2.5 Early 20th Century foreign exchange developments
At the end of World War II all countries had introduced foreign exchange control
measures and international finance was in disarray. Central and Eastern Europe lay
in ruins and rebuilding (mainly funded by international investments) received high
priority on industrialized countries’ national agendas.
After World War II a new agreement was reached between the United States and the
UK to manage foreign exchange in a manner that would prevent the problems
caused by the gold standard during the rebuilding of Europe after World War I. It
was the so-called
Bretton Woods agreement.
The Bretton Woods system differed from the gold exchange standard in three
important aspects:
• Exchange rates were fixed and pegged, but the pegs were adjustable in order to
avoid cycles of devaluation and revaluation.
• Controls on international capital flows were explicitly allowed.
• The International Monetary Fund (IMF) was founded to monitor the agreement. It
was also charged with the responsibility to decide whether exchange rate pegs
should be changed.
The IMF had the following objectives:
• To establish stable exchange rates
• To eliminate exchange control measures
• To bring about convertibility of all currencies
The IMF could also assist countries in keeping rates stable by lending them gold or
foreign currencies to avert short-term problems and de- or revaluation.
The Bretton Woods agreement stated that each member of the IMF set a fixed rate of
its currency relative to either
• either gold, or
• the US dollar
Furthermore each member country would guarantee the chosen rate within (more or
less) 1 per cent. This would be managed by central bank operations.
Through many years, until the late 1960s and early 1970s, the gold exchange
standard served its purpose, but it was beset with the same problems as that of the
simple gold standard era’s problems. It could not adequately cope with crises of
devaluation / revaluation and inflation.
The Bretton Woods system eventually collapsed, and so did the efforts of
industrialized economies / countries, to manage foreign exchange with fixed rate
regimes. The collapse of the gold exchange standard quickly opened the doors for a
completely new dispensation – floating exchange rate regimes.
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