Page 27 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes
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Caution The Bretton Woods Agreement placed major emphasis on the stability of exchange
rates by adopting the concept of fixed but adjustable rates.
The keystones of the system were (i) no provision was made for the United States to change the
value of gold at $35 per ounce and (ii) each country was obligated to define its monetary unit in
terms of gold or dollars. While other currencies were required to exchange their currencies for
gold, US dollars remained convertible into gold at $35 per ounce. Thus, each country established
par rates of exchange between its currency and the currencies of all other countries. Each currency
was permitted to fluctuate within plus or minus one per cent of par value by buying or selling
foreign exchange and gold as needed. However, if a currency became too weak to maintain its
par value, it was allowed to devalue up to ten per cent without formal approval by the
International Monetary Fund (IMF).

Thus, the main points of the post-war system evolving from the Bretton Woods Conference
were as follows:
1. A new institution, the International Monetary Fund (IMF), would be established in
Washington DC. Its purpose would be to lend foreign exchange to any member whose
supply of foreign exchange had become scarce. This lending would not be automatic but
would be conditional on the member’s pursuit of economic policies consistent with the
other points of the agreement, a determination that would be made by IMF.

2. The US dollar (and, de facto, the British pound) would be designated as reserve currencies,
and other nations would maintain their foreign exchange reserves principally in the form
of dollars or pounds.
3. Each Fund member would establish a par value for its currency and maintain the exchange
rate for its currency within one per cent of par value. In practice, since the principle reserve
currency would be the US dollar, this meant that other countries would peg their currencies
to the US dollar, and, once convertibility was restored, would buy and sell US dollars to
keep market exchange rates within the 1 per cent band around par value. The United
States, meanwhile, separately agreed to buy gold from or sell gold to foreign official
monetary authorities at $35 per ounce settlement of international financial transactions.
The US dollar was thus pegged to gold and any other currency pegged to the dollar was
indirectly pegged to gold at a price determined by its par value.
4. A Fund member could change its par value only with Fund approval and only if the
country’s balance of payments was in “fundamental disequilibrium.” The meaning of
fundamental disequilibrium was left unspecified but everyone understood that par value
changes were not to be used as a matter of course to adjust economic imbalances.
5. After a post-war transition period, currencies were to become convertible. That meant, to
anyone who was not a lawyer, that currencies could be freely bought and sold for other
foreign currencies. Restrictions were to be removed and, hopefully, eliminated. So, in
order to keep market exchange rates within 1 per cent of par value, central banks and
exchange authorities would have to build up a stock of dollar reserves with which to
intervene in the foreign exchange market.

6. The Fund would get gold and currencies to lend through “subscription.” That is, countries
would have to make a payment (subscription) of gold and currency to the IMF in order to
become a member. Subscription quotas were assigned according to a member’s size and
resources. Payment of the quota normally was 25 per cent in gold and 75 per cent in the
member’s own currency. Those with bigger quotas had to pay more but also got more
voting rights regarding Fund decisions.

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