In 1944, the representatives of 44 countries met at Bretton Woods, New Hampshire in the United states. The purpose of the meet was to create a Framework of the international monetary system. The conference of the Bretton Wood laid down the following guidelines for operating the world monetary system.
- The international monetary system should facilitate unrestricted trade and investment.
- The national currencies should be defined in terms of gold parities and there would be fixed exchange rates.
- The international liquidity will enable the countries to overcome the temporary BOP deficits.
Though initially the Bretten Wood System worked well, trouble started in 1971 when the United States’ dollar became in-convertible into gold.
Dollar crisis of 1971:
The following factors led to the dollar crisis of 1971.
Massive military aid:
In the aftermath of the World war II, U.S. followed a large scale economic assistance programme. It financed the reconstruction and rehabilitation of western Europe. Massive financial aid to such activities has depleted the American resources. Moreover, USA involved itself in many international issues and extension of military aid to nations. These had an adverse impact on the US economy.
U.S had spent a considerable amount of money during the Vietnam war. The amount spent was equal to one-third of its total federal spending. This massive expenditure was a major set back to U.S economy then.
Unproductive spending in space programme:
The U.S has spent extravagant sums of money in space research. Launching trips to the moon and programmes in space research resulted in massive spending. This has drained their resources and had an adverse effect on its economy.
Massive economic and military aid, costly Vietnam war and extravagance in space programmes had ultimately resulted in deficit financing and adverse balance of payments. The deficit financing in US which was usually 3 billion dollars a year increased to 11 billion dollars in 1970. The first three months of 1971 alone witnessed a deficit of 5 billion dollars.
The most serious problem that arose in U.S was the rising wage-efficiency ratio. Wages increased to a tune of 10 per cent a year while the rise in efficiency was only 3 per cent. As a result, U.S entrepreneurs shifted their investments to other developed countries of Europe. This enabled other countries to grow strong and pose intense competition to US in the world markets. At the same time, American industries were deprived of the investment finance. There was loss of jobs in the US economy. The foreign affiliates of U.S companies were regarded as anti-American. Direct investments of U.S firms in foreign countries increased from 3.8 billion dollars to 12.7 billion dollars during a decade, ending in 1970.
Monetary system after the collapse of Bretton Wood System:
After the collapse of the Bretton Wood System, IMF shouldered the responsibility of maintaining international monetary stability. It had appointed a committee represented by 20 countries to deal with the issue. India was one among them. The committee identified liquidity, confidence and adjustment as the areas of inefficiency in the Bretton Woods System.
Inspite of the prolonged discussions undertaken between 1972 and 1974, the committee could not reform the system. However, the agreement reached at Jamaica in 1976 brought about constructive amendments in the Articles of Agreement of the IMF. The important ones are as follows:
- Since 1978, the special drawing rights (SDR) were introduced in the place of gold as a reserve asset system. The official price of the gold was abolished and the restrictions on its sale in the open market were removed. National currencies constitute the major portion of reserve assets. About 75% of them is in U.S dollars. SDR is not related to gold
and its has been linked with all major currencies.
- The member countries were allowed either to float or peg their currencies. The exchange rate of one currency may be pegged to the currency of a particular country. The exchange rate is fixed under the guidelines and supervision of IMF.
Limitations of present monetary system:
The following are the shortcomings of the present monetary system.
- As a variety of exchange rate regime is in force, the supervision of it becomes difficult.
- The reserve asset system is dependent upon the portfolio decisions of central Bankers.
- There are no accepted rules governing the adjustments to payment imbalances.
- Floating exchange rates cause uncertainty in international trade and large disequilibrium in exchange rate.
- The present international monetary system suffers from wide fluctuations