How do you explain the rise and fall of the Bretton Woods system? and the creation of an optimal currency area?

Topics: Currency, Monetary policy, International economics Pages: 8 (2550 words) Published: February 19, 2005
How do you explain the rise and fall of the Bretton Woods system?

How far the emergence of the Euro can be seen against the background of the need for exchange rate stability and the creation of an optimal currency area?

1) The rise and fall of the Bretton Woods system:

The origins of the Bretton Woods system are to be found in the convergence of several key conditions: the shared experiences of the Great Depression, the concentration of power in a small number of states, and the presence of a dominant power willing and able to assume a leading role.

The depression of the 1930s, followed by the war, had vastly diminished commercial trade, the international exchange of currencies, and cross-border lending and borrowing. The creators of the Bretton Woods hoped to avoid a repeat of the disaster of the 1930s, when exchange controls undermined the international payments system that was the basis for world trade. Some of the primary policies to increase competitiveness in 1930's were currency devaluations and protectionist measures. Reduction in the real value of a currencies made export products relatively cheaper, which in its turn in most cases reduced balance of payments deficits. However, currency devaluations also worsened national deflationary spirals, which resulted in plummeting national incomes, shrinking demand, mass unemployment, and a overall decline in the world trade. Whereas, trade protection policies only led to the greater alienation of the world community and the consequent retaliation measures by affected countries. Although these strategies tended to increase government revenues in the short-run, they dramatically undermined the dynamic efficiency of the medium and longer-term. Trade in the 1930s became largely restricted to currency blocs, such as British Empire. These blocs according to the opinion of many prominent economic thinkers reduced possibility for international flow of capital, which resulted in reduction of foreign investment opportunities.

Also based on experience of interwar years, the concept of "economic security" was developed. The main idea of that concept was that a liberal international economic system would enhance the possibilities of the postwar peace. One of those who saw such a security link was Cordell Hull, the U.S. secretary of state from 1933 to 1944. 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 of Nazi Germany and the imperial trade preference system practiced by Britain. Hull argued that:

"...unhampered 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".

Whereas, the principal architect of the Bretton Woods system Harry Dexter White, argued that:

"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".

Another factor which proved extremely influential in the creation of such international system as the Bretton Woods was the fact that there was a country which was willing to take on itself the role of a facilitator. International economic management relied on the dominant power to lead the system. The concentration of power facilitated management by confining the number of actors whose agreement was necessary to establish rules, institutions, and procedures and to carry out management. The obvious candidate for the role was the United States. The relative advantages of the U.S. economy...

References: 1) J. Orlin Grabbe, 1996, "International Financial Markets", 3rd edition, Prentica Hall.
2) www.polsci.ucsb.edu, Benjamin J. Cohen.
3) www.ecb.int, 1998 (EMI / ECB).
4) Eichengreen B., 1993, "European Monetary Unification", Journal of Economic Literature (pp.1321-57).
5) Huhne C., Forder J., 2001, "Both sides of the coin", Profile Books Ltd.
6) Mundell R.A., Friedman M., 2001, "One world, one money"?, Options Politiques.
7) Mundell R.A., 1961, "A theory of optimum currency areas", American Economic Review.
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