
banking transactions, must have a banking relationship by either being a bank or affiliating itself with one
(or more) so as to enjoy those particular business features.

SWIFT is a cooperative society under Belgian law and it is owned by its member financial institutions.

SWIFT has offices around the world. SWIFT headquarters are located in La Hulpe, Belgium,
near Brussels. An average of 2.4 million messages, with aggregate value of $2 trillion, were processed by
SWIFT per day in 1995.

It was founded in Brussels in 1973, supported by 239 banks in 15 countries. It started to

establish common standards for financial transactions and a shared data processing system and
worldwide communications network. Fundamental operating procedures, rules forliability etc., were
established in 1975 and the first message was sent in 1977.

Clearing House Interbank Payments System

From Wikipedia, the free encyclopedia

The Clearing House Interbank Payments System (CHIPS) is the main privately held clearing house for
large-value transactions in the United States, settling well over US$1 trillion a day in around 250,000 interbank
payments. Together with the Fedwire Funds Service (which is operated by the Federal Reserve Banks), CHIPS
forms the primary U.S. network for large-value domestic and international USD payments (where it has a
market share of around 96%). CHIPS transfers are governed by Article 4A of Uniform Commercial Code.

CHIPS is owned by financial institutions. According to the Federal Financial Institutions Examination

Council (FFIEC), an interagency office of the United States government, "any banking organization with a
regulated U.S. presence may become an owner and participate in the network." [1] CHIPS participants may be
commercial banks, Edge Act corporations or investment companies. Until 1998, to be a CHIPS participant, a
financial institution was required to maintain a branch or an agency in New York City. A non-participant wishing
to make international payments using CHIPS was required to employ one of the CHIPS participants to act as
its correspondent or agent.

Banks typically prefer to make payments of higher value and of a less time-sensitive nature by CHIPS instead
of Fedwire, as CHIPS is less expensive (both by charges and by funds required).

CHIPS differs from the Fedwire payment system in three key ways. First, it is privately owned, whereas the Fed
is part of a regulatory body. Second, it has 47 member participants (with some merged banks constituting
separate participants), compared with 9,289 banking institutions (as of March 19, 2009) [2] eligible to make and
receive funds via Fedwire. Third, it is anetting engine (and hence, not real-time).
A netting engine consolidates all of the pending payments into fewer single transactions. For example, if Bank
of America is to pay American Express US$1.2 million, and American Express is to pay Bank of America
$800,000, the CHIPS system aggregates this to a single payment of $400,000 from Bank of America to
American Express — only 20% of the $2 million to be transferred actually changes hands. The Fedwire system
would require two separate payments for the full amounts ($1.2 million to American Express and $800,000 to
Bank of America).

Only the largest banks dealing in U.S. dollars participate in CHIPS; about 70% of these are non-U.S. banks.
Smaller banks have not found it cost effective to participate in CHIPS, [citation needed] but many have accounts at
CHIPS-participating banks to send and receive payments.

CHAPS
From Wikipedia, the free encyclopedia

For other uses, see Chaps (disambiguation).

The Clearing House Automated Payment System or CHAPS is a British company established in London in

1984, which offers same-day sterling fund transfers. CHAPS used to offer euro fund transfers, the service
which is now closed. CHAPS is a member of the trade organisation APACS, and the EU-area settlement
system TARGET.

A CHAPS transfer is initiated by the sender to move money to the recipient's account (at another banking
institution) where the funds need to be available (cleared) the same working day. Unlike with a bank giro credit,
no pre-printed slip specifying the recipient's details is required. Unlike cheques, the funds transfer is performed
in real-time removing the issue of floator the potential for payments to be purposefully stopped by the sender,
or returned due to insufficient funds, even after they appear to have arrived in the destination account.

CHAPS is used by 19 settlement banks including the Bank of England and over 400 sub member financial
institutions. In its first year of operation, average daily transactions numbered 7,000 with a value of 5 billion
pounds sterling. In 2004, twenty years later, average daily transactions numbered 130,000 with a value of 300
billion pounds sterling.[1]

CHAPS transfers are relatively expensive, with banks typically charging as much as £35 for a transfer. The cost
of fast transfers and the slow speed of free transfers (such as BACS) is sometimes a subject of controversy in
the UK,[2] although low value transactions are now available from CHAPS from its Faster Payments Service.[3]

In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate)

between two currencies specify how much one currency is worth in terms of the other. It is the value of a
foreign nation’s currency in terms of the home nation’s currency. For example an exchange rate of
91 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 91 is worth the same as
USD 1. The foreign exchange market is one of the largest markets in the world. By some estimates, about
3.2 trillion USD worth of currency changes hands every day.

The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an
exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-

counter financial market for the trading of currencies. Financial centers around the world function as
anchors of trading between a wide range of different types of buyers and sellers around the clock, with
the exception of weekends. The foreign exchange market determines the relative values of different
currencies.[1]

The primary purpose of the foreign exchange is to assist international trade and investment, by allowing
businesses to convert one currency to another currency. For example, it permits a US business to import
British goods and pay Pound Sterling, even though the business's income is in US dollars. It also
supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and
lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of
competitiveness in some countries.[2]

In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a
quantity of another currency. The modern foreign exchange market began forming during the 1970s when
countries gradually switched to floating exchange rates from the previous exchange rate regime, which
remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

 its huge trading volume, leading to high liquidity;

 its geographical dispersion;
 its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on
Sunday until 22:00 GMT Friday;
 the variety of factors that affect exchange rates;
 the low margins of relative profit compared with other markets of fixed income; and
 the use of leverage to enhance profit margins with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition,
notwithstanding currency intervention by central banks. According to the Bank for International
Settlements,[3] as of April 2010, average daily turnover in global foreign exchange markets is estimated at
$3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007.
The $3.98 trillion break-down is as follows:

 $1.490 trillion in spot transactions

 $475 billion in outright forwards
 $1.765 trillion in foreign exchange swaps
 $43 billion currency swaps
 $207 billion in options and other products
Market size and liquidity

Main foreign exchange market turnover, 1988–2007, measured in billions of USD.

The foreign exchange market is the largest and most liquid financial market in the world. Traders include
large banks, central banks, institutional investors, currency speculators, corporations, governments,
other financial institutions, and retail investors. The average daily turnover in the global foreign exchange
and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey,
coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April
2010 (vs $1.7 trillion in 1998).[3] Of this $3.98 trillion, $1.5 trillion was spot foreign exchange transactions
and $2.5 trillion was traded in outright forwards, FX swaps and other currency derivatives.

Trading in London accounted for 36.7% of the total, making London by far the most important global
center for foreign exchange trading. In second and third places respectively, trading in New York
City accounted for 17.9%, and Tokyo accounted for 6.2%.[4]

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years,
reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded
currency derivatives represent 4% of OTC foreign exchange turnover. FX futures contracts were
introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other
futures contracts.

Most developed countries permit the trading of FX derivative products (like currency futures and options
on currency futures) on their exchanges. All these developed countries already have fully convertible
capital accounts. A number of emerging countries do not permit FX derivative products on their
exchanges in view of controls on the capital accounts. The use of foreign exchange derivatives is growing
in many emerging economies.[5]Countries such as Korea, South Africa, and India have established
currency futures exchanges, despite having some

Top 10 currency traders [6] controls on the capital account.[1]; [2]

% of overall volume, May 2010
Foreign exchange trading increased by 20% between
Ran April 2007 and April 2010 and has more than doubled
Name Market share
k
since 2004.[7] The increase in turnover is due to a

1  Deutsche Bank 18.06% number of factors: the growing importance of foreign

exchange as an asset class, the increased trading
2  UBS AG 11.30% activity of high-frequency traders, and the emergence of
retail investors as an important market segment. The
3  Barclays Capital 11.08%
growth of electronic execution methods and the diverse
selection of execution venues have lowered transaction
4  Citi 7.69%
costs, increased market liquidity, and attracted greater
5  Royal Bank of Scotland 6.50% participation from many customer types. In particular,
electronic trading via online portals has made it easier
6  JPMorgan 6.35%
for retail traders to trade in the foreign exchange market.

7  HSBC 4.55% By 2010, retail trading is estimated to account for up to

10% of spot FX turnover, or $150 billion per day
8  Credit Suisse 4.44% (see retail trading platforms).

9  Goldman Sachs 4.28% Because foreign exchange is an OTC market where

brokers/dealers negotiate directly with one another,
10  Morgan Stanley 2.91% there is no central exchange or clearing house. The
biggest geographic trading centre is the UK, primarily
London, which according to TheCityUK estimates has
increased its share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April
2010. Due to London's dominance in the market, a particular currency's quoted price is usually the
London market price. For instance, when the IMFcalculates the value of its SDRs every day, they use the
London market prices at noon that day.
[edit]Market participants
Financial markets

Public market

Exchange

Securities

Bond market

Fixed income

Corporate bond

Government bond

Municipal bond

Bond valuation

High-yield debt

Stock market

Stock

Preferred stock

Common stock

Registered share

Voting share

Stock exchange

Derivatives market

Securitization

Hybrid security

Credit derivative

Futures exchange
 OTC, non organized

Spot market

Forwards

Swaps

Options

Foreign exchange

Exchange rate

Currency

Other markets

Money market

Reinsurance market

Commodity market

Real estate market

Practical trading

Participants

Clearing house

Financial regulation

Finance series

Banks and banking

Corporate finance

Personal finance

Public finance

v · d · e

Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is theinter-
bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-
bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not
known to players outside the inner circle. The difference between the bid and ask prices widens (for
example from 0-1 pip to 1-2 pips for a currencies such as the EUR) as you go down the levels of access.
This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can
demand a smaller difference between the bid and ask price, which is referred to as a better spread. The
levels of access that make up the foreign exchange market are determined by the size of the "line" (the
amount of money with which they are trading). The top-tier interbank marketaccounts for 53% of all
transactions. After that there are usually smaller banks, followed by large multi-national corporations
(which need to hedge risk and pay employees in different countries), large hedge funds, and even some
of the retail FX market makers. According to Galati and Melvin, “Pension funds, insurance companies,
mutual funds, and other institutional investors have played an increasingly important role in financial
markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes,
“Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size”.
[8]
 Central banks also participate in the foreign exchange market to align currencies to their economic
needs.

[edit]Banks

The interbank market caters for both the majority of commercial turnover and large amounts of
speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is
undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's
own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank
trading and matching anonymous counterparts for large fees. Today, however, much of this business has
moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing
interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few
years ago.[citation needed]

[edit]Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign
exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared
to those of banks or speculators, and their trades often have little short term impact on market rates.
Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate.
Some multinational companies can have an unpredictable impact when very large positions are covered
due to exposures that are not widely known by other market participants.

[edit]Central banks
National central banks play an important role in the foreign exchange markets. They try to control
the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their
currencies. They can use their often substantial foreign exchange reserves to stabilize the market.
Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks
do not go bankrupt if they make large losses, like other traders would, and there is no convincing
evidence that they do make a profit trading.
[edit]Forex Fixing
Forex fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is
that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing
exchange rates reflects the real value of equilibrium in the forex market. Banks, dealers and online foreign
exchange traders use fixing rates as a trend indicator.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but
aggressive intervention might be used several times each year in countries with a dirty float currency
regime. Central banks do not always achieve their objectives. The combined resources of the market can
easily overwhelm any central bank.[9] Several scenarios of this nature were seen in the 1992–
93 ERM collapse, and in more recent times in Southeast Asia.

[edit]Hedge funds as speculators

About 70% to 90%[citation needed] of the foreign exchange transactions are speculative. In other words, the
person or institution that bought or sold the currency has no plan to actually take delivery of the currency
in the end; rather, they were solely speculating on the movement of that particular currency.Hedge
funds have gained a reputation for aggressive currency speculation since 1996. They control billions of
dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to
support almost any currency, if the economic fundamentals are in the hedge funds' favor.

[edit]Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as
pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign
securities. For example, an investment manager bearing an international equity portfolio needs to
purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist currency overlay operations,
which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst
the number of this type of specialist firms is quite small, many have a large value of assets under
management (AUM), and hence can generate large trades.

[edit]Retail foreign exchange brokers

Retail traders (individuals) constitute a growing segment of this market, both in size and importance.
Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and
regulated in the USA by the CFTC and NFA have in the past been subjected to periodic foreign exchange
scams.[10][11] To deal with the issue, the NFA and CFTC began (as of 2009) imposing stricter requirements,
particularly in relation to the amount of Net Capitalization required of its members. As a result many of the
smaller, and perhaps questionable brokers are now gone.
There are two main types of retail FX brokers offering the opportunity for speculative currency
trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader
FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail
customer. They charge a commission or mark-up in addition to the price obtained in the
market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the
retail customer, and quote a price they are willing to deal at—the customer has the choice whether or not
to trade at that price.

In assessing the suitability of an FX trading service, the customer should consider the ramifications of
whether the service provider is acting as principal or agent. When the service provider acts as agent, the
customer is generally assured of a known cost above the best inter-dealer FX rate. When the service
provider acts as principal, no commission is paid, but the price offered may not be the best available in
the market—since the service provider is taking the other side of the transaction, a conflict of interest may
occur.

[edit]Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments to private
individuals and companies. These are also known as foreign exchange brokers but are distinct in that
they do not offer speculative trading but currency exchange with payments. I.e., there is usually a physical
delivery of currency to a bank account. Send Money Homeoffers an in-depth comparison into the services
offered by all the major non-bank foreign exchange companies.

It is estimated that in the UK, 14% of currency transfers/payments [12] are made via Foreign Exchange
Companies.[13] These companies' selling point is usually that they will offer better exchange rates or
cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance
Companies in that they generally offer higher-value services.

[edit]Money transfer/remittance companies

Money transfer companies/remittance companies perform high-volume low-value transfers generally by
economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369
billion of remittances (an increase of 8% on the previous year). The four largest markets
(India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider
is Western Union with 345,000 agents globally followed by UAE Exchange & Financial Services Ltd.[citation
needed]

Determinants of FX rates
• Trading activity in other currencies

• International capital and trade flows

• International institutional investor sentiment

• Financial and political stability

• Monetary policy and the central bank

• Domestic debt levels (e.g., debt-to-GDP ratio)

• Economic fundamentals

The following theories explain the fluctuations in FX rates in a floating exchange rate regime (In
a fixed exchange rate regime, FX rates are decided by its government):

(a) International parity conditions: Relative Purchasing Power Parity, interest rate

parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above
theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter
as they are based on challengeable assumptions [e.g., free flow of goods, services and capital]
which seldom hold true in the real world.
(b) Balance of payments model (see exchange rate): This model, however, focuses largely on
tradable goods and services, ignoring the increasing role of global capital flows. It failed to
provide any explanation for continuous appreciation of dollar during 1980s and most part of
1990s in face of soaring US current account deficit.
(c) Asset market model (see exchange rate): views currencies as an important asset class for
constructing investment portfolios. Assets prices are influenced mostly by people’s willingness to
hold the existing quantities of assets, which in turn depends on their expectations on the future
worth of these assets. The asset market model of exchange rate determination states that “the
exchange rate between two currencies represents the price that just balances the relative
supplies of, and demand for, assets denominated in those currencies.”

None of the models developed so far succeed to explain FX rates levels and volatility in
the longer time frames. For shorter time frames (less than a few days) algorithm can be
devised to predict prices. Large and small institutions and professional individual traders
have made consistent profits from it. It is understood from above models that many
macroeconomic factors affect the exchange rates and in the end currency prices are a
result of dual forces of demand and supply. The world's currency markets can be viewed
as a huge melting pot: in a large and ever-changing mix of current events, supply and
demand factors are constantly shifting, and the price of one currency in relation to
another shifts accordingly. No other market encompasses (and distills) as much of what
is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any
single element, but rather by several. These elements generally fall into three
categories:economic factors, political conditions and market psychology.
[edit]Economic factors
These include: (a)economic policy, disseminated by government agencies and central
banks, (b)economic conditions, generally revealed through economic reports, and
other economic indicators.

 Economic policy comprises government fiscal policy (budget/spending practices)

and monetary policy (the means by which a government's central bank influences
the supply and "cost" of money, which is reflected by the level of interest rates).
 Government budget deficits or surpluses: The market usually reacts negatively to
widening government budget deficits, and positively to narrowing budget deficits.
The impact is reflected in the value of a country's currency.
 Balance of trade levels and trends: The trade flow between countries illustrates the
demand for goods and services, which in turn indicates demand for a country's
currency to conduct trade. Surpluses and deficits in trade of goods and services
reflect the competitiveness of a nation's economy. For example, trade deficits may
have a negative impact on a nation's currency.
 Inflation levels and trends: Typically a currency will lose value if there is a high level
of inflation in the country or if inflation levels are perceived to be rising. This is
because inflation erodes purchasing power, thus demand, for that particular
currency. However, a currency may sometimes strengthen when inflation rises
because of expectations that the central bank will raise short-term interest rates to
combat rising inflation.
 Economic growth and health: Reports such as GDP, employment levels, retail
sales, capacity utilization and others, detail the levels of a country's economic
growth and health. Generally, the more healthy and robust a country's economy, the
better its currency will perform, and the more demand for it there will be.
 Productivity of an economy: Increasing productivity in an economy should positively
influence the value of its currency. Its effects are more prominent if the increase is in
the traded sector [3].
[edit]Political conditions
Internal, regional, and international political conditions and events can have a profound
effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about the new
ruling party. Political upheaval and instability can have a negative impact on a nation's
economy. For example, destabilization of coalition governments in Pakistan and Thailand
can negatively affect the value of their currencies. Similarly, in a country experiencing
financial difficulties, the rise of a political faction that is perceived to be fiscally
responsible can have the opposite effect. Also, events in one country in a region may
spur positive/negative interest in a neighboring country and, in the process, affect its
currency.

[edit]Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a
variety of ways:

 Flights to quality: Unsettling international events can lead to a " flight to quality," a
type of capital flight whereby investors move their assets to a perceived "safe
haven." There will be a greater demand, thus a higher price, for currencies perceived
as stronger over their relatively weaker counterparts. The U.S. dollar, Swiss
franc and gold have been traditional safe havens during times of political or
economic uncertainty.[15]
 Long-term trends: Currency markets often move in visible long-term trends. Although
currencies do not have an annual growing season like physical
commodities, business cycles do make themselves felt. Cycle analysis looks at
longer-term price trends that may rise from economic or political trends. [16]
 "Buy the rumor, sell the fact": This market truism can apply to many currency
situations. It is the tendency for the price of a currency to reflect the impact of a
particular action before it occurs and, when the anticipated event comes to pass,
react in exactly the opposite direction. This may also be referred to as a market being
"oversold" or "overbought".[17] To buy the rumor or sell the fact can also be an
example of the cognitive bias known as anchoring, when investors focus too much
on the relevance of outside events to currency prices.
 Economic numbers: While economic numbers can certainly reflect economic policy,
some reports and numbers take on a talisman-like effect: the number itself becomes
important to market psychology and may have an immediate impact on short-term
market moves. "What to watch" can change over time. In recent years, for
example, money supply,employment, trade balance figures
and inflation numbers have all taken turns in the spotlight.
 Technical trading considerations: As in other markets, the accumulated price
movements in a currency pair such as EUR/USD can form apparent patterns that
traders may attempt to use. Many traders study price charts in order to identify such
patterns.[18]

[ edit]Algorithmic trading in foreign exchange

Electronic trading is growing in the FX market, and algorithmic trading is becoming
much more common. According to financial consultancy Celent estimates, by 2008 up to
25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.
[citation needed]

[ edit]Financial instruments
[edit]Spot

A spot transaction is a two-day delivery transaction (except in the case of trades

between the US Dollar, Canadian Dollar, Turkish Lira, EURO and Russian Ruble, which
settle the next business day), as opposed to the futures contracts, which are usually
three months. This trade represents a “direct exchange” between two currencies, has the
shortest time frame, involves cash rather than a contract; and interest is not included in
the agreed-upon transaction.

[edit]Forward
See also:  forward contract

One way to deal with the foreign exchange risk is to engage in a forward transaction. In
this transaction, money does not actually change hands until some agreed upon future
date. A buyer and seller agree on an exchange rate for any date in the future, and the
transaction occurs on that date, regardless of what the market rates are then. The
duration of the trade can be one day, a few days, months or years. Usually the date is
decided by both parties. Then the forward contract is negotiated and agreed upon by
both parties.

[edit]Swap
Main article:  foreign exchange swap

The most common type of forward transaction is the FX swap. In an FX swap, two
parties exchange currencies for a certain length of time and agree to reverse the
transaction at a later date. These are not standardized contracts and are not traded
through an exchange.
[edit]Future
Main article:  currency future

Foreign currency futures are exchange traded forward transactions with standard
contract sizes and maturity dates — for example, $1000 for next November at an agreed
rate [4],[5]. Futures are standardized and are usually traded on an exchange created for
this purpose. The average contract length is roughly 3 months. Futures contracts are
usually inclusive of any interest amounts.

[edit]Option
Main article:  foreign exchange option

A foreign exchange option (commonly shortened to just FX option) is a derivative where

the owner has the right but not the obligation to exchange money denominated in one
currency into another currency at a pre-agreed exchange rate on a specified date. The
FX options market is the deepest, largest and most liquid market for options of any kind
in the world..

[ edit]Speculation
Controversy about currency speculators and their effect on currency devaluations and
national economies recurs regularly. Nevertheless, economists including Milton
Friedman have argued that speculators ultimately are a stabilizing influence on the
market and perform the important function of providing a market for hedgers and
transferring risk from those people who don't wish to bear it, to those who do. [19] Other
economists such as Joseph Stiglitz consider this argument to be based more on
politics and a free market philosophy than on economics. [20]

Large hedge funds and other well capitalized "position traders" are the main
professional speculators. According to some economists, individual traders could act as
"noise traders" and have a more destabilizing role than larger and better informed actors.
[21]

Currency speculation is considered a highly suspect activity in many countries.

[where?]
 While investment in traditional financial instruments like bonds or stocks often is
considered to contribute positively to economic growth by providing capital, currency
speculation does not; according to this view, it is simply gambling that often interferes
with economic policy. For example, in 1992, currency speculation forced the Central
Bank of Sweden to raise interest rates for a few days to 500% per annum, and later to
devalue the krona.[22] Former Malaysian Prime Minister Mahathir Mohamad is one
 well known proponent of this view. He blamed the devaluation of the Malaysian
ringgit in 1997 on George Soros and other speculators.

Gregory J. Millman reports on an opposing view, comparing speculators to

"vigilantes" who simply help "enforce" international agreements and anticipate the effects
of basic economic "laws" in order to profit.[23]

In this view, countries may develop unsustainable financial bubbles or otherwise

mishandle their national economies, and foreign exchange speculators made the
inevitable collapse happen sooner. A relatively quick collapse might even be preferable to
continued economic mishandling, followed by an eventual, larger, collapse. Mahathir
Mohamad and other critics of speculation are viewed as trying to deflect the blame from
themselves for having caused the unsustainable economic conditions.

Exchange Rate Management

Exchange rate management, in the context of a liberalised capital account, calls for

skillful operations by the central bank as there could be large capital inflows resulting in

appreciation of the exchange rate and a loss of India’s international competitiveness; equally,

large capital outflows could result in sharp depreciation of the currency which could be dislocative

to the economy. The articulation of the exchange rate policy gives the Committee some concern.

The Indian exchange rate regime is classified by the IMF as a “managed float with no

predetermined path for the exchange rate”. The authorities have centered the articulation of the

exchange rate policy on managing volatility. The Committee is of the view that apart from

volatility what is more important is the level of the exchange rate. Movements of the Indian rupee

vis-à-vis different currencies would show sharp directional differences as these currencies could

move in different directions. While these cannot be controlled, sharp appreciation or depreciation

of the exchange rate in real effective terms can have adverse impacts on the economy.

5.13 The RBI in its Bulletin for December 2005 has undertaken a revision of indices on the

nominal effective exchange rate (NEER) and the REER. The base year and country composition

of the 6-country and 36-country indices have been altered. While appreciating the limitation of the
REER index in the context of a rapid growth of services, the Committee recommends that work

needs to be undertaken by the RBI to refine the REER index by incorporation of services to the

extent possible. Furthermore, for periods where there are large import duty adjustments, these

should be built into the construction of the REER. According to the RBI, these indices are

constructed “as part of its communication policy and to aid researchers and analysts”. TheCommittee
would, however, stress that the REER should also be a valuable input into the

formulation of the RBI’s exchange rate policy.

5.14 The 1997 Committee recommended that :

“The RBI should have a Monitoring Exchange Rate Band of +/- 5.0 per cent

around the neutral REER. The RBI should ordinarily intervene as and when the

REER is outside the band. The RBI should ordinarily not intervene when the

REER is within the band. The RBI could, however, use its judgment to intervene

even within the band to obviate speculative forces and unwarranted volatility. The

Committee further recommends that the RBI should undertake a periodic review

of the neutral REER which could be changed as warranted by fundamentals.”

The present Committee endorses the recommendations of the 1997 Committee.

5.15 The Committee recommends that, as an operative rule, if the CAD persists beyond 3 per

cent of GDP (referred as an outer sustainable limit, at the present time) the exchange rate policy

should be reviewed

How are foreign exchange rates determined?

The increase in dollar value is due to the widening gap in trade deficit, high oil prices and FIIs pulling out money.

How are exchange rates determined?

Exchange rates between currencies can be either controlled as in the case of India prior to the reforms or left to the
market to decide, as is the case now in India. 

In the case of controlled exchange rates, it is quite obvious that the government would fix them, so the question really
boils down to what is the process by which markets determine rates. 

The process is really not different in its essentials from the way any market functions. The supply and demand for
different goods determine what their prices are. In this case, substitute currencies for goods. Lets take the case of
one foreign currency to understand how this market works. 

Thus, the dollar-rupee exchange rate will depend on how the demand-supply balance moves. When the demand for
dollars in India rises and supply does not rise correspondingly, each dollar will cost more rupees to buy.

Where does the supply of dollars come from?

The supply of dollars comes from several sources. One obvious source is Indian exporters of goods and services
who sell their wares in the international market for dollars. Another important source is Indian immigrant workers
abroad who repatriate money to their kin at home. 

The third major source is investments by foreign individuals, companies or institutions in India. This could be in the
form of foreign direct investment where they are using the money to create some assets in India or to buy into the
equity of an existing company. 

It could also be in the form of portfolio investments where dollars are being brought in to buy assets in the stock
markets, for instance, with the purpose of selling these assets when they appreciate in value to book a profit. While
all these forms contribute to the supply of dollars, it should be obvious that the last of them portfolio investment is a
relatively uncertain source, since it necessarily implies an exit of dollars at some point. 

That explains why such flows of capital from abroad are often described as hot flows, since they can move out very
rapidly. Foreign tourists visiting India would also contribute to the inflow of dollars.

What factors determine the demand for dollars?

Just as exporters earn dollars, importers spend them. Imports are thus the most important source of demand for
dollars. 

Another major source of demand is individuals or companies repatriating incomes or profits to their home countries. 

This would include portfolio investors as well as Indian branches of multinationals sending back some of their profits
to the parent company as dividends. 

A third source would be Indians investing abroad, whether as firms or as individuals. Besides this, of course, the forex
you buy when you travel abroad is also adding to the demand for dollars. 

As you can see, the factors that contribute to the demand for dollars are mirror images of those that add to their
supply.

What explains the rapid increase in the value of the dollar recently?

As should be clear by now, this is because the demand for dollars is surging when its supply is not. A couple of
factors have been particularly crucial in this. 

First, the trade deficit the gap between the value of our imports and that of our exports has been widening, meaning
exporters are earning a smaller proportion of the dollars that importers need. The high prices of crude oil have been a
large, but not the only, factor. 

Second, foreign institutional investors (FIIs) who had been pumping billions of dollars every year into a booming
Indian stock exchange have this year been equally desperately pulling out their money thanks to the financial crisis
facing them in their home market.
What role do expectations play in all this?

As in any market, expectations and the consequent speculation play a significant role.

For instance, when there is an expectation that the dollar will rise against the rupee, exporters tend to hold back their
earnings for a while in the hope of getting a higher rate when they ultimately bring their dollars in.

This, of course, skews the supply-demand equation even further confirming their initial expectations and thus setting
off a vicious cycle. 

Similarly, importers who expect to pay more for their dollars tomorrow will try and buy up as much as they can today,
adding to the current demand and making the dollar rise even more. Currency traders in such a situation would also
try to benefit by betting on what the future price of the dollar would be.

What can the RBI do about it?

With hundreds of billions of dollars in its reserves, the RBI would seem to have the ability to be a major factor in how
the dollar moves. 

If, for instance, it were to dump a huge amount of dollars in the market, it could dramatically add to the supply and
hence reduce the price. There are at least two major reasons why central banks are reluctant to do this. 

First, they do not like to interfere too much with market valuation of currencies, though they do try and contain
excessive volatility. 

Second, every time the RBI sells dollars, it buys up rupees, thus sucking some liquidity out of the system. Given the
current liquidity crunch, that is obviously not something it would be very keen to do.

Do we gain or lose when the rupee depreciates?

The answer is less simple than it might seem. Exporters clearly gain when there is a depreciation, since they can
price their goods cheaper in dollars and yet earn the same amount of rupees, making them more competitive
internationally. 

However, importers lose because their costs go up and since they are likely to pass this on to consumers it means
costs in the economy rise.

In theory, as import costs rise, imports should fall and with exports rising the trade gap should close thereby
correcting the demand-supply mismatch in dollars and leading to the rupee appreciating again. 

In practice, this often does not happen. One reason is that not all imports may be price elastic that is, some imports
might not be reduced despite higher costs. The same may be true in exports, where some exports may not gain since
their demand is not price elastic. Also, other factors including speculation may more than offset any reduction in the
trade deficit.

Quotations
An exchange system quotation is given by stating the number of units of "quote currency" (price currency,
payment currency) that can be exchanged for one unit of "base currency" (unit currency, transaction
currency). For example, in a quotation that says the EUR/USD exchange rate is 1.2290 (1.2290 USD per
EUR, also known as EUR/USD; see foreign exchange market), the quote currency is USD and the base
currency is EUR.
There is a market convention that determines which is the base currency and which is the term currency.
In most parts of the world, the order is: EUR – GBP – AUD – NZD – USD – others. Thus if you are doing
a conversion from EUR into AUD, EUR is the base currency, AUD is the term currency and the exchange
rate tells you how many Australian dollars you would pay or receive for 1 euro. Cyprus and Malta which
were quoted as the base to the USD and others were recently removed from this list when they joined the
euro. In some areas of Europe and in the non-professional market in the UK, EUR and GBP are reversed
so that GBP is quoted as the base currency to the euro. In order to determine which is the base currency
where both currencies are not listed (i.e. both are "other"), market convention is to use the base currency
which gives an exchange rate greater than 1.000. This avoids rounding issues and exchange rates being
quoted to more than 4 decimal places. There are some exceptions to this rule e.g. the Japanese often
quote their currency as the base to other currencies.

Quotes using a country's home currency as the price currency (e.g., EUR 0.735342 = USD 1.00 in
the euro zone) are known as direct quotation or price quotation (from that country's perspective) and are
used by most countries.

Quotes using a country's home currency as the unit currency (e.g., EUR 1.00 = USD 1.35991 in the euro
zone) are known as indirect quotation or quantity quotation and are used inBritish newspapers and are
also common in Australia, New Zealand and the eurozone.

 direct quotation: 1 foreign currency unit = x home currency units

 indirect quotation: 1 home currency unit = x foreign currency units

Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating, or becoming
more valuable) then the exchange rate number decreases. Conversely if the foreign currency is
strengthening, the exchange rate number increases and the home currency is depreciating.

Market convention from the early 1980s to 2006 was that most currency pairs were quoted to 4 decimal
places for spot transactions and up to 6 decimal places for forward outrights or swaps. (The fourth
decimal place is usually referred to as a "pip"). An exception to this was exchange rates with a value of
less than 1.000 which were usually quoted to 5 or 6 decimal places. Although there is no fixed rule,
exchange rates with a value greater than around 20 were usually quoted to 3 decimal places and
currencies with a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were
usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR : 0.765432 -
EURUSD : 1.5877 - GBPBEF : 58.234 - EURJPY : 165.29). In other words, quotes are given with 5 digits.
Where rates are below 1, quotes frequently include 5 decimal places.

In 2005 Barclays Capital broke with convention by offering spot exchange rates with 5 or 6 decimal places
on their electronic dealing platform. The contraction of spreads (the difference between the bid and offer
rates) arguably necessitated finer pricing and gave the banks the ability to try and win transaction on
multibank trading platforms where all banks may otherwise have been quoting the same price. A number
of other banks have now followed this.

While official quotations are given with the full number, for example 1.4320, many investors and analysts
drop the integer for convenience and use only the fractional part, such as 4320. These are used
frequently where a move in price is being described, for example 4320 to 4290 as opposed to 1.4320 to
1.4290.

Free or pegged
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is
determined by the market forces of supply and demand. Exchange rates for such currencies are likely to
change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable
or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a
currency. For example, between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to
the United States dollar at RMB 8.2768 to $1. China was not the only country to do this; from the end
of World War II until 1967, Western European countries all maintained fixed exchange rates with the US
dollar based on the Bretton Woods system. 

The "real exchange rate" (RER) is the purchasing power of two currencies relative to one another. It is
based on the GDP deflator measurement of the price level in the domestic and foreign countries ( P,Pf),
which is arbitrarily set equal to 1 in a given base year. Therefore, the level of the RER is arbitrarily set,
depending on which year is chosen as the base year for the GDP deflator of two countries. The changes
of the RER are instead informative on the evolution over time of the relative price of a unit of GDP in the
foreign country in terms of GDP units of the domestic country. If all goods were freely tradable, and
foreign and domestic residents purchased identical baskets of goods, purchasing power parity (PPP)
would hold for the GDP deflators of the two countries, and the RER would be constant and equal to one.

Bilateral vs. effective exchange rate

Bilateral exchange rate involves a currency pair, while effective exchange rate is weighted average of a
basket of foreign currencies, and it can be viewed as an overall measure of the country's external
competitiveness. A nominal effective exchange rate (NEER) is weighted with the inverse of the
asymptotic trade weights. A real effective exchange rate (REER) adjust NEER by appropriate foreign
price level and deflates by the home country price level. Compared to NEER, a GDP weighted effective
exchange rate might be more appropriate considering the global investment phenomenon.

Uncovered interest rate parity

Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one currency against
another currency might be neutralized by a change in the interest rate differential. If US interest rates
increase while Japanese interest rates remain unchanged then the US dollar should depreciate against
the Japanese yen by an amount that prevents arbitrage (in reality the opposite (appreciation) quite
frequently happens, as explained below). The future exchange rate is reflected into the forward exchange
rate stated today. In our example, theforward exchange rate of the dollar is said to be at a discount
because it buys fewer Japanese yen in the forward rate than it does in the spot rate. The yen is said to be
at a premium.

UIRP showed no proof of working after the 1990s. Contrary to the theory, currencies with high interest
rates characteristically appreciated rather than depreciated on the reward of the containment
of inflation and a higher-yielding currency.

Balance of payments model

This model holds that a foreign exchange rate must be at its equilibrium level - the rate which produces a
stable current account balance. A nation with a trade deficit will experience reduction in its foreign
exchange reserves which ultimately lowers (depreciates) the value of its currency. The cheaper currency
renders the nation's goods (exports) more affordable in the global market place while making imports
more expensive. After an intermediate period, imports are forced down and exports rise, thus stabilizing
the trade balance and the currency towards equilibrium.

Like PPP, the balance of payments model focuses largely on trade-able goods and services, ignoring the
increasing role of global capital flows. In other words, money is not only chasing goods and services, but
to a larger extent, financial assets such as stocks and bonds. Their flows go into the capital account item
of the balance of payments, thus, balancing the deficit in the current account. The increase in capital
flows has given rise to the asset market model.

Asset market model

The expansion in trading of financial assets (stocks and bonds) has reshaped the way analysts and
traders look at currencies. Economic variables such as economic growth, inflationand productivity are no
longer the only drivers of currency movements. The proportion of foreign exchange transactions
stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions
generated from trading in goods and services.

The asset market approach views currencies as asset prices traded in an efficient financial market.
Consequently, currencies are increasingly demonstrating a strong correlation with other markets,
particularly equities.
Like the stock exchange, money can be made or lost on the foreign exchange market by investors and
speculators buying and selling at the right times. Currencies can be traded at spot and foreign exchange
options markets. The spot market represents current exchange rates, whereas options are derivatives of
exchange rates

Fluctuations in exchange rates

Exchange rates display

A market based exchange rate will change whenever the values of either of the two component
currencies change. A currency will tend to become more valuable whenever demand for it is greater than
the available supply. It will become less valuable whenever demand is less than available supply (this
does not mean people no longer want money, it just means they prefer holding their wealth in some other
form, possibly another currency).

Increased demand for a currency is due to either an increased transaction demand for money, or an
increased speculative demand for money. The transaction demand for money is highly correlated to the
country's level of business activity, gross domestic product (GDP), and employment levels. The more
people there are unemployed, the less the public as a whole will spend on goods and services. Central
banks typically have little difficulty adjusting the available money supply to accommodate changes in the
demand for money due to business transactions.

The speculative demand for money is much harder for a central bank to accommodate but they try to do
this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest
rate) is high enough. The higher a country's interest rates, the greater the demand for that currency. It has
been argued that currency speculation can undermine real economic growth, in particular since large
currency speculators may deliberately create downward pressure on a currency by shorting in order to
force that central bank to sell their currency to keep it stable (once this happens, the speculator can buy
the currency back from the bank at a lower price, close out their position, and thereby take a profit).

Manipulation of exchange rates

Countries may gain an advantage in international trade if they manipulate the value of their currency by
artificially keeping its value low. It is argued that the People's Republic of Chinahas succeeded in doing
this over a long period of time. However, in a real-world situation, a 2005 appreciation of the Yuan by 22%
was followed by a 38.7% increase in Chinese imports to the US. ]

In 2010, other nations, including Japan and Brazil, attempted to devalue their currency in the hopes of
subsidizing cheap exports and bolstering their ailing economies. A low exchange rate lowers the price of
a country's goods for consumers in other countries but raises the price of goods, especially imported
goods, for consumers in the manipulating country.

United Nations Monetary and Financial Conference

Mount Washington Hotel

The United Nations Monetary and Financial Conference, commonly known as the Bretton Woods
conference, was a gathering of 730 delegates from all 44 Allied nations at the Mount Washington Hotel,
situated in Bretton Woods, New Hampshireto regulate the international monetary and financial order after the
conclusion of World War II.[1]

The conference was held from 1-22 July 1944, when the agreements were signed to set up the International
Bank for Reconstruction and Development (IBRD), the General Agreement on Tariffs and Trade (GATT), and
the International Monetary Fund (IMF).

As a result of the conference, the Bretton Woods system of exchange rate management was set up, which
remained in place until the early 1970s.

Purposes and goals

The Bretton Woods Conference took place in July 1944, but did not become operative until 1959, when all
the European currencies became convertible. Under this system, the IMF and the IBRD were established. The
IMF was developed as a permanent international body. The summary of agreements states, "The nations
should consult and agree on international monetary changes which affect each other. They should outlaw
practices which are agreed to be harmful to world prosperity, and they should assist each other to overcome
short-term exchange difficulties." The IBRD was created to speed up post-war reconstruction, to aid political
stability, and to foster peace. This was to be fulfilled through the establishment of programs for reconstruction
and development.

The main terms of this agreement were:

1. Formation of the IMF and the IBRD (presently part of the World Bank).
2. Adjustably pegged foreign exchange market rate system: The exchange rates were fixed, with the
provision of changing them if necessary.
3. Currencies were required to be convertible for trade related and other current account transactions.
The governments, however, had the power to regulate ostentatious capital flows.
4. As it was possible that exchange rates thus established might not be favourable to a country's balance
of payments position, the governments had the power to revise them by up to 10%.

5. All member countries were required to subscribe to the IMF's capital.

Encouraging open markets

The seminal idea behind the Bretton Woods Conference was the notion of open markets. In Henry
Morgenthau's farewell remarks at the conference, he stated that the establishment of the IMF and the World
Bank marked the end of economic nationalism. This meant countries would maintain their national interest, but
trade blocks and economic spheres of influence would no longer be their means. The second idea behind the
Bretton Woods Conference was joint management of the Western political-economic order. Meaning that the
foremost industrial democratic nations must lower barriers to trade and the movement of capital, in addition to
their responsibility to govern the system.

The Bank for International Settlements controversy

In the last stages of the Second World War, in 1944 at the Bretton Woods Conference, the Bank for
International Settlements became the crux of a fight that broke out when the Norwegian delegation put forth
evidence that the BIS was guilty of war crimes and put forth a motion to dissolve the bank; the Americans,
specifically President Franklin Delano Rooseveltand Henry Morgenthau, supported this motion. This resulted in
a fight between, on one side, several European nations, the American and the Norwegian delegation, led
by Henry Morgenthau and Harry Dexter White; and on the other side, the British delegation, headed by John
Maynard Keynes and Chase Bank representative Dean Acheson, who tried to veto the dissolution of the bank.
The problem was that the BIS, formed in 1930, had as the main proponents of its establishment the then
Governor of the Bank of England, Montagu Norman, and his colleague Hjalmar Schacht, later Adolf Hitler's
finance minister. The Bank was as far as known, originally primarily intended to facilitate money transfers
arising from settling an obligation from the peace treaty after WWI. After World War I, the need for the bank
was suggested in 1929 by the Young Committee, as a means of transfer for German reparations payments
- see  Treaty of Versailles. The plan was agreed in August of that year at a conference at the Hague, and a
charter for the bank was drafted at the International Bankers Conference at Baden Baden in November. The
charter was adopted at a second Hague Conference on January 20, 1930. The Original board of directors of
the BIS included two appointees of Hitler, Walter Funk andEmil Puhl, as well as Herman Schmitz the director
of IG Farben and Baron von Schroeder the owner of the J.H. Stein Bank, the bank that held the deposits of the
Gestapo.

As a result of allegations that the BIS had helped the Germans loot assets from occupied countries during
World War II, the United Nations Monetary and Financial Conference recommended the "liquidation of the
Bank for International Settlements at the earliest possible moment." [2] This task, which was originally proposed
by Norway and supported by other European delegates, as well as the United States
and Morgenthau and Harry Dexter White, was never undertaken. [3]

In July 1944 Dean Acheson interrupted Keynes in a meeting fearing that the BIS would be dissolved by
President Franklin Delano Roosevelt. Keynes went to Henry Morgenthau to prevent the dissolution of the BIS,
or have it postponed, but the next day the dissolution of the BIS was approved. The British delegation did not
give up and the dissolution of the bank was held up just long enough until after Roosevelt had died, in April of
1945 the British and Harry S. Truman stopped the process.

Monetary order in a post-war world

The need for postwar Western economic order was resolved with the agreements made on monetary
order and open system of trade at the 1944 Bretton Woods Conference which allowed for the synthesis of
Britain's desire for full employment and economic stability and the United States' desire for free trade.

[edit]Failed proposals
[edit]International Trade Organization
The Conference also proposed the creation of an International Trade Organization (ITO) to establish rules and
regulations for international trade. The ITO would have complemented the other two Bretton Woods proposed
international bodies: the IMF and the World Bank.

The ITO charter was agreed on at the U.N. Conference on Trade and Employment (held in Havana, Cuba, in
March 1948), but was not ratified by the U.S. Senate. As a result, the ITO never came into existence.
However, in 1995, the Uruguay Round of GATT negotiations established the World Trade Organization (WTO)
as the replacement body for GATT. The GATT principles and agreements were adopted by the WTO, which
was charged with administering and extending them.

[edit]International Clearing Union

Main article:  International Clearing Union

John Maynard Keynes (right) represented the UK at the conference, andHarry Dexter White represented the US.

John Maynard Keynes proposed the ICU as a way to regulate the balance of trade. His concern was that
countries with a trade deficit would be unable to climb out of it, paying ever more interest to service their ever
greater debt, and therefore stifling global growth. The ICU would effectively be a bank with its own currency
(the "bancor"), exchangeable with national currencies at a fixed rate. Nations would be the unit for accounting
between nations, so their trade deficits or surpluses could be measured by it.

On top of that, each country would have an overdraft facility in its "bancor" account with the ICU. Keynes
proposed having a maximum overdraft of half the average trade size over five years. If a country went over
that, it would be charged interest, obliging a country to reduce its currency value and prevent capital exports.
But countries with trade surpluses would also be charged interest at 10% if their surplus was more than halfthe
size of their permitted overdraft, obliging them to increase their currency values and export more capital. If, at
the year's end, their credit exceeded the maximum (half the size of the overdraft in surplus) the surplus would
be confiscated.

Lionel Robbins reported that "it would be difficult to exaggerate the electrifying effect on thought throughout the
whole relevant apparatus of government ... nothing so imaginative and so ambitious had ever been discussed".
However, Harry Dexter White, representing America which was the world's biggest creditor said "We have
been perfectly adamant on that point. We have taken the position of absolutely no."

Instead he proposed an International Stabilisation Fund (now the IMF), which would place the burden of
maintaining the balance of trade on the deficit nations, and imposing no limit on the surplus that rich countries
could accumulate. White also proposed creation of the IBRD (now part of the World Bank) which would provide
capital for economic reconstruction after the war.

White managed to ensure that the US had special veto powers over any major decision made by the IMF or the
World Bank, meaning effectively that their "conditionalities" in the way of strict institutional reforms are never
imposed. Furthermore, the IMF insists that the foreign exchange reserves maintained by other nations are held
in the form of dollars, so no matter how much debt the US accumulates, its economy will not collapse.

[edit]Negotiators

 The USA was represented at the conference by Harry Dexter White

 The UK was represented at the conference by Lord Keynes

 Australia was represented at the conference by Leslie Melville

 India was represented by Sir Chintāman Dwārakānāth Deshmukh

[edit]Quotes

The gold standard is a monetary system in which the standard economic unit of account is a fixed weight
of gold. There are distinct kinds of gold standard. First, the gold specie standard is a system in which the
monetary unit is associated with circulating gold coins, or with the unit of value defined in terms of one
particular circulating gold coin in conjunction with subsidiary coinage made from a lesser valuable metal.

Similarly, the gold exchange standard typically involves the circulation of only coins made of silver or
other metals, but where the authorities guarantee a fixed exchange rate with another country that is on
the gold standard. This creates a de facto gold standard, in that the value of the silver coins has a fixed
external value in terms of gold that is independent of the inherent silver value. Finally, the gold
bullion  standard is a system in which gold coins do not circulate, but in which the authorities have agreed
to sell gold bullion on demand at a fixed price in exchange for the circulating currency.

The gold specie standard was not designed, but rather arose out of a general acceptance that gold was
useful as a universal currency.[1] For these reasons, it existed not just in modern states, but in some of the
great empires of earlier times. One example is the  Byzantine Empire, which used a gold coin known as
the Byzant. But with the ending of the Byzantine Empire, the European world tended to see silver, rather
than gold, as the currency of choice, and, in doing so, created the  silver standard. An example is the
silver pennies that became the staple coin of Britain around the time of King Offa in the year 796 AD. The
Spanish discovery of the great silver deposits at Potosí and in Mexico in the 16th century led to an
international silver standard in conjunction with the famous  pieces of eight, important until the nineteenth
century.

In modern times the British West Indies was one of the first regions to adopt a gold specie standard.
Following Queen Anne's proclamation of 1704, the British West Indies gold standard was a  de facto gold
standard based on the Spanish gold doubloon coin. In the year 1717, master of the Royal Mint Sir Isaac
Newton established a new mint ratio between silver and gold that had the effect of driving silver out of
circulation and putting Britain on a gold standard. However, only in 1821, following the introduction of
the gold sovereign coin by the new Royal Mint at Tower Hill in the year 1816, was the United Kingdom
formally put on a gold specie standard, the first of the great industrial powers. Soon to follow
was Canada in 1853,Newfoundland in 1865, and the USA and Germany de jure in 1873. The USA used
the Eagle as their unit, and Germany introduced the new gold mark, while Canada adopted a dual system
based on both the American Gold Eagle and the British Gold Sovereign.

Australia and New Zealand adopted the British gold standard, as did the British West Indies, while
Newfoundland was the only British Empire territory to introduce its own gold coin as a standard. Royal
Mint branches were established in Sydney, New South Wales, Melbourne, Victoria, and Perth, Western
Australia for the purpose of minting gold sovereigns from Australia's rich gold deposits.

The crisis of silver currency and bank notes (1750–1870)

In the late 18th century, wars and trade with China, which sold to Europe but had little use for European
goods, drained silver from the economies of Western Europe and the United States. Coins were struck in
smaller and smaller amounts, and there was a proliferation of bank and stock notes used as money.

In the 1790s, England, suffering a massive shortage of silver coinage, ceased to mint larger silver coins
and issued "token" silver coins and overstruck foreign coins. With the end of the Napoleonic Wars,
England began a massive recoinage program that created standard gold sovereigns and circulating
crowns and half-crowns, and eventually copper farthings in 1821. The recoinage of silver in England after
a long drought produced a burst of coins: England struck nearly 40 million shillings between 1816 and
1820, 17 million half crowns and 1.3 million silver crowns. The 1819 Act for the Resumption of Cash
Payments set 1823 as the date for resumption of convertibility, reached instead by 1821. Throughout the
1820s, small notes were issued by regional banks, which were finally restricted in 1826, while the Bank of
England was allowed to set up regional branches. In 1833, however, the Bank of England notes were
made legal tender, and redemption by other banks was discouraged. In 1844 the Bank Charter Act
established that Bank of England Notes, fully backed by gold, were the legal standard. According to the
strict interpretation of the gold standard, this 1844 act marks the establishment of a full gold standard for
British money.
The US adopted a silver standard based on the Spanish milled dollar in 1785. This was codified in the
1792 Mint and Coinage Act, and by the Federal Government's use of the "Bank of the United States" to
hold its reserves, as well as establishing a fixed ratio of gold to the US dollar. This was, in effect, a
derivative silver standard, since the bank was not required to keep silver to back all of its currency. This
began a long series of attempts for America to create a bimetallic standard for the US Dollar, which would
continue until the 1920s. Gold and silver coins were legal tender, including the Spanish real, a silver coin
struck in the Western Hemisphere. Because of the huge debt taken on by the US Federal Government to
finance the Revolutionary War, silver coins struck by the government left circulation, and in 1806
President Jefferson suspended the minting of silver coins.

The US Treasury was put on a strict hard-money standard, doing business only in gold or silver coin as
part of the Independent Treasury Act of 1848, which legally separated the accounts of the Federal
Government from the banking system. However the fixed rate of gold to silver overvalued silver in relation
to the demand for gold to trade or borrow from England. The drain of gold in favor of silver led to the
search for gold, including the California Gold Rush of 1849. Following Gresham's law, silver poured into
the US, which traded with other silver nations, and gold moved out. In 1853, the US reduced the silver
weight of coins, to keep them in circulation, and in 1857 removed legal tender status from foreign
coinage.

In 1857 the final crisis of the free banking era of international finance began, as American banks
suspended payment in silver, rippling through the very young international financial system of central
banks. In the United States this collapse was a contributory factor in the American Civil War, and in 1861
the US government suspended payment in gold and silver, effectively ending the attempts to form a silver
standard basis for the dollar. Through the 1860–1871 period, various attempts to resurrect bi-metallic
standards were made, including one based on the gold and silver franc; however, with the rapid influx of
silver from new deposits, the expectation of scarcity of silver ended.

The interaction between central banking and currency basis formed the primary source of monetary
instability during this period. The combination that produced economic stability was a restriction of supply
of new notes, a government monopoly on the issuance of notes directly and, indirectly, a central bank and
a single unit of value. Attempts to avoid these conditions produced periodic monetary crises: as notes
devalued; or silver ceased to circulate as a store of value; or there was a depression as governments,
demanding specie as payment, drained the circulating medium out of the economy. At the same time,
there was a dramatically expanded need for credit, and large banks were being chartered in various
states, including, by 1872, Japan. The need for a solid basis in monetary affairs would produce a rapid
acceptance of the gold standard in the period that followed.
By way of example, and following Germany's decision after the  Franco-Prussian War to extract
reparations to facilitate a move to the gold standard, Japan gained the needed reserves after the Sino-
Japanese War of 1894-1895. Whether the gold standard provided a government sufficient bona fides
when it sought to borrow abroad is debated. For Japan, moving to gold was considered vital to gain
access to Western capital markets.[2]

The gold exchange standard (1870-1914)

This section does not cite any references or sources.
Please help improve this article by adding citations to reliable sources. Unsourced material may
be challenged and removed. (July 2010)

Towards the end of the 19th century, some of the remaining silver standard countries began to peg their
silver coin units to the gold standards of the United Kingdom or the USA. In 1898,British India pegged the
silver rupee to the pound sterling at a fixed rate of 1s 4d, while in 1906, the  Straits Settlements adopted a
gold exchange standard against the pound sterling with the silver Straits dollar being fixed at 2s 4d.

At the turn of the century, the Philippines pegged the silver Peso/dollar to the US dollar at 50 cents. A
similar pegging at 50 cents occurred at around the same time with the silver Peso of Mexico and the silver
Yen of Japan. When Siam adopted a gold exchange standard in 1908, this left only China and Hong Kong
on the silver standard.

Impact of World War I (1914-25)

Governments faced with the need to fund high levels of expenditure, but with limited sources of tax
revenue, suspended convertibility of currency into gold on a number of occasions in the 19th century. The
British government suspended convertibility (that is to say, it went off the gold standard) during
the Napoleonic wars and the US government during the US Civil War. In both cases, convertibility was
resumed after the war.[citation needed] The real test, however, came in the form of World War I, a test "it failed
utterly" according to economist Richard Lipsey.[1]

In order to finance the costs of war, most belligerent countries went off the gold standard during the war,
and suffered significant inflation. Because inflation levels varied between states, when they returned to
the standard after the war at price determined by themselves (some, for example, chose to enter at pre-
war prices), some countries' goods were undervalued and some overvalued. [1] Ultimately, the system as it
stood could not deal quickly enough with the large deficits and surpluses created in the  balance of
payments; this has previously been attributed to increasing rigidity of wages (particularly in terms of wage
cuts) brought about by the advent of unionized labor, but is now more likely to be thought of as an
inherent fault with the system which came to light under the pressures of war and rapid technological
change. In any case, prices had not reached equilibrium by the time of the Great Depression, which
served only to kill it off completely.[1] In related circumstances, Germany, having lost much of its gold in
reparations, could no longer produce gold Reichsmarks, and was forced to issue unbacked paper money,
leading to hyperinflation in the 1920s.

The gold bullion standard and the decline of the gold standard (1925–31)
This section does not cite any references or sources.
Please help improve this article by adding citations to reliable sources. Unsourced material may
be challenged and removed. (July 2010)

The gold specie standard ended in the United Kingdom and the rest of the British Empire at the outbreak
of World War I. Treasury notes replaced the circulation of the gold sovereigns and gold half sovereigns.
However, legally, the gold specie standard was not repealed. The end of the gold standard was
successfully effected by appeals to patriotism when somebody would request the Bank of England to
redeem their paper money for gold specie. It was only in the year 1925 when Britain returned to the gold
standard in conjunction with Australia and South Africa that the gold specie standard was officially ended.

The British Gold Standard Act 1925 both introduced the gold bullion standard and simultaneously
repealed the gold specie standard. The new gold bullion standard did not envisage any return to the
circulation of gold specie coins. Instead, the law compelled the authorities to sell gold bullion on demand
at a fixed price. This gold bullion standard lasted until 1931. [citation needed] On September 19, 1931, the United
Kingdom left the revised gold standard,[3] forced to suspend the gold bullion standard due to large
outflows of gold across the Atlantic Ocean. Australia and New Zealand had already been forced off the
gold standard by the same pressures connected with the Great Depression, and Canada quickly followed
suit with the United Kingdom.

Depression and World War II (1932–46)

Prolongation of the Great Depression

Some economic historians, such as American professor Barry Eichengreen, blame the gold standard of
the 1920s for prolonging the Great Depression.[4] Others including Federal Reserve Chairman Ben
Bernanke and Nobel Prize winning economist Milton Friedman lay the blame at the feet of the Federal
Reserve.[5][6] The gold standard limited the flexibility ofcentral banks monetary policy by limiting their
ability to expand the money supply, and thus their ability to lower interest rates. In the US, the Federal
Reserve was required by law to have 40% gold backing of its Federal Reserve demand notes, and thus,
could not expand the money supply beyond what was allowed by the gold reserves held in their vaults. [7]

In the early 1930s, the Federal Reserve defended the fixed price of dollars in respect to the gold standard
by raising interest rates, trying to increase the demand for dollars. Higher interest rates intensified the
deflationary pressure on the dollar and reduced investment in U.S. banks. Commercial banks also
converted Federal Reserve Notes to gold in 1931, reducing the Federal Reserve's gold reserves, and
forcing a corresponding reduction in the amount of Federal Reserve Notes in circulation. [8] This
speculative attack on the dollar created a panic in the U.S. banking system. Fearing imminent devaluation
of the dollar, many foreign and domestic depositors withdrew funds from U.S. banks to convert them into
gold or other assets.[8]

The forced contraction of the money supply caused by people removing funds from the banking system
during the bank panics resulted in deflation; and even as nominal interest rates dropped, inflation-
adjusted real interest rates remained high, rewarding those that held onto money instead of spending it,
causing a further slowdown in the economy.[9] Recovery in the United States was slower than in Britain, in
part due to Congressional reluctance to abandon the gold standard and float the U.S. currency as Britain
had done. It was not until 1933 when the United States finally decided to abandon the gold standard that
the economy began to improve.[10]
British hesitate to return to gold standard

During the 1939-1942 period, the UK depleted much of its gold stock in purchases of munitions and
weaponry on a "cash-and-carry" basis from the U.S. and other nations.[citation needed]This depletion of the
UK's reserve convinced Winston Churchill of the impracticality of returning to a pre-war style gold
standard. To put it simply, the war had bankrupted Britain.

John Maynard Keynes, who had argued against such a gold standard, proposed to put the power to print
money in the hands of the privately owned Bank of England. Keynes, in warning about the menaces of
inflation, said "By a continuous process of inflation, governments can confiscate, secretly and
unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but
they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some". [11]

Quite possibly because of this, the 1944 Bretton Woods Agreement established the International

Monetary Fund and an international monetary system based on convertibility of the various national
currencies into a U.S. dollar that was in turn convertible into gold. It also prevented countries from
manipulating their currency's value to gain an edge in international trade. [citation needed]

Post-war international gold-dollar standard (1946-1971)

Main article:  Bretton Woods system

After the Second World War, a system similar to a Gold Standard and sometimes described as a "gold
exchange standard" was established by the Bretton Woods Agreements. Under this system, many
countries fixed their exchange rates relative to the U.S. dollar. The U.S. promised to fix the price of gold at
approximately $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in
terms of gold.[1] Under the administration of the French President Charles de Gaulle up to 1970, France
reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing U.S.
economic influence abroad. This, along with the fiscal strain of federal expenditures for the  Vietnam
War and a persistent balance of payments deficits, led President  Richard Nixon to end the direct
convertibility of the dollar to gold in 1971, resulting in the system's breakdown (the "Nixon Shock").

Theory
Commodity money is inconvenient to store and transport. It also does not allow the government to control
or regulate the flow of commerce within their dominion with the same ease that a standardized currency
does. As such, commodity money gave way to representative money, and gold and other  specie were
retained as its backing.

Gold was a common form of money due to its rarity, durability, divisibility,  fungibility, and ease of
identification,[2] often in conjunction with silver. Silver was typically the main circulating medium, with gold
as the metal of monetary reserve.

It is difficult to manipulate a gold standard to tailor to an economy’s demand for money, providing practical
constraints against the measures that central banks might otherwise use to respond to economic crises.
[12]

The gold standard variously specified how the gold backing would be implemented, including the amount
of specie per currency unit. The currency itself is just paper and so has nointrinsic value, but is accepted
by traders because it can be redeemed any time for the equivalent specie. A U.S.  silver certificate, for
example, could be redeemed for an actual piece of silver.

Representative money and the gold standard protect citizens from  hyperinflation and other abuses
of monetary policy, as were seen in some countries during the Great Depression. However, they were not
without their problems and critics, and so were partially abandoned via the international adoption of
the Bretton Woods System. That system eventually collapsed in 1971, at which time nearly all nations
had switched to full fiat money.

According to later analysis, the earliness with which a country left the gold standard reliably predicted its
economic recovery from the great depression. For example, Great Britain and Scandinavia, which left the
gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much
longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The
connection between leaving the gold standard as a strong predictor of that country's severity of its
depression and the length of time of its recovery has been shown to be consistent for dozens of countries,
including developing countries. This partly explains why the experience and length of the depression
differed between national economies.[13]

Differing definitions
A 100%-reserve gold standard, or a full gold standard, exists when a monetary authority holds sufficient
gold to convert all of the representative money it has issued into gold at the promised exchange rate. It is
sometimes referred to as the gold specie standard to more easily identify it from other forms of the gold
standard that have existed at various times. Opponents of a 100%-reserve standard, such as  Byron Dale,
generally consider a 100%-reserve standard difficult to implement as the quantity of gold in the world is
too small to sustain current worldwide economic activity at current gold prices. Its implementation would
entail a many-fold increase in the price of gold.[citation needed]

This is due to the fractional-reserve banking system. As money is created by the central bank and spent
into circulation, the money expands via the money multiplier. Each subsequent loan and redeposit results
in an expansion of the monetary base. Therefore, the promised exchange rate would have to be
constantly adjusted.

In an international gold-standard system (which is necessarily based on an internal gold standard in the
countries concerned)[14], gold or a currency that is convertible into gold at a fixed price is used as a means
of making international payments. Under such a system, when exchange rates rise above or fall below
the fixed mint rate by more than the cost of shipping gold from one country to another, large inflows or
outflows occur until the rates return to the official level. International gold standards often limit which
entities have the right to redeem currency for gold. Under the  Bretton Woods system, these were called
"SDRs" for Special Drawing Rights.[citation needed]

Advantages

 Long-term price stability has been described as the great virtue of the gold standard. [15] Under the
gold standard, high levels of inflation are rare, and hyperinflation is impossible as the money supply
can only grow at the rate that the gold supply increases. [16] Economy-wide price increases caused by
ever-increasing amounts of currency chasing a constant supply of goods are rare, [16] as gold supply
for monetary use is limited by the available gold that can be minted into coin. [16] High levels of inflation
under a gold standard are usually seen only when warfare destroys a large part of the economy,
reducing the production of goods, or when a major new source of gold becomes available. [16] In the
U.S. one of those periods of warfare was the Civil War, which destroyed the economy of the South,
[17]
 while the California Gold Rush made large amounts of gold available for minting. [18]
 The gold standard limits the power of governments to inflate prices through excessive issuance of
paper currency.[16] It provides fixed international exchange rates between those countries that have
adopted it, and thus reduces uncertainty in international trade. [16] Historically, imbalances between
price levels in different countries would be partly or wholly offset by an automatic balance-of-payment
adjustment mechanism called the "price specie flow mechanism."[16]
 The gold standard makes chronic deficit spending by governments more difficult, as it prevents
governments from inflating away the real value of their debts. [19] A central bank cannot be an
 unlimited buyer of last resort of government debt. A central bank could not create unlimited quantities
of money at will, as there is a limited supply of gold.[16]
Disadvantages
The examples and perspective in this article may not represent a worldwide view of
the subject. Please improve this article and discuss the issue on the talk
page. (January 2011)

Gold prices (US$ per ounce) from 1968 to 2006, in nominal US$ and inflation adjusted US$.

 The total amount of gold that has ever been mined has been estimated at around 142,000  metric
tons.[20] This is less than the value of circulating money in the U.S. alone, where more than $8.3 trillion
is in circulation or in deposit (M2).[21] Therefore, a return to the gold standard, if also combined with a
mandated end to fractional reserve banking, would result in a significant increase in the current value
of gold, which may limit its use in current applications. [22] However, this is specifically a disadvantage
of return to the gold standard and not the efficacy of the gold standard itself. Some gold standard
advocates consider this to be both acceptable and necessary [23]The amount of such base currency
(M0) is only about one tenth as much as the figure (M2) listed above.[24]
 Deflation rewards savers[25][26] and punishes debtors.[27][28] Real debt burdens therefore rise,
causing borrowers to cut spending to service their debts or to default. Lenders become wealthier, but
may choose to save some of their additional wealth rather than spending it all. [29] The overall amount
of expenditure is therefore likely to fall.[29] Deflation also prevents a central bank of its ability to
stimulate spending.[29] However in practice it has always been possible for governments to control
deflation by leaving the gold standard or by artificial expenditure. [29][30][31]
 Mainstream economists believe that economic recessions can be largely mitigated by increasing
money supply during economic downturns.[32] Following a gold standard would mean that the amount
of money would be determined by the supply of gold, and hence  monetary policy could no longer be
used to stabilize the economy in times of economic recession.[33] Such reason is often employed to
 partially blame the gold standard for the Great Depression, citing that the Federal Reserve couldn't
expand credit enough to offset the deflationary forces at work in the market. [34] Opponents of this
viewpoint have argued that gold stocks were available to the Federal Reserve for credit expansion in
the early 1930s, but Fed operatives failed to utilize them. [35]
 Monetary policy would essentially be determined by the rate of gold production. [36] Fluctuations in
the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a
decrease.[36][37] Some hold the view that this contributed to the severity and length of the Great
Depression as the gold standard forced the central banks to keep monetary policy too tight, creating
deflation.[22][38] Milton Friedman however argued that the main cause of the severity of the Great
Depression in the United States was the Federal Reserve, and not the gold standard, as they willfully
kept monetary policy tighter than was required by the gold standard. [39] Additionally, three increases
by the Federal Reserve in bank reserve requirements occurred in 1936 and 1937, which doubled
bank reserve requirements[40]
 Although the gold standard gives long-term price stability, it does in the short term bring high
price volatility.[37] In the United States from 1879 to 1913, the  coefficient of variation of the annual
change in price levels was 17.0, whereas from 1943 to 1990 it was only 0.88. [37] It has been argued by
among others Anna Schwartz that this kind of instability in short-term price levels can lead to financial
instability as lenders and borrowers become uncertain about the value of debt. [41]
 James Hamilton contended that the gold standard may be susceptible to  speculative
attacks when a government's financial position appears weak, although others contend that this very
threat discourages governments' engaging in risky policy (see  Moral Hazard).[38] For example, some
believe that the United States was forced to raise its interest rates in the middle of the Great
Depression to defend the credibility of its currency after unusually easy credit policies in the 1920s.
[38]
 This disadvantage however is shared by all fixed exchange rate regimes and not just limited to
gold money. All fixed currencies that appear weak are subject to speculative attack. [42]
 If a country wanted to devalue its currency, it would generally produce sharper changes than the
smooth declines seen in fiat currencies, depending on the method of devaluation. [43]
Advocates of a renewed gold standard
The return to the gold standard is supported by many followers of the  Austrian School of Economics and,
in the United States, by strict constitutionalists, Objectivists, and free-marketlibertarians[44] largely
because they object to the role of the government in issuing  fiat currency through central banks. A
significant number of gold-standard advocates also call for a mandated end to fractional-reserve banking.
[citation needed]
Few politicians[23] today advocate a return to the gold standard, other than adherents of the Austrian
school and some supply-siders. However, some prominent economists have expressed sympathy with a
hard-currency basis, and have argued against fiat money, including former U.S. Federal
Reserve Chairman Alan Greenspan (himself a former Objectivist), and macro-economist Robert Barro.
[45]
 Greenspan famously argued the case for returning to a gold standard in his 1966 paper "Gold and
Economic Freedom", in which he described supporters of fiat currencies as "welfare statists" intent on
using monetary policies to finance deficit spending. He has argued that the fiat money system of his day
(pre-Nixon Shock) had retained the favorable properties of the gold standard because central bankers
had pursued monetary policy as if a gold standard were still in place. [46] U.S. Congressman Ron Paulhas
continually argued for the reinstatement of the gold standard, but is no longer a strict advocate, instead
supporting a basket of commodities that emerges on the free markets. [47]

The current global monetary system relies on the U.S. dollar as a reserve currency by which major
transactions, such as the price of gold itself, are measured. [citation needed] A host of alternatives has been
suggested, including energy-based currencies, and market baskets of currencies or commodities, gold
being one of the alternatives.

In 2001, Malaysian Prime Minister Mahathir bin Mohamad proposed a new currency that would be used
initially for international trade among Muslim nations. The currency he proposed was called the  Islamic
gold dinar and it was defined as 4.25 grams of pure (24-carat) gold. Mahathir Mohamad promoted the
concept on the basis of its economic merits as a stable unit of account and also as a political symbol to
create greater unity between Islamic nations. The purported purpose of this move would be to reduce
dependence on the United States dollaras a reserve currency, and to establish a non-debt-backed
currency in accord with Islamic law against the charging of interest.[48] However, to date, Mahathir's
proposed gold-dinar currency has failed to take hold. [citation needed]

Gold as a reserve today

Main article:  Gold reserves

The Swiss Franc was based on a 40% legal gold-reserve requirement from 1936, when it ended gold
convertibility,[49] until 2000. However, gold reserves are held in significant quantity by many nations as a
means of defending their currency, and hedging against the U.S. Dollar, which forms the bulk of liquid
currency reserves.

Both gold coins and gold bars are widely traded in liquid markets, and therefore still serve as a private
store of wealth. Some privately issued currencies, such as digital gold currency, are backed by gold
reserves.
In 1999, to protect the value of gold as a reserve,  European Central Bankers signed the Washington
Agreement on Gold, which stated that they would not allow gold leasing for speculative purposes, nor
would they enter the market as sellers except for sales that had already been agreed upon.

Bretton Woods system

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The Bretton Woods system of monetary management established the rules

for commercial and financial relations among the world's major industrial states in the mid 20th century. The
Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary
relations among independent nation-states.

Preparing to rebuild the international economic system as World War II was still raging, 730 delegates from all
44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States,
for the United Nations Monetary and Financial Conference. The delegates deliberated upon and signed the
Bretton Woods Agreements during the first three weeks of July 1944.

Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the
planners at Bretton Woods established the International Monetary Fund(IMF) and the International Bank for
Reconstruction and Development (IBRD), which today is part of the World Bank Group. These organizations
became operational in 1945 after a sufficient number of countries had ratified the agreement.

The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary
policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to
bridge temporary imbalances of payments.

On August 15, 1971, the United States unilaterally terminated convertibility of the dollar to gold. This action,
referred to as the Nixon shock, created the situation in which the United States dollar became the sole backing
of currencies and a reserve currency for the member states.

Contents
 [hide]

1 Origins

o 1.1 Great Depression

 1.1.1 Economic security
  1.1.2 Rise of governmental intervention

 1.1.3 Atlantic Charter

 1.1.4 Wartime devastation of Europe and East Asia

2 Design of the financial system

o 2.1 Informal regimes

 2.1.1 Previous regimes

 2.1.2 Fixed exchange rates

o 2.2 Formal regimes

 2.2.1 International Monetary Fund

 2.2.1.1 Design

 2.2.1.2 Subscriptions and quotas

 2.2.1.3 Trade deficits

 2.2.1.4 Par value

 2.2.1.5 Operations

 2.2.2 International Bank for Reconstruction and

Development

3 Readjustment

o 3.1 Dollar shortages and the Marshall Plan

o 3.2 Cold War

4 Late application

o 4.1 U.S. balance of payments crisis

o 4.2 Structural changes

 4.2.1 Return to convertibility

 4.2.2 Growth of international currency markets

 4.2.3 Decline

 4.2.3.1 U.S. monetary influence

 4.2.3.2 Dollar

o 4.3 Paralysis of international monetary management

 4.3.1 Floating-rate system during 1968–1972

 4.3.2 Nixon Shock

 4.3.3 Smithsonian Agreement

5 Bretton Woods II

6 Academic legacy
 7 Pegged rates

o 7.1 Japanese yen

o 7.2 Deutsche Mark

o 7.3 Pound sterling

o 7.4 French franc

o 7.5 Italian lira

o 7.6 Spanish peseta

o 7.7 Dutch gulden

o 7.8 Belgian franc

o 7.9 Greek drachma

o 7.10 Swiss franc

o 7.11 Danish krone

o 7.12 Finnish markka

8 See also

9 Notes

10 References

11 Further reading

12 External links

[edit]Origins

The political basis for the Bretton Woods system was in the confluence of several key conditions: the shared
experiences of the Great Depression, the concentration of power in a small number of states (further enhanced
by the exclusion of a number of important nations because of the war), and the presence of a dominant power
willing and able to assume a leadership role in global monetary affairs.

[edit]Great Depression
A high level of agreement among the powerful on the goals and means of international economic management
facilitated the decisions reached by the Bretton Woods Conference. Its foundation was based on a shared
belief in capitalism. Although the developed countries' governments differed in the type of capitalism they
preferred for their national economies (France, for example, preferred greater planning and state intervention
(dirigisme), whereas the United States favored relatively limited state intervention), all relied primarily on market
mechanisms and on private ownership.
Thus, it is their similarities rather than their differences that appear most striking. All the participating
governments at Bretton Woods agreed that the monetary chaos of the interwar period had yielded several
valuable lessons.

The experience of the Great Depression was fresh on the minds of public officials. The planners at Bretton
Woods hoped to avoid a repeat of the debacle of the 1930s, when intransigent American insistence as a
creditor nation on the repayment of Allied war debts, combined with an inclination to isolationism, led to a
breakdown of the international financial system and a worldwide economic depression. [1] The "beggar thy
neighbor" policies of 1930s governments—using currency devaluations to increase the competitiveness of a
country's export products to reduce balance of payments deficits—worsened other nations' deflationary spirals,
which resulted in plummeting national incomes, shrinking demand, mass unemployment, and an overall decline
in world trade. Trade in the 1930s became largely restricted to currency blocs (groups of nations that use an
equivalent currency, such as the "Sterling Area" of the British Empire). These blocs retarded the international
flow of capital and foreign investment opportunities. Although this strategy tended to increase government
revenues in the short run, it dramatically worsened the situation in the medium and longer run.

Thus, for the international economy, planners at Bretton Woods all favored a regulated system, one that relied
on a regulated market with tight controls on the value of currencies. Although they disagreed on the specific
implementation of this system, all agreed on the need for tight controls.

[edit]Economic security

Cordell Hull

Also based on experience of inter-war years, U.S. planners developed a concept of economic security—that a
liberal international economic system would enhance the possibilities of postwar peace. One of those who saw
such a security link was Cordell Hull, the United States Secretary of State from 1933 to 1944.[Notes 1] Hull
believed that the fundamental causes of the two world wars lay in economic discrimination and trade warfare.
Specifically, he had in mind the trade and exchange controls (bilateral arrangements) [2] of Nazi Germany and
the imperial preference system practiced by Britain, by which members or former members of the British
Empire were accorded special trade status, itself provoked by German, French, and American protectionist
policies. Hull argued

[U]nhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with
war…if we could get a freer flow of trade…freer in the sense of fewer discriminations and obstructions…so that
one country would not be deadly jealous of another and the living standards of all countries might rise, thereby
eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.

—[3]

[edit]Rise of governmental intervention

The developed countries also agreed that the liberal international economic system required governmental
intervention. In the aftermath of the Great Depression, public management of the economy had emerged as a
primary activity of governments in the developed states.[citation needed] Employment, stability, and growth were now
important subjects of public policy. In turn, the role of government in the national economy had become
associated with the assumption by the state of the responsibility for assuring its citizens of a degree of
economic well-being.[citation needed] The welfare state grew out of the Great Depression, which created a popular
demand for governmental intervention in the economy, and out of the theoreticalcontributions of
the Keynesian school of economics, which asserted the need for governmental intervention to maintain an
adequate level of employment.[citation needed]

However, increased government intervention in domestic economy brought with it isolationist sentiment that
had a profoundly negative effect on international economics. [citation needed] The priority of national goals,
independent national action in the interwar period, and the failure to perceive that those national goals could
not be realized without some form of international collaboration—which resulted in “beggar-thy-neighbor”
policies such as high tariffs, competitive devaluations that contributed to the breakdown of the gold-based
international monetary system, domestic political instability, and international war. The lesson learned was, as
the principal architect of the Bretton Woods system New Dealer Harry Dexter White put it:

the absence of a high degree of economic collaboration among the leading nations will…inevitably result in
economic warfare that will be but the prelude and instigator of military warfare on an even vaster scale.

—[Notes 2]

To ensure economic stability and political peace, states agreed to cooperate to closely regulate the production
of their individual currencies to maintain fixed exchange rates between countries with the aim of more easily
facilitating international trade.[citation needed] This was the foundation of the U.S. vision of postwar world free trade,
which also involved lowering tariffs and among other things maintaining a balance of trade via fixed exchange
rates that would be favorable to the capitalist system.[citation needed]
Thus, the more developed market economies agreed with the U.S. vision of post-war international economic
management, which was to be designed to create and maintain an effectiveinternational monetary system and
foster the reduction of barriers to trade and capital flows. [citation needed] In a sense, the new international monetary
system was in fact a return to a system similar to the pre-war gold standard, only using US dollars as the
world's new reserve currency until the world's gold supply could be reallocated via international trade. [citation
needed]
 Thus, the new system would be devoid (initially) of governments meddling with their currency supply as
they had during the years of economic turmoil preceding WWII. Instead, governments would closely police the
production of their currencies and ensure that they would not artificially manipulate their price levels. [citation
needed]
 If anything, Bretton Woods was in fact a return to a time devoid of increased governmental intervention in
economies and currency systems.[citation needed]

[edit]Atlantic Charter

Roosevelt and Churchill during their secret meeting of August 9 – 12, 1941, in Newfoundlandthat resulted in the Atlantic
Charter, which the U.S. and Britain officially announced two days later.

The Atlantic Charter, drafted during U.S. President Franklin D. Roosevelt's August 1941 meeting with British
Prime Minister Winston Churchill on a ship in the North Atlantic, was the most notable precursor to the Bretton
Woods Conference. Like Woodrow Wilson before him, whose "Fourteen Points" had outlined U.S. aims in the
aftermath of the First World War, Roosevelt set forth a range of ambitious goals for the postwar world even
before the U.S. had entered the Second World War. The Atlantic Charter affirmed the right of all nations to
equal access to trade and raw materials. Moreover, the charter called for freedom of the seas (a principal U.S.
foreign policy aim sinceFrance and Britain had first threatened U.S. shipping in the 1790s), the disarmament of
aggressors, and the "establishment of a wider and more permanent system of general security."

As the war drew to a close, the Bretton Woods conference was the culmination of some two and a half years of
planning for postwar reconstruction by the Treasuries of the U.S. and the UK. U.S. representatives studied with
their British counterparts the reconstitution of what had been lacking between the two world wars: a system of
international payments that would allow trade to be conducted without fear of sudden currency depreciation or
wild fluctuations in exchange rates—ailments that had nearly paralyzed world capitalism during the Great
Depression.

Without a strong European market for U.S. goods and services, most policymakers believed, the U.S. economy
would be unable to sustain the prosperity it had achieved during the war. [citation needed] In addition, U.S. unions had
only grudgingly accepted government-imposed restraints on their demands during the war, but they were
willing to wait no longer, particularly as inflation cut into the existing wage scales with painful force. (By the end
of 1945, there had already been major strikes in the automobile, electrical, and steelindustries.)[citation needed]

In early 1945 Bernard Baruch described the spirit of Bretton Woods as: if we can "stop subsidization of labor
and sweated competition in the export markets," as well as prevent rebuilding of war machines, "oh boy, oh
boy, what long term prosperity we will have."[4] The United States [c]ould therefore use its position of influence
to reopen and control the [rules of the] world economy, so as to give unhindered access to all nations' markets
and materials.

[edit]Wartime devastation of Europe and East Asia

Besides that, U.S. allies—economically exhausted by the war—accepted this leadership. They needed U.S.
assistance to rebuild their domestic production and to finance their international trade; indeed, they needed it to
survive.[citation needed]

Before the war, the French and the British were realizing that they could no longer compete with U.S. industry
in an open marketplace.[citation needed] During the 1930s, the British had created their own economic bloc to shut
out U.S. goods. Churchill did not believe that he could surrender that protection after the war, so he watered
down the Atlantic Charter's "free access" clause before agreeing to it. [citation needed]

Yet, the U.S. officials were determined to open their access to the British empire. The combined value of British
and U.S. trade was well over half of all the world's trade in goods. For the U.S. to open global markets, it first
had to split the British (trade) empire. While Britain had economically dominated the 19th century, the U.S.
officials intended the second half of the 20th to be under U.S. hegemony.[5]

According to one commentator,

One of the reasons Bretton Woods worked was that the US was clearly the most powerful country at the table
and so ultimately was able to impose its will on the others, including an often-dismayed Britain. At the time, one
senior official at the Bank of England described the deal reached at Bretton Woods as “the greatest blow to
Britain next to the war”, largely because it underlined the way in which financial power had moved from the UK
to the US.

—Business Spectator[6]
A devastated Britain had little choice. Two world wars had destroyed the country's principal industries that paid
for the importation of half the nation's food and nearly all its raw materials except coal. The British had no
choice but to ask for aid. Not until the United States signed an agreement on December 6, 1945 to grant Britain
aid of $4.4 billion did the British Parliament ratify the Bretton Woods Agreements (which occurred later in
December 1945).[7]

For nearly two centuries, French and U.S. interests had clashed in both the Old World and the New World.[citation
needed]
 During the war, French mistrust of the United States was embodied by General Charles de Gaulle,
president of the French provisional government.[citation needed] De Gaulle bitterly fought U.S. officials as he tried to
maintain his country's colonies and diplomatic freedom of action. In turn, U.S. officials saw de Gaulle as a
political extremist.[citation needed]

But in 1945 de Gaulle—at that point the leading voice of French nationalism—was forced to grudgingly ask the
U.S. for a billion-dollar loan.[citation needed] Most of the request was granted; in return France promised to curtail
government subsidies and currency manipulation that had given its exporters advantages in the world market.
[citation needed]

On a far more profound level, as the Bretton Woods conference was convening, the greater part of the Third
World remained politically and economically subordinate. Linked to the developed countries of the West
economically and politically—formally and informally—these states had little choice but to acquiesce in the
international economic system established for them. [citation needed] In the East, Soviet hegemony in Eastern
Europe provided the foundation for a separate international economic system. [citation needed]

[edit]Design of the financial system

This article does not cite any references or sources.
Please help improve this article by adding citations to reliable sources. Unsourced material may
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Free trade relied on the free convertibility of currencies. Negotiators at the Bretton Woods conference, fresh
from what they perceived as a disastrous experience with floating rates in the 1930s, concluded that major
monetary fluctuations could stall the free flow of trade.

The new economic system required an accepted vehicle for investment, trade, and payments. Unlike national
economies, however, the international economy lacks a central governmentthat can issue currency and
manage its use. In the past this problem had been solved through the gold standard, but the architects of
Bretton Woods did not consider this option feasible for the postwar political economy. Instead, they set up a
system of fixed exchange rates managed by a series of newly created international institutions using the U.S.
dollar (which was a gold standard currency for central banks) as a reserve currency.
[edit]Informal regimes
[edit]Previous regimes

In the 19th and early 20th centuries gold played a key role in international monetary transactions. The gold
standard was used to back currencies; the international value of currency was determined by its fixed
relationship to gold; gold was used to settle international accounts. The gold standard maintained fixed
exchange rates that were seen as desirable because they reduced the risk of trading with other countries.

Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with
a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall
in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be
rectified. Any country experiencing inflationwould lose gold and therefore would have a decrease in the amount
of money available to spend. This decrease in the amount of money would act to reduce
the inflationary pressure. Supplementing the use of gold in this period was the British pound. Based on the
dominant British economy, the pound became a reserve, transaction, and intervention currency. But the pound
was not up to the challenge of serving as the primary world currency, given the weakness of the British
economy after the Second World War.

The architects of Bretton Woods had conceived of a system wherein exchange rate stability was a prime goal.
Yet, in an era of more activist economic policy, governments did not seriously consider permanently fixed rates
on the model of the classical gold standard of the nineteenth century. Gold production was not even sufficient
to meet the demands of growing international trade and investment. And a sizeable share of the world's known
gold reserves were located in the Soviet Union, which would later emerge as a Cold War rival to the United
States and Western Europe.

The only currency strong enough to meet the rising demands for international currency transactions was
the U.S. dollar. The strength of the U.S. economy, the fixed relationship of the dollar to gold ($35 an ounce),
and the commitment of the U.S. government to convert dollars into gold at that price made the dollar as good
as gold. In fact, the dollar was even better than gold: it earned interest and it was more flexible than gold.

Another view is that in the time of discount banks, discount was the interest earned on gold, and that the only
way to repay interest on government bonds is by printing more dollars, thus raising the price of gold. If gold is
fixed at $35 then other countries will demand gold and not accept dollars. The closing of the gold window in
1971 was the result.

[edit]Fixed exchange rates

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 the reserve currency (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 (a World Currency Unit that was never implemented),
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[citation needed]. 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".

[edit]Formal regimes
The Bretton Woods Conference led to the establishment of the IMF and the IBRD (now the World Bank), which
still remain powerful forces in the world economy.

As mentioned, a major point of common ground at the Conference was the goal to avoid a recurrence of the
closed markets and economic warfare that had characterized the 1930s. Thus, negotiators at Bretton Woods
also agreed that there was a need for an institutional forum for international cooperation on monetary matters.
Already in 1944 the British economistJohn Maynard Keynes emphasized "the importance of rule-based
regimes to stabilize business expectations"—something he accepted in the Bretton Woods system of fixed
exchange rates. Currency troubles in the interwar years, it was felt, had been greatly exacerbated by the
absence of any established procedure or machinery for intergovernmental consultation.

As a result of the establishment of agreed upon structures and rules of international economic interaction,
conflict over economic issues was minimized, and the significance of the economic aspect of international
relations seemed to recede.

[edit]International Monetary Fund

Main article:  International Monetary Fund

Officially established on December 27, 1945, when the 29 participating countries at the conference of Bretton
Woods signed its Articles of Agreement, the IMF was to be the keeper of the rules and the main instrument of
public international management. The Fund commenced its financial operations on March 1, 1947. IMF
approval was necessary for any change in exchange rates in excess of 1%. It advised countries on policies
affecting the monetary system.

[edit]Design

The big question at the Bretton Woods conference with respect to the institution that would emerge as the IMF
was the issue of future access to international liquidity and whether that source should be akin to a world
central bank able to create new reserves at will or a more limited borrowing mechanism.

John Maynard Keynes (right) and Harry Dexter White at the inaugural meeting of the International Monetary Fund's Board of
Governors in Savannah, Georgia, U.S., March 8, 1946
Although attended by 44 nations, discussions at the conference were dominated by two rival plans developed
by the United States and Britain. As the chief international economist at the U.S. Treasury in 1942–44, Harry
Dexter White drafted the U.S. blueprint for international access to liquidity, which competed with the plan
drafted for the British Treasury by Keynes. Overall, White's scheme tended to favor incentives designed to
create price stability within the world's economies, while Keynes' wanted a system that encouraged economic
growth.

At the time, gaps between the White and Keynes plans seemed enormous. Outlining the difficulty of creating a
system that every nation could accept in his speech at the closing plenary session of the Bretton Woods
conference on July 22, 1944, Keynes stated:

We, the delegates of this Conference, Mr. President, have been trying to accomplish something very difficult to
accomplish.[...] It has been our task to find a common measure, a common standard, a common rule
acceptable to each and not irksome to any.

—[Notes 3]

Keynes' proposals would have established a world reserve currency (which he thought might be called
"bancor") administered by a central bank vested with the possibility of creating money and with the authority to
take actions on a much larger scale (understandable considering deflationary problems in Britain at the time).

In case of balance of payments imbalances, Keynes recommended that both debtors and creditors should
change their policies. As outlined by Keynes, countries with payment surpluses should increase their imports
from the deficit countries and thereby create a foreign trade equilibrium. Thus, Keynes was sensitive to the
problem that placing too much of the burden on the deficit country would be deflationary.

But the United States, as a likely creditor nation, and eager to take on the role of the world's economic
powerhouse, balked at Keynes' plan and did not pay serious attention to it. The U.S. contingent was too
concerned about inflationary pressures in the postwar economy, and White saw an imbalance as a problem
only of the deficit country.

Although compromise was reached on some points, because of the overwhelming economic and military power
of the United States, the participants at Bretton Woods largely agreed on White's plan.

[edit]Subscriptions and quotas

What emerged largely reflected U.S. preferences: a system of subscriptions and quotas embedded in the IMF,
which itself was to be no more than a fixed pool of national currencies and gold subscribed by each country as
opposed to a world central bank capable of creating money. The Fund was charged with managing various
nations' trade deficits so that they would not produce currency devaluations that would trigger a decline in
imports.
The IMF is provided with a fund, composed of contributions of member countries in gold and their own
currencies. The original quotas were to total $8.8 billion. When joining the IMF, members are assigned "quotas"
reflecting their relative economic power, and, it is as a sort of credit deposit, were obliged are to pay a
"subscription" of an amount commensurate to the quota. The subscription is to be paid 25% in gold or currency
convertible into gold (effectively the dollar, which was the only currency then still directly gold convertible for
central banks) and 75% in the member's own currency.

Quota subscriptions are to form the largest source of money at the IMF's disposal. The IMF set out to use this
money to grant loans to member countries with financial difficulties. Each member is then entitled to withdraw
25% of its quota immediately in case of payment problems. If this sum should be insufficient, each nation in the
system is also able to request loans for foreign currency.

[edit]Trade deficits

In the event of a deficit in the current account, Fund members, when short of reserves, would be able to borrow
foreign currency in amounts determined by the size of its quota. In other words, the higher the country's
contribution was, the higher the sum of money it could borrow from the IMF.

Members were required to pay back debts within a period of 18 months to five years. In turn, the IMF embarked
on setting up rules and procedures to keep a country from going too deeply into debt year after year. The Fund
would exercise "surveillance" over other economies for the U.S. Treasury in return for its loans to prop up
national currencies.

IMF loans were not comparable to loans issued by a conventional credit institution. Instead, they were
effectively a chance to purchase a foreign currency with gold or the member's national currency.

The U.S.-backed IMF plan sought to end restrictions on the transfer of goods and services from one country to
another, eliminate currency blocs, and lift currency exchange controls.

The IMF was designed to advance credits to countries with balance of payments deficits. Short-run balance of
payment difficulties would be overcome by IMF loans, which would facilitate stable currency exchange rates.
This flexibility meant a member state would not have to induce a depression to cut its national income down to
such a low level that its imports would finally fall within its means. Thus, countries were to be spared the need
to resort to the classical medicine of deflating themselves into drastic unemployment when faced with chronic
balance of payments deficits. Before the Second World War, European nations—particularly Britain—often
resorted to this.

[edit]Par value

The IMF sought to provide for occasional discontinuous exchange-rate adjustments (changing a member's par
value) by international agreement. Member nations were permitted to adjust their currency exchange rate by
10%. This tended to restore equilibrium in their trade by expanding their exports and contracting imports. This
would be allowed only if there was a fundamental disequilibrium. A decrease in the value of a country's money
was called a devaluation, while an increase in the value of the country's money was called a revaluation.

It was envisioned that these changes in exchange rates would be quite rare. However, the concept of
fundamental disequilibrium, though key to the operation of the par value system, was never defined in detail.

[edit]Operations

Never before had international monetary cooperation been attempted on a permanent institutional basis. Even
more groundbreaking was the decision to allocate voting rights among governments, not on a one-state one-
vote basis, but rather in proportion to quotas. Since the United States was contributing the most, U.S.
leadership was the key. Under the system of weighted voting, the United States exerted a preponderant
influence on the IMF. The United States held one-third of all IMF quotas at the outset, enough on its own to
veto all changes to the IMF Charter.

In addition, the IMF was based in Washington, D.C., and staffed mainly by U.S. economists. It regularly
exchanged personnel with the U.S. Treasury. When the IMF began operations in 1946, President Harry S.
Truman named White as its first U.S. Executive Director. Since no Deputy Managing Director post had yet
been created, White served occasionally as Acting Managing Director and generally played a highly influential
role during the IMF's first year.

[edit]International Bank for Reconstruction and Development

Main article:  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.

[edit]Readjustment
[edit]Dollar shortages and the Marshall Plan
The Bretton Woods arrangements were largely adhered to and ratified by the participating governments. It was
expected that national monetary reserves, supplemented with necessary IMF credits, would finance any
temporary balance of payments disequilibria. But this did not prove sufficient to get Europe out of its doldrums.

Postwar world capitalism suffered from a huge dollar shortage. The United States was running huge balance of
trade surpluses, and the U.S. reserves were immense and growing. It was necessary to reverse this flow.
Dollars had to leave the United States and become available for international use. In other words, the United
States would have to reverse the natural economic processes and run a balance of payments deficit.

The modest credit facilities of the IMF were clearly insufficient to deal with Western Europe's huge balance of
payments deficits. The problem was further aggravated by the reaffirmation by the IMF Board of Governors in
the provision in the Bretton Woods Articles of Agreement that the IMF could make loans only for current
account deficits and not for capital and reconstruction purposes. Only the United States contribution of $570
million was actually available for IBRD lending. In addition, because the only available market for IBRD bonds
was the conservative Wall Street banking market, the IBRD was forced to adopt a conservative lending policy,
granting loans only when repayment was assured. Given these problems, by 1947 the IMF and the IBRD
themselves were admitting that they could not deal with the international monetary system's economic
problems.[8]

The United States set up the European Recovery Program (Marshall Plan) to provide large-scale financial and
economic aid for rebuilding Europe largely through grants rather than loans. This included countries belonging
to the Soviet bloc, e.g., Poland. In a speech at Harvard University on June 5, 1947, U.S. Secretary of
State George Marshall stated:

The breakdown of the business structure of Europe during the war was complete. …Europe's requirements for
the next three or four years of foreign food and other essential products… principally from the United States…
are so much greater than her present ability to pay that she must have substantial help or face economic,
social and political deterioration of a very grave character.

—[Notes 4]

From 1947 until 1958, the U.S. deliberately encouraged an outflow of dollars, and, from 1950 on, the United
States ran a balance of payments deficit with the intent of providing liquidity for the international economy.
Dollars flowed out through various U.S. aid programs: the Truman Doctrine entailing aid to the pro-
U.S. Greek and Turkish regimes, which were struggling to suppress communist revolution, aid to various pro-
U.S. regimes in the Third World, and most important, the Marshall Plan. From 1948 to 1954 the United States
provided 16 Western European countries $17 billion in grants.
To encourage long-term adjustment, the United States promoted European and Japanese trade
competitiveness. Policies for economic controls on the defeated former Axis countries were scrapped. Aid to
Europe and Japan was designed to rebuild productivity and export capacity. In the long run it was expected
that such European and Japanese recovery would benefit the United States by widening markets for U.S.
exports, and providing locations for U.S. capital expansion.

In 1956, the World Bank created the International Finance Corporation and in 1960 it created the International
Development Association (IDA). Both have been controversial. Critics of the IDA argue that it was designed to
head off a broader based system headed by the United Nations, and that the IDA lends without consideration
for the effectiveness of the program. Critics also point out that the pressure to keep developing economies
"open" has led to their having difficulties obtaining funds through ordinary channels, and a continual cycle of
asset buy up by foreign investors and capital flight by locals. Defenders of the IDA pointed to its ability to make
large loans for agricultural programs which aided the "Green Revolution" of the 1960s, and its functioning to
stabilize and occasionally subsidize Third World governments, particularly in Latin America.

Bretton Woods, then, created a system of triangular trade: the United States would use the convertible financial
system to trade at a tremendous profit with developing nations, expanding industry and acquiring raw materials.
It would use this surplus to send dollars to Europe, which would then be used to rebuild their economies, and
make the United States the market for their products. This would allow the other industrialized nations to
purchase products from the Third World, which reinforced the American role as the guarantor of stability. When
this triangle became destabilized, Bretton Woods entered a period of crisis that ultimately led to its collapse.

[edit]Cold War
In 1945, Roosevelt and Churchill prepared the postwar era by negotiating with Joseph Stalin at Yalta about
respective zones of influence; this same year Germany was divided into four occupation zones (Soviet,
American, British, and French).

Harry Dexter White succeeded in getting the Soviet Union to participate in the Bretton Woods conference in
1944, but his goal was frustrated when the Soviet Union would not join the IMF. In the past, the reasons why
the Soviet Union chose not to subscribe to the articles by December 1945 have been the subject of
speculation. But since the release of relevant Soviet archives, it is now clear that the Soviet calculation was
based on the behavior of the parties that had actually expressed their assent to the Bretton Woods
Agreements. The extended debates about ratification that had taken place both in the UK and the U.S. were
read in Moscow as evidence of the quick disintegration of the wartime alliance.

Facing the Soviet Union, whose power had also strengthened and whose territorial influence had expanded,
the U.S. assumed the role of leader of the capitalist camp. The rise of the postwar U.S. as the world's leading
industrial, monetary, and military power was rooted in the fact that the mainland U.S. was untouched by the
war, in the instability of the national states in postwar Europe, and the wartime devastation of the Soviet and
European economies.

Despite the economic effort imposed by such a policy, being at the center of the international market gave the
U.S. unprecedented freedom of action in pursuing its foreign affairs goals. A trade surplus made it easier to
keep armies abroad and to invest outside the U.S., and because other nations could not sustain foreign
deployments, the U.S. had the power to decide why, when and how to intervene in global crises. The dollar
continued to function as a compass to guide the health of the world economy, and exporting to the U.S.
became the primary economic goal of developing or redeveloping economies. This arrangement came to be
referred to as the Pax Americana, in analogy to the Pax Britannica of the late 19th century and thePax
Romana of the first. (See Globalism)

[edit]Late application
[edit]U.S. balance of payments crisis
After the end of World War II, the U.S. held $26 billion in gold reserves, of an estimated total of $40 billion
(approx 60%). As world trade increased rapidly through the 1950s, the size of the gold base increased by only
a few percent. In 1950, the U.S. balance of payments swung negative. The first U.S. response to the crisis was
in the late 1950s when the Eisenhower administration placed import quotas on oil and other restrictions on
trade outflows. More drastic measures were proposed, but not acted upon. However, with a mounting
recession that began in 1958, this response alone was not sustainable. In 1960, with Kennedy's election, a
decade-long effort to maintain the Bretton Woods System at the $35/ounce price was begun.

The design of the Bretton Woods System was that nations could only enforce gold convertibility on the anchor
currency—the United States’ dollar. Gold convertibility enforcement was not required, but instead, allowed.
Nations could forgo converting dollars to gold, and instead hold dollars. Rather than full convertibility, it
provided a fixed price for sales between central banks. However, there was still an open gold market. For the
Bretton Woods system to remain workable, it would either have to alter the peg of the dollar to gold, or it would
have to maintain the free market price for gold near the $35 per ounce official price. The greater the gap
between free market gold prices and central bank gold prices, the greater the temptation to deal with internal
economic issues by buying gold at the Bretton Woods price and selling it on the open market.

In 1960 Robert Triffin noticed that holding dollars was more valuable than gold because constant U.S. balance
of payments deficits helped to keep the system liquid and fuel economic growth. What would later come to be
known as Triffin's Dilemma was predicted when Triffin noted that if the U.S. failed to keep running deficits the
system would lose its liquidity, not be able to keep up with the world's economic growth, and, thus, bring the
system to a halt. But incurring such payment deficits also meant that, over time, the deficits would erode
confidence in the dollar as the reserve currency created instability. [9]
The first effort was the creation of the London Gold Pool on November 1 of 1961 between eight nations. The
theory behind the pool was that spikes in the free market price of gold, set by the morning gold fix in London,
could be controlled by having a pool of gold to sell on the open market, that would then be recovered when the
price of gold dropped. Gold's price spiked in response to events such as the Cuban Missile Crisis, and other
smaller events, to as high as $40/ounce. The Kennedy administration drafted a radical change of the tax
system to spur more production capacity and thus encourage exports. This culminated with the 1963 tax cut
program, designed to maintain the $35 peg.

In 1967, there was an attack on the pound and a run on gold in the sterling area, and on November 18, 1967,
the British government was forced to devalue the pound.[10] U.S. PresidentLyndon Baines Johnson was faced
with a brutal choice, either institute protectionist measures, including travel taxes, export subsidies and slashing
the budget—or accept the risk of a "run on gold" and the dollar. From Johnson's perspective: "The world supply
of gold is insufficient to make the present system workable—particularly as the use of the dollar as a reserve
currency is essential to create the required international liquidity to sustain world trade and growth." [11] He
believed that the priorities of the United States were correct, and, although there were internal tensions in the
Western alliance, that turning away from open trade would be more costly, economically and politically, than it
was worth: "Our role of world leadership in a political and military sense is the only reason for our current
embarrassment in an economic sense on the one hand and on the other the correction of the economic
embarrassment under present monetary systems will result in an untenable position economically for our
allies."[citation needed]

While West Germany agreed not to purchase gold from the U.S., and agreed to hold dollars instead, the
pressure on both the dollar and the pound sterling continued. In January 1968 Johnson imposed a series of
measures designed to end gold outflow, and to increase U.S. exports. This was unsuccessful, however, as in
mid-March 1968 a run on gold ensued, theLondon Gold Pool was dissolved, and a series of meetings
attempted to rescue or reform the existing system.[12] But, as long as the U.S. commitments to foreign
deployment continued, particularly to Western Europe, there was little that could be done to maintain the gold
peg.[citation needed][original research?]

All attempts to maintain the peg collapsed in November 1968, and a new policy program attempted to convert
the Bretton Woods system into an enforcement mechanism of floating the gold peg, which would be set by
either fiat policy or by a restriction to honor foreign accounts. The collapse of the gold pool and the refusal of
the pool members to trade gold with private entities—on March 18, 1968 the Congress of the United
States repealed the 25% requirement of gold backing of the dollar [13]—as well as the US pledge to suspend
gold sales to governments that trade in the private markets,[14] led to the expansion of the private markets for
international gold trade, in which the price of gold rose much higher than the official dollar price. [15] [16] The US
gold reserves continued to be depleted due to the actions of some nations, notably France, [16] who continued to
build up their gold reserves.
[edit]Structural changes
[edit]Return to convertibility

In the 1960s and 70s, important structural changes eventually led to the breakdown of international monetary
management. One change was the development of a high level of monetary interdependence. The stage was
set for monetary interdependence by the return to convertibility of the Western European currencies at the end
of 1958 and of the Japanese yen in 1964. Convertibility facilitated the vast expansion of international financial
transactions, which deepened monetary interdependence.

[edit]Growth of international currency markets

Another aspect of the internationalization of banking has been the emergence of international banking
consortia. Since 1964 various banks had formed international syndicates, and by 1971 over three quarters of
the world's largest banks had become shareholders in such syndicates. Multinational banks can and do make
huge international transfers of capital not only for investment purposes but also
for hedging and speculating against exchange rate fluctuations.

These new forms of monetary interdependence made possible huge capital flows. During the Bretton Woods
era countries were reluctant to alter exchange rates formally even in cases of structural disequilibria. Because
such changes had a direct impact on certain domestic economic groups, they came to be seen as political risks
for leaders. As a result official exchange rates often became unrealistic in market terms, providing a virtually
risk-free temptation for speculators. They could move from a weak to a strong currency hoping to reap profits
when a revaluation occurred. If, however, monetary authorities managed to avoid revaluation, they could return
to other currencies with no loss. The combination of risk-free speculation with the availability of huge sums was
highly destabilizing.

[edit]Decline

[edit]U.S. monetary influence

A second structural change that undermined monetary management was the decline of U.S. hegemony. The
U.S. was no longer the dominant economic power it had been for more than two decades. By the mid-1960s,
the E.E.C. and Japan had become international economic powers in their own right. With total reserves
exceeding those of the U.S., with higher levels of growth and trade, and with per capita income approaching
that of the U.S., Europe and Japan were narrowing the gap between themselves and the United States.

The shift toward a more pluralistic distribution of economic power led to increasing dissatisfaction with the
privileged role of the U.S. dollar as the international currency. As in effect the world's central banker, the U.S.,
through its deficit, determined the level of international liquidity. In an increasingly interdependent world, U.S.
policy greatly influenced economic conditions in Europe and Japan. In addition, as long as other countries were
willing to hold dollars, the U.S. could carry out massive foreign expenditures for political purposes—military
activities and foreign aid—without the threat of balance-of-payments constraints.

Dissatisfaction with the political implications of the dollar system was increased by détente between the U.S.
and the Soviet Union. The Soviet threat had been an important force in cementing the Western capitalist
monetary system. The U.S. political and security umbrella helped make American economic domination
palatable for Europe and Japan, which had been economically exhausted by the war. As gross domestic
production grew in European countries, trade grew. When common security tensions lessened, this loosened
the transatlantic dependence on defence concerns, and allowed latent economic tensions to surface.

[edit]Dollar

Reinforcing the relative decline in U.S. power and the dissatisfaction of Europe and Japan with the system was
the continuing decline of the dollar—the foundation that had underpinned the post-1945 global trading system.
The Vietnam War and the refusal of the administration of U.S. President Lyndon B. Johnson to pay for it and
its Great Society programs through taxation resulted in an increased dollar outflow to pay for the military
expenditures and rampant inflation, which led to the deterioration of the U.S. balance of trade position. [citation
needed]
In the late 1960s, the dollar was overvalued with its current trading position, while the Deutsche Mark and
the yen were undervalued; and, naturally, the Germans and the Japanese had no desire to revalue and thereby
make their exports more expensive, whereas the U.S. sought to maintain its international credibility by avoiding
devaluation.[17] Meanwhile, the pressure on government reserves was intensified by the new international
currency markets, with their vast pools of speculative capital moving around in search of quick profits. [16]

In contrast, upon the creation of Bretton Woods, with the U.S. producing half of the world's manufactured
goods and holding half its reserves, the twin burdens of international management and the Cold War were
possible to meet at first. Throughout the 1950s Washington sustained a balance of payments deficit to finance
loans, aid, and troops for allied regimes. But during the 1960s the costs of doing so became less tolerable. By
1970 the U.S. held under 16% of international reserves. Adjustment to these changed realities was impeded by
the U.S. commitment to fixed exchange rates and by the U.S. obligation to convert dollars into gold on demand.
[citation needed]

[edit]Paralysis of international monetary management

[edit]Floating-rate system during 1968–1972

By 1968, the attempt to defend the dollar at a fixed peg of $35/ounce, the policy of the Eisenhower, Kennedy
and Johnson administrations, had become increasingly untenable. Gold outflows from the U.S. accelerated,
and despite gaining assurances from Germany and other nations to hold gold, the unbalanced fiscal spending
of the Johnson administration had transformed the dollar shortage of the 1940s and 1950s into a dollar glut by
the 1960s. In 1967, the IMF agreed in Rio de Janeiro to replace the tranche division set up in 1946. Special
Drawing Rights were set as equal to one U.S. dollar, but were not usable for transactions other than between
banks and the IMF. Nations were required to accept holding Special Drawing Rights (SDRs) equal to three
times their allotment, and interest would be charged, or credited, to each nation based on their SDR holding.
The original interest rate was 1.5%.

The intent of the SDR system was to prevent nations from buying pegged gold and selling it at the higher free
market price, and give nations a reason to hold dollars by crediting interest, at the same time setting a clear
limit to the amount of dollars that could be held. The essential conflict was that the American role as military
defender of the capitalist world's economic system was recognized, but not given a specific monetary value. In
effect, other nations "purchased" American defense policy by taking a loss in holding dollars. They were only
willing to do this as long as they supported U.S. military policy. Because of the Vietnam War and other
unpopular actions, the pro-U.S. consensus began to evaporate. The SDR agreement, in effect, monetized the
value of this relationship, but did not create a market for it.

The use of SDRs as paper gold seemed to offer a way to balance the system, turning the IMF, rather than the
U.S., into the world's central banker. The U.S. tightened controls over foreign investment and currency,
including mandatory investment controls in 1968. In 1970, U.S. President Richard Nixon lifted import quotas on
oil in an attempt to reduce energy costs; instead, however, this exacerbated dollar flight, and created pressure
from petro-dollars. Still, the U.S. continued to draw down reserves. In 1971 it had a reserve deficit of $56 billion;
as well, it had depleted most of its non-gold reserves and had only 22% gold coverage of foreign reserves. In
short, the dollar was tremendously overvalued with respect to gold.

[edit]Nixon Shock

Main article:  Nixon Shock

By the early 1970s, as the Vietnam War accelerated inflation, the United States as a whole began running a
trade deficit. The crucial turning point was 1970, which saw U.S. gold coverage deteriorate from 55% to 22%.
This, in the view of neoclassical economists, represented the point where holders of the dollar had lost faith in
the ability of the U.S. to cut budget and trade deficits.

In 1971 more and more dollars were being printed in Washington, then being pumped overseas, to pay for
government expenditure on the military and social programs. In the first six months of 1971, assets for $22
billion fled the U.S. In response, on August 15, 1971, Nixon unilaterally imposed 90-day wage and price
controls, a 10% import surcharge, and most importantly "closed the gold window", making the dollar
inconvertible to gold directly, except on the open market. Unusually, this decision was made without consulting
members of the international monetary system or even his own State Department, and was soon dubbed
the Nixon Shock.
The surcharge was dropped in December 1971 as part of a general revaluation of major currencies, which
were henceforth allowed 2.25% devaluations from the agreed exchange rate. But even the more flexible official
rates could not be defended against the speculators. By March 1976, all the major currencies were floating—in
other words, exchange rates were no longer the principal method used by governments to administer monetary
policy.

[edit]Smithsonian Agreement

The shock of August 15 was followed by efforts under U.S. leadership to develop a new system of international
monetary management. Throughout the fall of 1971, there was a series of multilateral and bilateral negotiations
of the Group of Ten seeking to develop a new multilateral monetary system.

On December 17 and 18, 1971, the Group of Ten, meeting in the Smithsonian Institution in Washington,
created the Smithsonian Agreement, which devalued the dollar to $38/ounce, with 2.25% trading bands, and
attempted to balance the world financial system using SDRs alone. It was criticized at the time, and was by
design a "temporary" agreement. It failed to impose discipline on the U.S. government, and with no other
credibility mechanism in place, the pressure against the dollar in gold continued.

This resulted in gold becoming a floating asset, and in 1971 it reached $44.20/ounce, in 1972 $70.30/ounce
and still climbing. By 1972, currencies began abandoning even this devalued peg against the dollar, though it
took a decade for all of the industrialized nations to do so. In February 1973 the Bretton Woods currency
exchange markets closed, after a last-gasp devaluation of the dollar to $44/ounce, and reopened in March in
a floating currency regime.

[edit]Bretton Woods II

Main article:  Bretton Woods II

Dooley, Folkerts-Landau and Garber have referred to the monetary system of today as Bretton Woods II.
[18]
 They argue that in the early 2000s, like 40 years earlier, the international system is composed of a core
issuing the dominant international currency, and a periphery. The periphery is committed to export-led growth
based on the maintenance of an undervalued exchange rate. In the 1960s, the core was the United States and
the periphery was Europe and Japan. This old periphery has since graduated, and the new periphery is Asia.
The core remains the same, the United States. The argument is that a system of pegged currencies, in which
the periphery export capital to the core that provides a financial intermediary role is both stable and desirable,
although this notion is controversial.[18]

In the wake of the Global financial crisis of 2008, policymakers and others have called for a new international
monetary system that some of them also dub Bretton Woods II. On the other side, this crisis has revived the
debate about Bretton Woods II. [Notes 5]
The term dollar hegemony is coined by Henry C.K. Liu to describe the hegemonic role of the US dollar in the
globalized economy.

On September 26, 2008, French president, Nicolas Sarkozy, said, "we must rethink the financial system from
scratch, as at Bretton Woods.”[19]

On September 24–25, 2009 US President Obama hosted the G20 in Pittsburgh. A realignment of currency
exchange rates was proposed. This meeting's policy outcome could be known as the Pittsburgh Agreement of
2009, where deficit nations may devalue their currencies and surplus nations may revalue theirs upward.

In March 2010, Prime Minister Papandreou of Greece wrote an op-ed in the International Herald Tribune, in
which he said: "Democratic governments worldwide must establish a new global financial architecture, as bold
in its own way as Bretton Woods, as bold as the creation of the European Community and European Monetary
Union. And we need it fast." In interviews coinciding with his meeting with President Obama, he indicated that
Obama would raise the issue of new regulations for the international financial markets at the next G20
meetings in June and November 2010.

[edit]Academic legacy

The collapse of the Bretton Woods system led to the study in economics of credibility as a distinct field, and to
the prominence of open macroeconomic models, such as the Mundell-Fleming model.[citation needed]

[edit]Pegged rates

Dates shown are those on which the rate was introduced; "*" indicates floating rate supplied by IMF[20]

[edit]Japanese yen

Date # yen = $1 US

August 1946 15

12 March 1947 50

5 July 1948 270

25 April 1949 360

20 July 1971 308

30 December 1998 115.60*

5 December 2008 92.499*

Note: GDP for 2007 is $4.272 trillion US Dollars[21]

[edit]Deutsche Mark

Date # marks = $1 US Note

21 June 1948 3.33

18 September
4.20
1949

6 March 1961 4

29 October 1969 3.67

30 December 1998 1.673* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $2.807 trillion US Dollars[21]

[edit]Pound sterling

Date # pounds = $1 US

27 December 1945 1/4.03 = 0.25

18 September
1/2.8 = 0.36
1949
17 November 1967 1/2.4 = 0.42

30 December 1998 0.598*

5 December 2008 0.681*

Note: GDP for 2007 is $2.1 trillion US Dollars[21]

[edit]French franc

Date # francs = $1 US Note

27 December 1945 119.11 £1 = 480 FRF

26 January 1948 214.39 £1 = 864 FRF

18 October 1948 263.52 £1 = 1062 FRF

27 April 1949 272.21 £1 = 1097 FRF

20 September
350 £1 = 980 FRF
1949

10 August 1957 420 £1 = 1176 FRF

27 December 1958 493.71 1 FRF = 1.8 mg gold

1 January 1960 4.9371 1 new franc = 100 old francs

10 August 1968 5.48 1 new franc = 162 mg gold

31 December 1998 5.627* Last day of trading; converted to euro (Jan 4 1999)
Note: GDP for 2007 is $2.075 trillion US Dollars[21]

[edit]Italian lira

Date # lire = $1 US Note

4 January 1946 225

26 March 1946 509

7 January 1947 350

28 November 1947 575

18 September
625
1949

31 December 1998 1,654.569* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $1.8 trillion US Dollars[21]

[edit]Spanish peseta

Date # pesetas = $1 US Note

17 July 1959 60

20 November 1967 70 Devalued in line with sterling

31 December 1998 142.734* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $1.361 trillion US Dollars[21]

[edit]Dutch gulden

Date # gulden = $1 US Note

27 December 1945 2.652

20 September 1949 3.8

7 March 1961 3.62

31 December 1998 1.888* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $0.645 trillion US Dollars[21]

[edit]Belgian franc

Date # francs = $1 US Note

27 December 1945 43.77

1946 43.8725

21 September
50
1949

31 December 1998 34.605* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $0.376 trillion US Dollars[21]

[edit]Greek drachma

Date # drachmae = $1 US Note

1954 30
31 December 1998 281.821* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $0.327 trillion US Dollars[21]

[edit]Swiss franc

Date # francs = $1 US Note

27 December 1945 4.30521 £1 = 17.35 CHF

September 1949 4.375 £1 = 12.25 CHF

31 December 1998 1.377* £1 = 2.289 CHF

5 December 2008 1.211* £1 = 1.778 CHF

Note: GDP for 2007 is $0.303 trillion US Dollars[21]

[edit]Danish krone

Date # kroner = $1 US Note

August 1945 4.8

19 September 1949 6.91 Devalued in line with sterling

21 November 1967 7.5

31 December 1998 6.392*

5 December 2008 5.882*

Note: GDP for 2007 is $0.203 trillion US Dollars[21]

[edit]Finnish markka

Date # markkaa = $1 US Note

17 October 1945 136

5 July 1949 160

19 September
230
1949

15 September
320
1957

1 January 1963 3.2 1 new markka = 100 old markka

12 October 1967 4.2

30 December 1998 5.084* Last day of trading; converted to euro (Jan 4 1999)

Note: GDP for 2007 is $0.188 trillion US Dollars[21]

Marshall Plan
From Wikipedia, the free encyclopedia
Labeling used on aid packages

The Marshall Plan (officially the European Recovery Program, ERP) was the large-scale economic program,
1947–51, of the United States for rebuilding and creating a stronger economic foundation for the countries of
Europe. The initiative was named after Secretary of State George Marshall[1]) and was largely the creation
of State Department officials, especially William L. Clayton and George F. Kennan. Marshall spoke of urgent
need to help the European recovery in his address at Harvard University in June 1947. [2]

The reconstruction plan, developed at a meeting of the participating European states, was established on June
5, 1947. It offered the same aid to the Soviet Union and its allies, but they did not accept it.[3][4] The plan was in
operation for four years beginning in April 1948. During that period some US $13 billion in economic and
technical assistance were given to help the recovery of the European countries that had joined in
theOrganization for European Economic Co-operation. This $13 billion was in the context of a U.S. GDP of
$258 billion in 1948, and was on top of $12 billion in American aid to Europe between the end of the war and
the start of the Plan that is counted separately from the Marshall Plan. [5]

The ERP addressed each of the obstacles to postwar recovery. The plan looked to the future, and did not focus
on the destruction caused by the war. Much more important were efforts to modernize European industrial and
business practices using high-efficiency American models, reduce artificial trade barriers, and instill a sense of
hope and self-reliance.[6]

By 1952 as the funding ended, the economy of every participant state had surpassed pre-war levels; for all
Marshall plan recipients, output in 1951 was 35% higher than in 1938. [7] Over the next two decades, Western
Europe enjoyed unprecedented growth and prosperity, but economists are not sure what proportion was due
directly to the ERP, what proportion indirectly, and how much would have happened without it. The Marshall
Plan was one of the first elements ofEuropean integration, as it erased trade barriers and set up institutions to
coordinate the economy on a continental level—that is, it stimulated the total political reconstruction of western
Europe.[8]

Belgian economic historian Herman Van der Wee concludes the Marshall Plan was a "great success":

"It gave a new impetus to reconstruction in Western Europe and made a decisive contribution to the
renewal of the transport system, the modernization of industrial and agricultural equipment, the
resumption of normal production, the raising of productivity, and the facilitating of intra-European
trade."[9]
Contents
 [hide]
 1 Wartime destruction

2 Initial post-war events

o 2.1 Slow recovery

3 Soviet negotiations

4 The speech

5 Rejection by the Soviets

o 5.1 Initial reactions

o 5.2 Compulsory Eastern Bloc

rejection

o 5.3 Szklarska Poręba meeting

6 Negotiations

7 Implementation

o 7.1 German level of industry

restrictions

8 Expenditures

9 Effects and legacy

10 Repayment

11 Areas without the Plan

o 11.1 Aid to Asia

o 11.2 Canada

o 11.3 World total

12 Criticism

o 12.1 Early criticism

o 12.2 Modern criticism

13 In popular culture

14 See also

15 Notes

16 References

17 Further reading

18 External links

[edit]Wartime destruction
By the end of World War II much of Europe was devastated. Sustained aerial bombardment had badly
damaged most major cities, and industrial facilities especially hard-hit. Many of the continent's greatest
cities, including Warsaw, London and Berlin, lay in ruins.[10] The region's economic structure was ruined,
and millions were homeless. The general devastation of agriculture had led to near-starvation conditions
in several parts of the continent, which was to be exacerbated by the particularly harsh winter of 1946–
1947 in northwestern Europe.

Especially damaged was transportation infrastructure, as railways, bridges, and docks had been
specifically targeted by air strikes, while much merchant shipping had been sunk. Although most small
towns and villages in Western Europe had not suffered as much damage, the destruction of
transportation left them economically isolated. None of these problems could be easily remedied, as most
nations engaged in the war had exhausted their treasuries in its execution. [11]

1960 German stamp with portrait of Marshall

The only major power whose infrastructure had not been significantly harmed in World War II was the
United States. It was much more prosperous than before the war but exports were a small factor in the
American economy. Much of the Marshall Plan aid would be used by the Europeans to buy manufactured
goods and raw materials from the United States and Canada. [12]

[edit]Initial post-war events

[edit]Slow recovery

The hunger-winter of 1947, thousands protest in Germany against the disastrous food situation (March 31, 1947).

Europe's economies were recovering very slowly, as unemployment and food shortages led to strikes and
unrest in several nations. In 1947 the European economies were still well below their pre-war levels and
were showing few signs of growth. Agricultural production was 83% of 1938 levels, industrial production
was 88%, and exports only 59%.[13] In Germany, homes went unheated and hundreds froze to death. In
Britain the situation was not as severe. Germany received many offers from Western European nations to
trade food for desperately needed coal and steel. The Allies were however not willing to let the Germans
trade.[14]

During the first three years of occupation of Germany the UK and US vigorously pursued an industrial
disarmament program in Germany, partly by removal of equipment but mainly through an import embargo
on raw materials and deliberate economic neglect. [15] As a consequence of the industrial disarmament of
Germany, whose economy by mid-1947 was deteriorating rapidly, the economic stagnation of Europe
became inevitable.[16] By shutting down the German industry the Allies disrupted the intra-European trade,
a trade that was vital for European recovery, and they thereby delayed the European economic recovery.
[17]
 Nicholas Balabkins concludes that "as long as German industrial capacity was kept idle the economic
recovery of Europe was delayed" and that "To nurse Europe back to economic health the Marshall Plan
scrapped the early postwar economic chains of Germany." [18] Vladimir Petrov concludes that as a result of
the early punitive occupation of Germany the Allies "delayed by several years the economic
reconstruction of the wartorn continent".[19]

In addition, the power and popularity of indigenous communist parties in several Western European
states worried the United States. In both France and Italy, the crisis of the postwar era had provided fuel
for their Communist Parties, which had become well organized in the resistance movements of the war.
These parties had seen significant electoral success in the postwar elections. Though today many
historians feel the threat of France and Italy falling to the communists was remote, [20] it was regarded as a
very real possibility by American policy makers at the time.
The American administration of Harry Truman began to believe this possibility in early March 1946, with
the Soviets' violation of the withdrawal deadline in Iran, and Churchill's Iron Curtain speech, given in
Truman's presence a few days later. In the administration's view, the United States needed to adopt a
definite position on the world scene or fear losing credibility. The emerging doctrine of containment (as
opposed to rollback) argued that the United States needed to substantially aid non-communist countries
to stop the spread of Soviet influence. There was also some hope that the Eastern European nations
would join the plan, and thus be pulled out of the emerging Soviet bloc, but that was not to happen.

In January 1947, Truman appointed retired General George Marshall as Secretary of State, in July 1947
he scrapped JCS 1067 which had decreed "take no steps looking toward the economic rehabilitation of
Germany [or] designed to maintain or strengthen the German economy." Thereafter, JCS 1067 was
supplanted by JCS 1779, stating that "an orderly and prosperous Europe requires the economic
contributions of a stable and productive Germany." [21] The restrictions placed on German heavy industry
production were partly ameliorated, permitted steel production levels were raised from 25% of pre-war
capacity to a new limit placed at 50% of pre-war capacity. [22]

With a Communist insurgency threatening Greece, and Britain financially unable to continue its aid, the
President announced his Truman Doctrine on 12 March 1947, "to support free peoples who are resisting
attempted subjugation by armed minorities or by outside pressures", with an aid request for consideration
and decision, concerning Greece and Turkey. Also in March 1947, former U.S. President Herbert Hoover,
in one of his reports from Germany, argued for a change in U.S. occupation policy, amongst other things
stating:

There is the illusion that the New Germany left after the annexations can be reduced to a 'pastoral
state'. It cannot be done unless we exterminate or move 25,000,000 people out of it. [23]

Hoover further noted that, "The whole economy of Europe is interlinked with German economy
through the exchange of raw materials and manufactured goods. The productivity of Europe cannot
be restored without the restoration of Germany as a contributor to that productivity." [24] Hoover's
report led to a realization in Washington that a new policy was needed; ""almost any action would
be an improvement" on current policy."[25] In Washington, the Joint Chiefs declared that the
"complete revival of Germany industry, particularly coal mining" was now of "primary importance" to
American security.[21]

The United States was already spending a great deal to help Europe recover. Over $14 billion was
spent or loaned during the postwar period through the end of 1947, and is not counted as part of the
marshall Plan. Much of this aid was designed to restore infrastructure and help refugees. Britain, for
example, received an emergency loan of $3.75 billion.[26]
The United Nations also launched a series of humanitarian and relief efforts almost wholly funded
by the United States. These efforts had important effects, but they lacked any central organization
and planning, and failed to meet many of Europe's more fundamental needs. [27] Already in 1943, the
United Nations Relief and Rehabilitation Administration (UNRRA) was founded to provide relief to
areas liberated from Germany. UNRRA provided billions of dollars of rehabilitation aid, and helped
about 8 million refugees. It ceased operations in the DP camps of Europe in 1947; many of its
functions were transferred to several UN agencies.

[edit]Soviet negotiations

After Marshall's appointment in January 1947, administration officials met with Soviet Foreign
Minister Vyacheslav Molotov and others to press for an economically self-sufficient Germany,
including a detailed accounting of the industrial plants, goods and infrastructure already removed by
the Soviets in their occupied zone.[28][29] The Soviets took a punitive approach, pressing for a delay
rather than an acceleration economic rehabilitation, demanding unconditional fulfillment of all prior
reparation claims, and pressing for progress toward nationwide socioeconomic transformation.
[30]
After six weeks of negotiations, Molotov rejected all of these American and british proposals. [28]
[30]
 Molotov also rejected the counter-offer to scrap the British-American "Bizonia" and to include the
Soviet zone within the newly constructed Germany. [30] Marshall was particularly discouraged after
personally meeting with Stalin to explain that the United States could not possibly abandon its
position on Germany, while Stalin expressed little interest in a solution to German economic
problems.[28][30]

[edit]The speech

Wikisource has original text

related to this article:

The Marshall Plan Speech

After the adjournment of the Moscow conference following six weeks of failed discussions with the
Soviets regarding a potential German reconstruction, the United States concluded that a solution
could not wait any longer.[28]

To clarify the U.S.'s position, a major address by Secretary of State George Marshall was planned.
Marshall gave the address to the graduating class of Harvard University on June 5, 1947. Standing
on the steps of Memorial Church in Harvard Yard, he offered American aid to promote European
recovery and reconstruction. The speech described the dysfunction of the European economy and
presented a rationale for U.S. aid.
The modern system of the division of labor upon which the exchange of products is based is in
danger of breaking down. . . . Aside from the demoralizing effect on the world at large and the
possibilities of disturbances arising as a result of the desperation of the people concerned, the
consequences to the economy of the United States should be apparent to all. It is logical that the
United States should do whatever it is able to do to assist in the return of normal economic health to
the world, without which there can be no political stability and no assured peace. Our policy is not
directed against any country, but against hunger, poverty, desperation and chaos. Any government
that is willing to assist in recovery will find full co-operation on the part of the U.S.A. Its purpose
should be the revival of a working economy in the world so as to permit the emergence of political
and social conditions in which free institutions can exist.

Marshall was convinced that economic stability would provide political stability in Europe. He offered
aid, but the European countries had to organise the programme themselves.

The speech, written by Charles Bohlen, contained virtually no details and no numbers. More a
proposal than a plan, it was presented vaguely and made little impact in America. Eight weeks after
the Harvard speech, the State Department wrote in a confidential memorandum that "The Marshall
Plan has been compared to a flying saucer — nobody knows what it looks like, how big it is, in what
direction it is moving, or whether it really exists." [31] The most important element of the speech was
the call for the Europeans to meet and create their own plan for rebuilding Europe, and that the
United States would then fund this plan. The administration felt that the plan would likely be
unpopular among many Americans, and the speech was mainly directed at a European audience.
In an attempt to keep the speech out of American papers journalists were not contacted, and on the
same day Truman called a press conference to take away headlines. In contrast, Dean Acheson, an
Under Secretary of State, was dispatched to contact the European media, especially the British
media, and the speech was read in its entirety on the BBC.[32][33]

[edit]Rejection by the Soviets

British Foreign Secretary Ernest Bevin heard Marshall's radio broadcast speech and immediately
contacted French Foreign Minister Georges Bidault to begin preparing a quick European response
to (and acceptance of) the offer. The two agreed that it would be necessary to invite the Soviets as
the other major allied power. Marshall's speech had explicitly included an invitation to the Soviets,
feeling that excluding them would have been too clear a sign of distrust. State Department officials,
however, knew that Stalin would almost certainly not participate, and that any plan that would send
large amounts of aid to the Soviets was unlikely to be approved by Congress.
[edit]Initial reactions
While the Soviet ambassador in Washington saw the Marshall Plan as means to create an anti-
Soviet bloc, Stalin felt that the Soviets should take the offer. [34] Stalin directed that, in negotiations to
be held in Paris regarding the aid, countries in the Eastern Bloc must not agree to accepting
economic conditions.[34] Stalin changed his outlook when he learned that credits would be extended
only on willingness to accept economic cooperation and that Germany would also be extended aid,
which he thought would retard the Soviets' ability to exercise influence in western Germany. [34]

Initially, Stalin planned to attempt to kill, or at least hamper, the Plan through destructive
participation in the Paris talks regarding conditions.[34] However, he quickly realized that this would
be impossible when Molotov reported after his July 1947 arrival in Paris that no major modifications
were negotiable in accepting the credit.[34] Looming as just as large a concern was the
Czechoslovak eagerness to accept the aid, as well as indications of a similar Polish attitude. [34]

Stalin suspected a possibility that these Eastern Bloc countries might defy Soviet directives not to
accept the aid, potentially causing a loss of control in the Eastern Bloc. [34] In addition, the most
important condition was that every country to join the plan would need to have its economic
situation independently assessed, scrutiny to which the Soviets could not agree. Bevin and Bidault
also insisted that any aid be accompanied by the creation of a unified European economy,
something incompatible with the strict Soviet command economy.

[edit]Compulsory Eastern Bloc rejection

Molotov left Paris, rejecting the plan.[35] Thereafter, statements were made suggesting a future
confrontation with the West, calling the United States both a "fascizing" power and the "center of
worldwide reaction and anti-Soviet activity," with all U.S.-aligned countries branded as enemies.
[35]
 The Soviets also then blamed the United States for communist losses in elections in Belgium,
France and Italy months earlier, in the spring of 1947.[35] It claimed that "marshallization" must be
resisted and prevented by any means, and that French and Italian communist parties were to take
maximum efforts to sabotage the implementation of the Plan.[35] In addition, Western embassies in
Moscow were isolated, with their personnel being denied contact with Soviet officials. [35]

On July 12, a larger meeting was convened in Paris. Every country of Europe was invited, with the
exceptions of Spain (a World War II neutral that had sympathized with Axis powers) and the small
states of Andorra, San Marino, Monaco, and Liechtenstein. The Soviet Union was invited with the
understanding that it would likely refuse. The states of the future Eastern Bloc were also
approached, and Czechoslovakia and Poland agreed to attend. In one of the clearest signs of
Soviet control over the region, the Czechoslovakian foreign minister, Jan Masaryk, was summoned
to Moscow and berated by Stalin for thinking of joining the Marshall Plan. Polish Prime
minister Josef Cyrankiewicz was rewarded by Stalin for the Polish rejection of the Plan. Russia
rewarded Poland with a lucrative five-year trade agreement, the equivalent of 450 million 1948
dollars in credit, 200,000 tons of grain, heavy machinery, and factories. [36]

The Marshall Plan participants were not surprised when the Czechoslovakian and Polish
delegations were prevented from attending the Paris meeting. The other Eastern European states
immediately rejected the offer.[37] Finland also declined in order to avoid antagonizing the Soviets
(see also Finlandization). The Soviet Union's "alternative" to the Marshall plan, which was purported
to involve Soviet subsidies and trade with western Europe, became known as the Molotov Plan, and
later, the COMECON. In a 1947 speech to the United Nations, Soviet deputy foreign minister Andrei
Vyshinsky said that the Marshall Plan violated the principles of the United Nations. He accused the
United States of attempting to impose its will on other independent states, while at the same time
using economic resources distributed as relief to needy nations as an instrument of political
pressure.[38]

Stalin immediately sought to take stronger control over the Eastern Bloc countries, abandoning the
prior appearance of democratic institutions. [39] When it appeared that, in spite of heavy pressure,
non-communist parties might receive in excess of 40 percent of the vote in the August 1947
Hungarian elections, an all-out repression was instituted to suppress independent political forces.
[39]
 In that same month, total annihilation of the opposition in Bulgaria began on the basis of
continuing instructions by Soviet cadres.[39][40]

[edit]Szklarska Poręba meeting

In late September, the Soviet Union called a meeting of nine European Communist parties in
southwest Poland.[41] A Communist Party of the Soviet Union (CPSU) report was read at the outset
to set the heavily anti-Western tone, stating now that "international politics is dominated by the
ruling clique of the American imperialists" which have embarked upon the "enslavement of the
weakened capitalist countries of Europe."[42] Parties were to struggle against the U.S. presence in
Europe by any means necessary, including sabotage.[43] The report further claimed that "reactionary
imperialist elements throughout the world, particularly in the U.S.A., in Britain and France, had put
particular hope on Germany and Japan, primarily on Hitlerite Germany — first as a force most
capable of striking a blow at the Soviet Union." [44]

Referring to the Eastern Bloc, the report stated that "the Red Army's liberating role was
complemented by an upsurge of the freedom-loving peoples' liberation struggle against the fascist
predators and their hirelings."[44] It argued that "the bosses of Wall Street" were "tak[ing] the place of
Germany, Japan and Italy."[44] The Marshall Plan was described as "the American plan for the
enslavement of Europe".[44] It described the world now breaking down "into basically two camps—
the imperialist and antidemocratic camp on the one hand, and the antiimperialist and democratic
camp on the other".[44]

Although the Eastern Bloc countries except Czechoslovakia had immediately rejected Marshall Plan
aid, Eastern Bloc communist parties were blamed for permitting even minor influence by non-
communists in their respective countries during the run up to the Marshall Plan. [39] The meeting's
chair, Andreia Zhadanov, who was in permanent radio contact with the Kremlin from whom he
received instructions,[42] also castigated communist parties in France and Italy for collaboration with
those countries' domestic agendas.[45] Zhadanov warned that if they continued to fail to maintain
international contact with Moscow to consult on all matters, "extremely harmful consequences for
the development of the brother parties' work" would result. [45]

Italian and French communist leaders were prevented by party rules from pointing out that it was
actually Stalin who had directed them not to take opposition stances in 1944. [45] The French
communist party, as others, was then to redirect its mission to "destroy capitalist economy" and that
the Soviet Communist Information Bureau (Cominform) would take control of the French
Communist Party's activities to oppose the Marshall Plan. [43] When they asked Zhadanov if they
should prepare for armed revolt when they returned home, he did not answer. [43] In a follow-up
conversation with Stalin, he explained that an armed struggle would be impossible and that the
struggle against the Marshall Plan was to be waged under the slogan of national independence. [46]

[edit]Negotiations

Turning the plan into reality required negotiations among the participating nations, and to get the
plan through the United States Congress. Sixteen nations met in Paris to determine what form the
American aid would take, and how it would be divided. The negotiations were long and complex,
with each nation having its own interests. France's major concern was that Germany not be rebuilt
to its previous threatening power. The Benelux countries, despite also suffering under the Nazis,
had long been closely linked to the German economy and felt their prosperity depended on its
revival. The Scandinavian nations, especially Sweden, insisted that their long-standing trading
relationships with the Eastern bloc nations not be disrupted and that their neutrality not be infringed.
The United Kingdom insisted on special status, concerned that if it were treated equally with the
devastated continental powers it would receive virtually no aid. The Americans were pushing the
importance of free trade and European unity to form a bulwark against communism. The Truman
administration, represented by William L. Clayton, promised the Europeans that they would be free
to structure the plan themselves, but the administration also reminded the Europeans that
implementation depended on the plan's passage through Congress. A majority of Congress
members were committed to free trade and European integration, and were hesitant to spend too
much of the money on Germany.[47] However, before the Marshall Plan was in effect, France,
Austria, and Italy needed immediate aid. On December 17, 1947, the United States agreed to give
$40 million to France, Austria, China, and Italy.[48]

Agreement was eventually reached and the Europeans sent a reconstruction plan to Washington. In
the document the Europeans asked for $22 billion in aid. Truman cut this to $17 billion in the bill he
put to Congress. The plan encountered sharp opposition in Congress, mostly from the portion of
the Republican Party led by Robert A. Taft that advocated a moreisolationist policy and was weary
of massive government spending. The plan also had opponents on the left, Henry A.
Wallace notably among them. Wallace saw the plan as a subsidy for American exporters and sure
to polarize the world between East and West.[49] Wallace, the former vice president and secretary of
agriculture, mockingly called this the "Martial Plan," arguing that it was just another step towards
war.[50] However, opposition against the Marshall Plan was greatly reduced by the shock of the
overthrow of the democratic government ofCzechoslovakia in February 1948. Soon after, a bill
granting an initial $5 billion passed Congress with strong bipartisan support. The Congress would
eventually allocate $12.4 billion in aid over the four years of the plan. [51]

On 17 March 1948, President Harry S. Truman addressed European security and condemned the
Soviet Union before a hastily convened Joint Session of Congress. Attempting to contain spreading
Soviet influence in Eastern Europe, Truman asked Congress to restore a peacetime military draft
and to swiftly pass the Economic Cooperation Act (also known as the Marshall Plan), to provide
billions in economic assistance to Western European countries. Truman’s speech also offered
strong criticism of the Soviet Union. “The situation in the world today in not primarily the result of the
natural difficulties which follow a great war,” Truman declared. “It is chiefly due to the fact that one
nation has not only refused to cooperate in the establishment of a just and honorable peace but—
even worse—has actively sought to prevent it.” Members of the Republican-dominated 80th
Congress (1947–1949) were skeptical. “In effect, he told the Nation that we have lost the peace,
that our whole war effort was in vain,” noted Representative Frederick Smith of Ohio. Others
thought he had not been forceful enough to contain the USSR. “What [Truman] said fell short of
being tough,” noted Representative Eugene Cox, a Democrat from Georgia. “There is no prospect
of ever winning Russian cooperation.” Despite its reservations, the 80th Congress implemented
Truman’s requests, further escalating the Cold War with the USSR. [52]

Truman signed the Economic Cooperation Act, the Marshall Plan, into law on April 3, 1948; the
Act established the Economic Cooperation Administration (ECA) to administer the program. ECA
was headed by economic cooperation administrator Paul G. Hoffman. In the same year, the
participating countries (Austria, Belgium, Denmark, France, West Germany, the United Kingdom,
Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Sweden, Switzerland,
Turkey, and the United States) signed an accord establishing a master financial-aid-coordinating
agency, the Organization for European Economic Cooperation (later called the Organization for
Economic Cooperation and Development, OECD), which was headed by Frenchman Robert
Marjolin.

[edit]Implementation

First page of the Marshall Plan

The first substantial aid went to Greece and Turkey in January 1947, which were seen as the front
line of the battle against communist expansion, and were already receiving aid under the Truman
Doctrine. Initially Britain had supported the anti-communist factions in those countries, but due to its
dire economic condition it decided to pull out and in February 1947 requested the U.S. to continue
its efforts.[53] The ECA formally began operation in July 1948.

The ECA's official mission statement was to give a boost to the European economy: to promote
European production, to bolster European currency, and to facilitate international trade, especially
with the United States, whose economic interest required Europe to become wealthy enough to
import U.S. goods. Another unofficial goal of ECA (and of the Marshall Plan) was the containment of
growing Soviet influence in Europe, evident especially in the growing strength of communist
parties in Czechoslovakia, France, and Italy.
The Marshall Plan money was transferred to the governments of the European nations. The funds
were jointly administered by the local governments and the ECA. Each European capital had an
ECA envoy, generally a prominent American businessman, who would advise on the process. The
cooperative allocation of funds was encouraged, and panels of government, business, and labor
leaders were convened to examine the economy and see where aid was needed.

The Marshall Plan aid was mostly used for the purchase of goods from the United States. The
European nations had all but exhausted theirforeign exchange reserves during the war, and the
Marshall Plan aid represented almost their sole means of importing goods from abroad. At the start
of the plan these imports were mainly much-needed staples such as food and fuel, but later the
purchases turned towards reconstruction needs as was originally intended. In the latter years, under
pressure from the United States Congress and with the outbreak of the Korean War, an increasing
amount of the aid was spent on rebuilding the militaries of Western Europe. Of the some $13 billion
allotted by mid-1951, $3.4 billion had been spent on imports of raw materials and semi-
manufactured products; $3.2 billion on food, feed, and fertilizer; $1.9 billion on machines, vehicles,
and equipment; and $1.6 billion on fuel.[54]

Also established were counterpart funds, which used Marshall Plan aid to establish funds in the
local currency. According to ECA rules 60% of these funds had to be invested in industry. This was
prominent in Germany, where these government-administered funds played a crucial role in lending
money to private enterprises which would spend the money rebuilding. These funds played a
central role in the reindustrialization of Germany. In 1949–50, for instance, 40% of the investment in
the German coal industry was by these funds.[55]

The companies were obligated to repay the loans to the government, and the money would then be
lent out to another group of businesses. This process has continued to this day in the guise of the
state owned KfW bank. The Special Fund, then supervised by the Federal Economics Ministry, was
worth over DM 10 billion in 1971. In 1997 it was worth DM 23 billion. Through the revolving loan
system, the Fund had by the end of 1995 made low-interest loans to German citizens amounting to
around DM 140 billion. The other 40% of the counterpart funds were used to pay down the debt,
stabilize the currency, or invest in non-industrial projects. France made the most extensive use of
counterpart funds, using them to reduce the budget deficit. In France, and most other countries, the
counterpart fund money was absorbed into general government revenues, and not recycled as in
Germany.[citation needed]

A far less expensive, but also quite effective, ECA initiative was the Technical Assistance Program.
This program funded groups of European engineers and industrialists to visit the United States and
tour mines, factories, and smelters so that they could then copy the American advances at home. At
the same time several hundred American technical advisors were sent to Europe.

[edit]German level of industry restrictions

Even while the Marshall Plan was being implemented, the dismantling of German industry
continued, and in 1949 Konrad Adenauer wrote to the Allies requesting that it end, citing the
inherent contradiction between encouraging industrial growth and removing factories and also the
unpopularity of the policy.[56] Support for dismantling was by this time coming predominantly from
the French, and the Petersberg Agreement of November 1949 reduced the levels vastly, though
dismantling of minor factories continued until 1951.[57] The first "level of industry" plan, signed by the
Allies on March 29, 1946, had stated that German heavy industry was to be lowered to 50% of its
1938 levels by the destruction of 1,500 listedmanufacturing plants.[58]

In January 1946 the Allied Control Council set the foundation of the future German economy by
putting a cap on German steel production—the maximum allowed was set at about 5,800,000 tons
of steel a year, equivalent to 25% of the pre-war production level. [59] The UK, in whose occupation
zone most of the steel production was located, had argued for a more limited capacity reduction by
placing the production ceiling at 12 million tons of steel per year, but had to submit to the will of the
U.S., France and the Soviet Union (which had argued for a 3 million ton limit). Steel plants thus
made redundant were to be dismantled. Germany was to be reduced to the standard of life it had
known at the height of the Great Depression(1932).[60] Consequently, car production was set to 10%
of pre-war levels, and the manufacture of other commodities were reduced as well. [61]

The first "German level of industry" plan was subsequently followed by a number of new ones, the
last signed in 1949. By 1950, after the virtual completion of the by then much watered-out "level of
industry" plans, equipment had been removed from 706 manufacturing plants in western Germany
and steel production capacity had been reduced by 6,700,000 tons. [62]Vladimir Petrov concludes
that the Allies "delayed by several years the economic reconstruction of the war-torn continent, a
reconstruction which subsequently cost the United States billions of dollars." [63] In 1951 West
Germany agreed to join the European Coal and Steel Community (ECSC) the following year. This
meant that some of the economic restrictions on production capacity and on actual production that
were imposed by the International Authority for the Ruhr were lifted, and that its role was taken over
by the ECSC.[64]

[edit]Expenditures
Map of Cold-War era Europe showing countries that received Marshall Plan aid. The blue columns show the
relative amount of total aid per nation.

The Marshall Plan aid was divided amongst the participant states on a roughly per capita basis. A
larger amount was given to the major industrial powers, as the prevailing opinion was that their
resuscitation was essential for general European revival. Somewhat more aid per capita was also
directed towards the Allied nations, with less for those that had been part of the Axis or remained
neutral. The table below shows Marshall Plan aid by country and year (in millions of dollars)
from The Marshall Plan Fifty Years Later. There is no clear consensus on exact amounts, as
different scholars differ on exactly what elements of American aid during this period were part of the
Marshall Plan.

1948/49 1949/50 1950/51 Cumulative

Country ($ millions) ($ millions) ($ millions) ($ millions)

 Austria 232 166 70 468

 Belgium and   Luxembourg 195 222 360 777

 Denmark 103 87 195 385

 France 1085 691 520 2296

 Germany 510 438 500 1448

 Greece 175 156 45 376

  Iceland 6 22 15 43

 Ireland 88 45 0 133

 Italy and   Trieste 594 405 205 1204

 Netherlands 471 302 355 1128

 Norway 82 90 200 372

 Portugal 0 0 70 70

 Sweden 39 48 260 347

 Switzerland 0 0 250 250

 Turkey 28 59 50 137

 United Kingdom 1316 921 1060 3297

Totals 4,924 3,652 4,155 12,731

[edit]Effects and legacy

One of a number of posters created to promote the Marshall Plan in Europe. Note the pivotal position of the
American flag. The blue and white flag between those of Germany and Italy is a version of the Triesteflag.

The Marshall Plan was originally scheduled to end in 1953. Any effort to extend it was halted by the
growing cost of the Korean War and rearmament. American Republicans hostile to the plan had
also gained seats in the 1950 Congressional elections, and conservative opposition to the plan was
revived. Thus the plan ended in 1951, though various other forms of American aid to Europe
continued afterwards.

The years 1948 to 1952 saw the fastest period of growth in European history. Industrial production
increased by 35%. Agricultural production substantially surpassed pre-war levels. [51] The poverty
and starvation of the immediate postwar years disappeared, and Western Europe embarked upon
an unprecedented two decades of growth that saw standards of living increase dramatically. There
is some debate among historians over how much this should be credited to the Marshall Plan. Most
reject the idea that it alone miraculously revived Europe, as evidence shows that a general recovery
was already underway. Most believe that the Marshall Plan sped this recovery, but did not initiate it.
The United States worked to direct the Marshall Plan towards children and an increase of nutritional
material for all citizens within western Europe so as to shed a positive light on its goals as it worked
to effectively defeat communist threats. One effect of the plan was that it subtly “Americanized”
countries, especially Austria, who embraced United States’ assistance, through popular culture,
such as Hollywood movies and rock n’ roll (Bischof, Pelinka and Stiefel 174-175).

The political effects of the Marshall Plan may have been just as important as the economic ones.
Marshall Plan aid allowed the nations of Western Europe to relax austerity measures and rationing,
reducing discontent and bringing political stability. The communist influence on Western Europe
was greatly reduced, and throughout the region communist parties faded in popularity in the years
after the Marshall Plan. The trade relations fostered by the Marshall Plan helped forge the North
Atlantic alliance that would persist throughout the Cold War. At the same time, the nonparticipation
of the states of Eastern Europe was one of the first clear signs that the continent was now divided.

The Marshall Plan also played an important role in European integration. Both the Americans and
many of the European leaders felt that European integration was necessary to secure the peace
and prosperity of Europe, and thus used Marshall Plan guidelines to foster integration. In some
ways this effort failed, as the OEEC never grew to be more than an agent of economic cooperation.
Rather it was the separate European Coal and Steel Community, which notably excluded Britain,
that would eventually grow into the European Union. However, the OEEC served as both a testing
and training ground for the structures and bureaucrats that would later be used by the European
Economic Community. The Marshall Plan, linked into the Bretton Woods system, also mandated
free trade throughout the region.

While some historians today feel some of the praise for the Marshall Plan is exaggerated, it is still
viewed favorably and many thus feel that a similar project would help other areas of the world. After
the fall of communism several proposed a "Marshall Plan for Eastern Europe" that would help revive
that region. Others have proposed a Marshall Plan for Africa to help that continent, and U.S. vice
president Al Gore suggested a Global Marshall Plan.[65] "Marshall Plan" has become a metaphor for
any very large scale government program that is designed to solve a specific social problem. It is
usually used when calling for federal spending to correct a perceived failure of the private sector.

[edit]Repayment

The Organization for European Economic Cooperation took the leading role in allocating funds, and
the ECA arranged for the transfer of the goods. The American supplier was paid in dollars, which
were credited against the appropriate European Recovery Program funds. The European recipient,
however, was not given the goods as a gift, but had to pay for them (though not necessarily at once;
on credit, etc.) in local currency, which was then deposited by the government in a counterpart fund.
This money, in turn, could be used by the ERP countries for further investment projects.

Most of the participating ERP governments were aware from the beginning that they would never
have to return the counterpart fund money to the U.S.; it was eventually absorbed into their national
budgets and "disappeared". Originally the total American aid to Germany (in contrast to grants
given to other countries in Europe) had to be repaid. But under the London debts agreement of
1953, the repayable amount was reduced to about $1 billion. Aid granted after July 1, 1951
amounted to around $270 million, of which Germany had to repay $17 million to the
Washington Export-Import Bank of the United States. In reality, Germany did not know until 1953
exactly how much money it would have to pay back to the U.S., and insisted money was given out
only in the form of interest-bearing loans—a revolving system ensuring the funds would grow rather
than shrink. A lending bank was charged with overseeing the program. European Recovery
Program loans were mostly used to support small- and medium-sized businesses. Germany paid
the U.S. back in installments (the last cheque was handed over in June 1971). However, the money
was not paid from the ERP fund, but from the central government budget. [citation needed]

[edit]Areas without the Plan

Large parts of the world devastated by World War II did not benefit from the Marshall Plan. The only
major Western European nation excluded was Francisco Franco's Spain, which did not overtly
participate in World War II. After the war, it pursued a policy of self-sufficiency, currency controls,
and quotas, with little success. With the escalation of the Cold War, the United States reconsidered
its position, and in 1951 embraced Spain as an ally, encouraged by Franco's aggressive anti-
communist policies. Over the next decade, a considerable amount of American aid would go to
Spain, but less than its neighbors had received under the Marshall Plan. [66]

While the western portion of the Soviet Union had been as badly affected as any part of the world
by the war, the eastern portion of the country was largely untouched and had seen a rapid
industrialization during the war. The Soviets also imposed large reparations payments on the Axis
allies that were in its sphere of influence. Austria, Finland, Hungary, Romania, and especially East
Germany were forced to pay vast sums and ship large amounts of supplies to the USSR. These
reparation payments meant the Soviet Union received about the same itself as 16 European
countries received in total from Marshall Plan aid. [67]

In accordance with the agreements with the USSR shipment of dismantled German industrial
installations from the west began on March 31, 1946. Under the terms of the agreement the Soviet
Union would in return ship raw materials such as food and timber to the western zones. In view of
the Soviet failure to do so the U.S. temporarily halted shipments east (although they were never
resumed), although it was later shown that although utilized for cold war propaganda reasons the
main reason for halting shipments east was not the behavior of the USSR but rather the recalcitrant
behavior of France.[68] Examples of material received by the USSR were equipment from the Kugel-
Fischer ballbearing plant at Schweinfurt, the Daimler-Benz underground aircraft-engine plant
at Obrigheim, the Deschimag shipyards at Bremen-Weser, and the Gendorf powerplant.[69][70]

Eastern Europe saw no Marshall Plan money, as their Moscow-controlled governments rejected
joining the program, and moreover received little help from the Soviets. The Soviets did
establish COMECON as a riposte to the Marshall Plan. The members of Comecon looked to the
Soviet Union for oil; in turn, they provided machinery, equipment, agricultural goods, industrial
goods, and consumer goods to the Soviet Union. Economic recovery in the east was much slower
than in the west, and the economies never fully recovered in the communist period, resulting in the
formation of the shortage economies and a gap in wealth between East and West. Finland, which
did not join the Marshall Plan and which was required to give large reparations to the USSR, saw its
economy recover to pre-war levels in 1947.[71] France, which received billions of dollars through the
Marshall Plan, similarly saw its average income per person return to almost pre-war level by 1949.
[72]
 By mid-1948 industrial production in Poland, Hungary, Bulgaria, and Czechoslovakia had
recovered to a level somewhat above pre-war level. [73]
[edit]Aid to Asia
From the end of the war to the end of 1953, the U.S. provided grants and credits amounting to $5.9
billion to Asian countries, especially China/Taiwan ($1.051 billion), India ($255 million), Indonesia
($215 million), Japan ($2.44 billion), South Korea ($894 million), Pakistan ($98 million) and the
Philippines ($803 million). In addition, another $282 million went to Israel and $196 million to the
rest of the Middle East.[74] All this aid was separate from the Marshall Plan.

[edit]Canada

Canada, like the United States, was little damaged by the war and in 1945 was one of the world's
largest economies. It operated its own aid program. In 1948, the U.S. allowed ERP aid to be used in
purchasing goods from Canada. Canada made over a billion dollars in sales in the first two years of
operation.[75]

[edit]World total
The total of American grants and loans to the world, 1945–53, came to $44.3 billion. [76]

[edit]Criticism

[edit]Early criticism
Initial criticism of the Marshall Plan came from a number of economists. Wilhelm Röpke, who
influenced German Minister for Economy Ludwig Erhard in his economic recovery program,
believed recovery would be found in eliminating central planning and restoring a market economy in
Europe, especially in those countries which had adopted more fascist and corporatisteconomic
policies. Röpke criticized the Marshall plan for forestalling the transition to the free market by
subsidizing the current, failing systems. Erhard put Röpke's theory into practice and would later
credit Röpke's influence for West Germany's preeminent success. [77] Henry Hazlitt criticized the
Marshall Plan in his 1947 book Will Dollars Save the World?, arguing that economic recovery
comes through savings, capital accumulation and private enterprise, and not through large cash
subsidies. Ludwig von Mises also criticized the Marshall Plan in 1951, believing that "the American
subsidies make it possible for [Europe's] governments to conceal partially the disastrous effects of
the various socialist measures they have adopted".[78] Some critics and Congressmen at the time
believed that America was giving too much aid to Europe. America had already given Europe $9
billion in other forms of help in previous years. The Marshall Plan gave another $13 billion which is
equivalent to about $100 billion in today’s economy. Critics did not think that it was necessary for
Americans to be using so much money to help nations they had already assisted in many ways
before.[79]
[edit]Modern criticism
Criticism of the Marshall Plan became prominent among historians of the revisionist school, such
as Walter LaFeber, during the 1960s and 1970s. They argued that the plan was American
economic imperialism, and that it was an attempt to gain control over Western Europe just as the
Soviets controlled Eastern Europe. In a review of West Germany's economy from 1945 to 1951,
German analyst Werner Abelshauser concluded that "foreign aid was not crucial in starting the
recovery or in keeping it going". The economic recoveries of France, Italy, and Belgium, Cowen
found, also predated the flow of U.S. aid. Belgium, the country that relied earliest and most heavily
on free market economic policies after its liberation in 1944, experienced the fastest recovery and
avoided the severe housing and food shortages seen in the rest of continental Europe. [80]

Former U.S. Chairman of the Federal Reserve Bank Alan Greenspan gives most credit to Ludwig
Erhard for Europe's economic recovery. Greenspan writes in his memoir The Age of
Turbulence that Erhard's economic policies were the most important aspect of postwar Western
Europe recovery, far outweighing the contributions of the Marshall Plan. He states that it was
Erhard's reductions in economic regulations that permitted Germany's miraculous recovery, and
that these policies also contributed to the recoveries of many other European countries. Japan's
recovery is also used as a counter-example, since it experienced rapid growth without any aid
whatsoever.[citation needed] Its recovery is attributed to traditional economic stimuli, such as increases in
investment, fueled by a high savings rate and low taxes. Japan saw a large infusion of US
investment during the Korean War.[81] U.S. PresidentGeorge W. Bush told his Argentine
counterpart Néstor Kirchner during a summit in Mexico, upon being told a "Marshall Plan" would be
a solution for Latin America problems, that the "Marshall Plan is a crazy idea of the Democrats."[82]

Criticism of the Marshall Plan also aims at showing that it began a legacy of disastrous
foreign aid programs. Since the 1990s, economic scholarship has been more hostile to the idea of
foreign aid. For example, Alberto Alesina and Beatrice Weder, summing up economic literature on
foreign aid and corruption, find that aid is primarily used wastefully and self-servingly by government
officials, and ends up increasing governmental corruption. [83] This policy of promoting corrupt
government is then attributed back to the initial impetus of the Marshall Plan. [84]

Noam Chomsky wrote that the amount of American dollars given to France and
the Netherlands equaled the funds these countries used to finance their military forces in southeast
Asia. The Marshall Plan was said to have "set the stage for large amounts of private U.S.
investment in Europe, establishing the basis for modern transnational corporations".[85] Other
criticism of the Marshall Plan stemmed from reports that the Netherlands used a significant portion
 of the aid it received to re-conquer Indonesia in the Indonesian National Revolution and was forced
into joining the Korean War in 1950 after threats the project would end if it did not comply. [86]

Nixon Shock
From Wikipedia, the free encyclopedia

This article is about ending the gold standard for US dollars. For Nixon's unexpected diplomacy towards China,
see  1972 Nixon visit to China.

US President Richard Nixon

The Nixon Shock was a series of economic measures taken by U.S. President Richard Nixon in 1971
including unilaterally canceling the direct convertibility of the United States dollar to gold that essentially ended
the existing Bretton Woods system of international financial exchange.

Contents
 [hide]

1 Background

2 The shock

3 Later

ramifications

4 Criticism

5 See also
 6 References

[edit]Background

By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation,
[1]
 the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century. The year
1970 was the crucial turning point, which, because of foreignarbitrage of the U.S. dollar, caused governmental
gold coverage of the paper dollar to decline from 55% to 22%. That, in the view ofNeoclassical Economists and
the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s
ability to cut its budget and trade deficits.

In 1971, the U.S. government again printed more dollars (a 10% increase) [1] and then sent them overseas, to
pay for the nation's military spending and private investments. In the first six months of 1971, $22 billion dollars
in assets left the U.S.[citation needed] In May 1971, inflation-wary West Germany was the first member country to
unilaterally leave the Bretton Woods system — unwilling to deflate the Deutsche Mark to prop up the dollar.[1] In
order to prevent the dumping of the Deutsche Mark on the open market, West Germany did not consult with the
international monetary community before making the change. In the next three months, West Germany’s move
strengthened their economy; simultaneously, the dollar dropped 7.5% against the Deutsche Mark. [1]

Because of the excess printed dollars, and the negative U.S. trade balance, other nations began demanding
fulfillment of America’s “promise to pay” - that is, the redemption of their dollars for gold. Switzerland redeemed
$50 million of paper for gold in July.[1] France, in particular, repeatedly made aggressive demands, and
acquired $191 million in gold, further depleting the gold reserves of the U.S. [1] On 5 August 1971, Congress
released a report recommending devaluation of the dollar, in an effort to protect the dollar against foreign price-
gougers.[1] Still, on 9 August 1971, as the dollar dropped in value against European currencies, Switzerland
unilaterally withdrew the Swiss franc from the Bretton Woods system.[1]

[edit]The shock

To stabilize the economy and combat the 1970 inflation rate of 5.84%[2], on August 15, 1971, President Nixon
imposed a 90-day wage and price freeze, a 10 percent import surcharge, and, most importantly, “closed the
gold window”, ending convertibility between US dollars and gold. The President and fifteen advisors made that
decision without consulting the members of the international monetary system, so the international community
informally named it the Nixon shock. Given the importance of the announcement — and its impact upon foreign
currencies — presidential advisors recalled that they spent more time deciding when to announce publicly the
controversial plan than they spent creating the plan.[3] He was advised that the practical decision was to make
an announcement before the stock markets opened on Monday (and just when Asian markets also were
opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular
and raised the public's spirit. The President was credited with finally rescuing the American public from price-
gougers, and from a foreign-caused exchange crisis.[3][4]

By December 1971, the import surcharge was dropped, as part of a general revaluation of the major
currencies, which thereafter were allowed 2.25% devaluations from the agreed exchange rate. By March 1976,
the world’s major currencies were floating — in other words, the currency exchange rates no longer were
governments' principal means of administeringmonetary policy.

[edit]Later ramifications

Economist Paul Krugman summarizes the post-Nixon Shock era as follows:

The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged
to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful
advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened
recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash
of 1987--which started out every bit as frightening as that of 1929--did not cause a slump in the real economy.

While a freely floating national money has advantages, however, it also has risks. For one thing, it can create
uncertainties for international traders and investors. Over the past five years, the dollar has been worth as
much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because
sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant.
Furthermore, a system that leaves monetary managers free to do good also leaves them free to be
irresponsible--and, in some countries, they have been quick to take the opportunity. [5]

[edit]Criticism

The return to a gold standard is supported by many followers of the Austrian

School, Objectivists and Libertarians[6][not in citation given] largely because they object to the role of the government in
issuing fiat currency through central banks. A significant number of gold standard advocates also call for a
mandated end to fractional reserve banking.

Smithsonian Agreement
From Wikipedia, the free encyclopedia

For similar uses and terms, see Smithsonian (disambiguation).

Foreign exchange

Exchange rates

Currency band
 Exchange rate

Exchange rate regime

Fixed exchange rate

Floating exchange rate

Linked exchange rate

Markets

Foreign exchange market

Futures exchange

Retail forex

Products

Currency

Currency future

Non-deliverable forward

Forex swap

Currency swap

Foreign exchange option

Historical agreements

Bretton Woods Conference

Smithsonian Agreement

Plaza Accord

Louvre Accord

See also

Bureau de change / currency exchange

(office)

The Smithsonian Agreement was a December 1971 agreement that ended the fixed exchange

rates established at the Bretton Woods Conference of 1944.

[edit]History

The Bretton Woods Conference of 1944 established an international fixed exchange rate regime in which

currencies were pegged to the United States dollar, which was based on the gold standard.
By 1970, however, it was clear that the exchange rate regime was under threat, as the United States dollar was
greatly overvalued because of heavy American spending on Lyndon B. Johnson's Great Society and
the Vietnam War. The American economy was also coming under serious inflationarypressures.

In response, on August 15, 1971, President Richard Nixon unilaterally suspended the convertibility of dollars
into gold, effectively ending the gold standard. The United States then entered negotiations with its
industrialized allies to appreciate their own currencies, in response to this change.

Meeting in December 1971 at the Smithsonian Institution, the Group of Ten signed the Smithsonian

Agreement. In the Agreement, the countries agreed to appreciate their currencies against the United States
dollar.

Although the Smithsonian Agreement was hailed by President Nixon as a fundamental reorganization of
international monetary affairs, it quickly proved to be too little and of only temporary benefit. The gold value of
the dollar was realigned again in 1973, from $38.02 to $42.22. In addition, further devaluation of the dollar
occurred against European currencies. The end of the system came in March 1973 when the major currencies
began to floatagainst each other, as governments still had difficulties maintaining the exchange rates within the
+/-2% band stated in the agreement, essentially bringing into effect the floating exchange rate system which
determined exchange rates based on the market forces of supply and demand. A few currencies, such as the
British pound, had begun to float earlier.

Plaza Accord
From Wikipedia, the free encyclopedia

Foreign exchange

Exchange rates

Currency band

Exchange rate

Exchange rate regime

Fixed exchange rate

Floating exchange rate

Linked exchange rate

Markets

Foreign exchange market

Futures exchange

Retail forex
 Products

Currency

Currency future

Non-deliverable forward

Forex swap

Currency swap

Foreign exchange option

Historical agreements

Bretton Woods Conference

Smithsonian Agreement

Plaza Accord

Louvre Accord

See also

Bureau de change / currency exchange

(office)

Foreign Exchange Rate Transition (DEM/USD, FRF/USD,GBP/USD and JPY/USD) from January 1981 to December 1990
In the first half of 1980s, USD was stronger than DEM, FRF, GBP and JPY, but before and after the Plaza Accord, USD was
depreciated[1].

The Plaza Accord or Plaza Agreement was an agreement between the governments of France, West

Germany, Japan, the United States, and theUnited Kingdom, to depreciate the U.S. dollar in relation to
the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments
signed the accord on September 22, 1985 at the Plaza Hotel in New York City.
The exchange rate value of the dollar versus the yen declined by 51% from 1985 to 1987. Most of
this devaluation was due to the $10 billion spent by the participating central banks.[citation needed] Currency
speculation caused the dollar to continue its fall after the end of coordinated interventions. Unlike some
similar financial crises, such as the Mexican and the Argentine financial crises of 1994 and 2001 respectively,
this devaluation was planned, done in an orderly, pre-announced manner and did not lead to financial panic in
the world markets.

The reason for the dollar's devaluation was twofold: to reduce the U.S. current account deficit, which had
reached 3.5% of the GDP, and to help the U.S. economy to emerge from a serious recession that began in the
early 1980s. The U.S. Federal Reserve System under Paul Volcker had halted thestagflation crisis of the 70s
by raising interest rates, but this resulted in the dollar becoming overvalued to the extent that it made industry
in the U.S. (particularly the automobile industry) less competitive in the global market.

The 1985 "Plaza Accord" is named after New York City's Plaza Hotel, which was the location of a meeting of finance
ministers who reached an agreement about managing the fluctuating value of the US dollar. From left are Gerhard
Stoltenberg of West Germany, Pierre Bérégovoy of France,James A. Baker III of the United States, Nigel Lawson of Britain
and Noboru Takeshita of Japan.

Devaluing the dollar made U.S. exports cheaper to its trading partners, which in turn meant that other countries
bought more American-made goods andservices.

The Plaza Accord was successful in reducing the U.S. trade deficit with Western European nations but largely
failed to fulfil its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural
conditions that were insensitive to monetary policy, specifically trade conditions.

The Manufactured goods of the United States became more competitive in the exports market but were still
largely unable to succeed in the Japanese domestic market due to Japan's structural restrictions on imports.
[clarification needed]

The recessionary effects of the strengthened yen in Japan's export-dependent economy created an incentive
for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s.
The Louvre Accord was signed in 1987 to halt the continuing decline of the U.S. dollar.
The signing of the Plaza Accord was significant in that it reflected Japan's emergence as a real player in
managing the international monetary system. Yet it is postulated[2] that it contributed to the Japanese asset
price bubble, which ended-up in a serious reccession, the so-called Lost Decade.

Louvre Accord
From Wikipedia, the free encyclopedia

Foreign exchange

Exchange rates

Currency band

Exchange rate

Exchange rate regime

Fixed exchange rate

Floating exchange rate

Linked exchange rate

Markets

Foreign exchange market

Futures exchange

Retail forex

Products

Currency

Currency future

Non-deliverable forward

Forex swap

Currency swap

Foreign exchange option

Historical agreements

Bretton Woods Conference

Smithsonian Agreement

Plaza Accord

Louvre Accord

See also

Bureau de change / currency exchange

 (office)

The Louvre Accord was signed by the then G6 (France, West Germany, Japan, Canada, the United States and the United

Kingdom) on February 22, 1987 in Paris, France. Italy had been an invited member, but declined to finalize the agreement. The

goal of the Louvre Accord was to stabilize the international  currency markets and halt the continued decline of the US

Dollar caused by the Plaza Accord (of which a primary aim was depreciation of the US dollar in relation to the Japanese  yen and

German Deutsche Mark by the mutual agreement of the G7 Minister of Finance meeting (i.e. a conference of ministers of the

"group of seven") that had been held in Louvre in Paris in 1987. Since the Plaza accord, the dollar rate had continued to slide,

reaching an exchange rate of ¥150 per US$1 in 1987. The ministers of the G7 nations gathered at the Louvre in Paris to "put the

brakes" on this decline.