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Unit 2: International Monetary System

resulted in many of the world’s major currencies losing their convertibility. The only major Notes
currency that continued to remain convertible was the dollar.
Thus the inter-war period was characterised by half-hearted attempts and failure to restore the
gold standard, economic and political instabilities, widely fluctuating exchange rates, bank
failures and financial crisis. The Great Depression in 1929 and the stock market crash also
resulted in the collapse of many banks.

2.1.3 The Bretton Woods System, 1945–1973

The depression of the 1930s, followed by another war, had vastly diminished commercial trade,
the international exchange of currencies and cross-border lending and borrowing. What was left
was only memories of what the system had once been. Revival of the system was necessary and
the reconstruction of the post-war financial system began with the Bretton Woods Agreement
that emerged from the International Monetary and Financial Conference of the united and
associated nations in July 1944 at Bretton Woods, New Hampshire.
There was a general agreement that restoring the gold standard was out of question, that exchange
rates should basically be stable, that governments needed access to credits in convertible currencies
if they were to stabilise exchange rates and that governments should make major adjustments in
exchange rates only after consultation with other countries. On specifics, however, opinion was
divided. The British wanted a reduced role for gold, more exchange rate flexibility than had
existed with the gold standard, a large pool of lendable resources at the disposal of a proposed
international monetary organisation and acceptance of the principle that the burden of correcting
payment disequilibria should be shared by both, surplus countries and deficit countries. The
Americans favoured a major role for gold, highly stable exchange rates, a small pool of lendable
resources and the principle that the burden of adjustment of payment imbalances should fall
primarily on deficit countries.
The negotiators at Bretton Woods made certain recommendations in 1944:

Each nation should be at liberty to use macroeconomic policies for full employment. (This
tenet ruled out a return to the gold standard.)
Free-floating exchange rates could not work. Their ineffectiveness had been demonstrated
during the 1920s and 1930s. But the extremes of both permanently fixed and free-floating
rates should be avoided.
A monetary system was needed that would recognise that exchange rates were both a
national and an international concern.
The agreement established a dollar based International Monetary System and created two new
institutions: The International Monetary Fund (IMF) and The International Bank for Reconstruction
and Development (World Bank). The basic role of the IMF would be to help countries with
balance of payments and exchange rate problems while the World Bank would help countries
with post-war reconstruction and general economic development.
The basic purpose of this new monetary system was to facilitate the expansion of world trade
and to use the US dollar as a standard of value. The Bretton Woods Agreement produced three
propositions (i) The stable exchange rates under the gold standard before World War I were
desirable but there were certain conditions to make adjustments in exchange rates necessary
(ii) Performance of fluctuating exchange rates had been unsatisfactory and (iii) The complex
network of government controls during 1931–1945 deterred the expansion of world trade and
investment. However, there were certain conditions which required government controls over
international trade and payments.

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