The Interwar Years 1914-1939
The gold standard broke down during World War 1. Initially the international trading and
payments system was dominated by flexible exchange rates. 'The gold standard was briefly
reinstated from 1925-31 as the Gold Exchange Standard. Under this, the central banks of
individual countries would exchange home currency for the currency of some other country
on the gold standard rather than gold itself. In 1931, England departed from the gold standard
in the face of massive gold and capital outflows. The gold exchange standard was finished. It
was replaced by the use of independent and uncoordinated trade policies of individual
countries. These included managed exchange rates: devaluations of currencies and
protectionism. The result was a 'beggar-thy-neighbour' trade war in which nations cheapened
their currencies in order to increase their exports at other's expense and reduce imports. The
Great Depression was the result. Output and employment levels in individual countries came
down for a decade. Only the extreme event like the World War I1 could kick-start the
economy again.
Bretton Woods, IMF and the World Bank
As mentioned above, towards the end of the World War II the outline of the post-war
international monetary system had already been agreed upon. This was largely the result of
the intensive work during the war by Lord Keynes and his colleagues in U.K. and Harry
Dexter White in U.S.A. Keynes, the foremost economist of his generation, the writer of
"General Theory of Employment, Interest and Money" (1939) had joined the Treasury during
the War. He and White, of the U.S. treasury exchanged drafts and a compromise proposal
was agreed to at the international conference held in Bretton Woods, New Hampshire, U.S.A.
in June 1944. This agreement, signed by 44 nations, was the constitution, the Articles of
Agreement of the International Monetary Fund. The World Bank (The International Bank for
Reconstruction and Development) was established at the same time.
The IMF Agreement
The key provisions of the Bretton Woods Agreement were as follows:
A new permanent institution, the International Monetary Fund (IMF), was to be established
to promote consultation and collaboration on international monetary payments deficits. Each
Fund member would establish, with the approval of the IMF, a par value for its currency and
would undertake to maintain market exchange rates for its currency within one per cent of the
declared par value. Countries would intervene by buying and selling the dollars against their
own currencies, to keep the rates within one per cent of their parities with the dollar.
Members would change their par values only after having secured the Fund approval. This
approval would be given only if the country’s balance of payments was in "fundamental
disequilibrium". Exchange rate adjustment was not to be undertaken lightly. Temporary and
cyclical imbalances were to be financed out of reserves or through borrowings from the Fund.
Only a, long and continuous loss of reserve assets in support of an exchange rate would be
evidence of this fundamental disequilibrium.
Each IMF member country would pay into the IMF pool, a quota, one quarter of which would
be in gold and the remainder in its own currency.
The Fund would be in a position to lend countries in deficit, out of its holdings of gold and
other currencies arising from the subscriptions of its members in relation to their quotas (to
be determined according to each member's size in the world economy).
The gold standard broke down during World War 1. Initially the international trading and
payments system was dominated by flexible exchange rates. 'The gold standard was briefly
reinstated from 1925-31 as the Gold Exchange Standard. Under this, the central banks of
individual countries would exchange home currency for the currency of some other country
on the gold standard rather than gold itself. In 1931, England departed from the gold standard
in the face of massive gold and capital outflows. The gold exchange standard was finished. It
was replaced by the use of independent and uncoordinated trade policies of individual
countries. These included managed exchange rates: devaluations of currencies and
protectionism. The result was a 'beggar-thy-neighbour' trade war in which nations cheapened
their currencies in order to increase their exports at other's expense and reduce imports. The
Great Depression was the result. Output and employment levels in individual countries came
down for a decade. Only the extreme event like the World War I1 could kick-start the
economy again.
Bretton Woods, IMF and the World Bank
As mentioned above, towards the end of the World War II the outline of the post-war
international monetary system had already been agreed upon. This was largely the result of
the intensive work during the war by Lord Keynes and his colleagues in U.K. and Harry
Dexter White in U.S.A. Keynes, the foremost economist of his generation, the writer of
"General Theory of Employment, Interest and Money" (1939) had joined the Treasury during
the War. He and White, of the U.S. treasury exchanged drafts and a compromise proposal
was agreed to at the international conference held in Bretton Woods, New Hampshire, U.S.A.
in June 1944. This agreement, signed by 44 nations, was the constitution, the Articles of
Agreement of the International Monetary Fund. The World Bank (The International Bank for
Reconstruction and Development) was established at the same time.
The IMF Agreement
The key provisions of the Bretton Woods Agreement were as follows:
A new permanent institution, the International Monetary Fund (IMF), was to be established
to promote consultation and collaboration on international monetary payments deficits. Each
Fund member would establish, with the approval of the IMF, a par value for its currency and
would undertake to maintain market exchange rates for its currency within one per cent of the
declared par value. Countries would intervene by buying and selling the dollars against their
own currencies, to keep the rates within one per cent of their parities with the dollar.
Members would change their par values only after having secured the Fund approval. This
approval would be given only if the country’s balance of payments was in "fundamental
disequilibrium". Exchange rate adjustment was not to be undertaken lightly. Temporary and
cyclical imbalances were to be financed out of reserves or through borrowings from the Fund.
Only a, long and continuous loss of reserve assets in support of an exchange rate would be
evidence of this fundamental disequilibrium.
Each IMF member country would pay into the IMF pool, a quota, one quarter of which would
be in gold and the remainder in its own currency.
The Fund would be in a position to lend countries in deficit, out of its holdings of gold and
other currencies arising from the subscriptions of its members in relation to their quotas (to
be determined according to each member's size in the world economy).
