INTRODUCTION

The increased integration of the worlds economies has led to a significant increase in the
volume of financial transactions. This increase in the volume of financial transactions has led
to increased growth in many countries and though financial markets have hugely contributed
to this growth market failures have led to prolonged depression in the economy. This has
been witnessed through the various market failures through the years with the most recent
one being the 2008 global financial crisis. In order to prevent such market failures in the
future various institutions have been set up over the years such as the International Monetary
Fund (IMF) and the World Bank which were a product of the historic Bretton Wood
conference. In this project we will primarily be analysing the Bretton Woods system in
general as well as the various institutions formed under it and since politics has general
played a prominent role in such institutions which can witnessed through the fact that
majority of the institutions have generally been formed after the end of major wars and other
significant political events, secondly politics has played a major role in determining how
these institutions function, hence through this project we will try to understand in detail the
role of politics in such institutions.

INTERNATIONAL MONETARY SYSTEM BEFORE BRETTON WOODS

Before World War I the prevailing international monetary system was the gold standard. Gold
was the internationally accepted reserve asset and its value was fixed by the declared par
value specified by that particular country. This system to relate currency with gold reserves
was relatively successful in conducting free trade and payments1.
But all this changed post World War I, the standard broke down and in 1920 countries
allowed a great deal of exchange rate flexibility. In the mid 20s Britain tried to restore the
gold standard and hence adopted the pre-war value of the pound. This greatly inflated the
value of the pound and hence caused payment difficulties for Britain 2. Due to the Great
Depression in the 1930s which led to a tremendous decline in economic activity which led
1 Appleyard, Dennis R., and Alfred J. Field, Jr. " Issues in World Monetary Arrangements." in
International Economics. 3rd ed. Edited by McGraw-Hill Companies Inc., 1998.
2 Ibid.

to payment difficulties emerge for many countries hence nations desperate for foreign buyers
of their goods decided to sell their currency at a lower value than the real value to undercut
the trade of other nations selling the same products. This practice known as competitive
devaluation merely evoked retaliations through similar devaluation by trading rivals. Because
of uncertainty about the value of money, nations hoarded gold and money that could be
converted into gold, further contracting the amount and frequency of monetary transactions
among nations. These various actions led to great reductions in the volume and value of
international trade. The measures also most likely worsened the Great Depression, and the
low level of economic activity continued throughout most the 1930s. Economic activity
spurted upward with the advent of World War II, but involvement in the war prevented
comprehensive consideration and adoption of a new system of international payments3.

BRETTONWOOD SYSTEM
The Bretton Woods was to a large extent a product of the ambitious Anglo-American
planning during the Second World War. John Maynard Keynes and Harry Dexter White were
the chief architects of an attempt to design a new liberal international economic order which
was a response wide fluctuations, competitive depreciation, shrinkage in trade and instability
of the worlds economy in the 1930s4. These deliberations were then incorporated into the
draft articles of agreement of the International Monetary Fund (IMF) which were in due
course submitted to the historic conference convened at Bretton woods, July 1944. The
conference was hugely influential not only because it laid down the legal framework for a
new international institution, but also shaped the international monetary system for the next
quarter of the century5.
The architects of the Bretton Woods system wanted a set of monetary arrangements that
would combine the benefits of the old gold standard (i.e exchange range stability) with the
benefits of floating interest rates( so that nations could pursue their own national policy)
They sought to avoid the defects of floating rates (destabilizing speculation and competitive n
3< https://www.gwu.edu/~ibi/minerva/Spring1999/Henrique.Jereissa/Henrique.Jereissa.html>, last
visited on 28th July 2016.
4 Driscoll, Davis D. "What Is the International Monetary Fund" IMF, Washington D.C., September
1998.
5 Supra at 4.

devaluations to increase exports) and the defects of the fixed exchange rate gold standard
(subordination of national monetary policies to the dictates of external balance and subjection
of the economy to the international transmission of the business cycle) 6. As a result they they
set up the adjustable peg system of fixed parties that could only be changed in the light of
extreme events. This eventually lead to a system where the United States defined the value of
its dollar in terms of gold, so that one once of gold was equal to exactly US$ 35. The U. S.
Government stood behind this definition and would exchange gold for dollars at that rate on
demand. Other countries then defined their currency in terms of dollars. Thus, parity values
were established by agreement, but variations of 1 percent were permitted7.
Another goal of the IMF was the reconciliation of country adjustments to payments
imbalances with the national autonomy in macroeconomics policy. Countries experiencing
balance of payments difficulties were expected to approach the fund. If difficulties were
deemed temporary, a loan would be provided to finance the payments imbalance until it
reversed itself. Thus there would be no need for alteration of the deficit nations macro
policies in the direction of sacrificing internal goals. This would avoid the results of an
increase in interest rates to attract foreign capital, which could lead to an economy
contraction causing a rise in unemployment and a fall in real income. On the other hand, with
difficulties were thought to be fundamental, an exchange rate change would be approved 8.
Further borrowing was subjected to increasingly stringent over-sight or conditions as its
magnitude increases. These conditions are designed to ensure that the borrowing country is
taking action to reduce its balance of payments deficit9.

THE BREAKDOWN OF THE BRETTONWOODS SYSTEM

The system worked well till the mid 60s when certain problems started emerging. The
system was facing a liquidity problem. World trade was growing rapidly so was the size of
payments imbalances. Gold was envisioned to be the primary international reserves asset, but
6 <http://www.nber.org/chapters/c6867.pdf>, last visited on 28th July 2016.
7<http://content.time.com/time/business/article/0,8599,1852254,00.html>, last visited on 28th July
2016.
8 Supra at 6.
9 Supra at 6.

its the supply was growing at a rate of only 1 to 1.5 percent per year while trade in the 1960s
was rowing at a rate close to 7 percent per year. As reserves were not growing apace with
payments imbalances, countries would have to use trade and payments restrictions to reduce
their deficits and these policies could reduce the gains from trade and the rate of world
economic growth. Related to these problems another problem began to emerge, the dollar was
the lynchpin of the global economy but the problem was that the non-US central banks were
holding more dollars than the official US gold stock. This meant that if all other central banks
wanted to convert their dollars into gold the United States did not have enough gold to fulfil
their requirements10.
Another problem which was noticed was the adjustment problem. This refers to the problem
that the nations within the Bretton Wood System had prolonged their payment imbalances.
Thus the contraction in the money supply expected of a deficit country did not occur, nor did
the expansion of a surplus country. This was especially true in respect to the United States
deficit because of its concern about slow economic growth and high unemployment. In a
similar vein, Germanys concern about inflation prevented it from adjusting to a surplus by
expanding its money supply11.
In 1967 Britain officially decided to devalue the pound due to speculative short term capital
inflows. The devaluation sent shockwaves through global financial markets because the
pound along with the dollar were the two national currencies most prominently held by
central banks as official international reserves12.
The increasing private demand for gold kept on increasing the price of gold. The ppressure
could eased only through the sale of gold by central banks.As the demand kept on increasing
in 1968 the Central banks decided that they would no longer deal with private individual and
firms. Transactions between central banks would be at the official price of $35 per ounce but

10 Supra at 3.
11 Camdessus, Michel. "The IMFs Role in Todays Globalized World." IMF, Frankfurt, Germany,
July 2nd ,1998.
12<http://news.bbc.co.uk/onthisday/hi/dates/stories/november/19/newsid_3208000/3208396.stm>,
last visited on 29th July 2016.

private individuals and firms would buy and sell at the price which cleared the private
market.This new structure for gold was called the "two-tier gold market"13.
On August 15,1971, because of its continuing deficit, escalating inflation, and lagging
economic growth, the United States announced that it would no longer buy and sell gold with
central banks this fundamentally altered the then existing nature of the global monetary
system. Without the gold guarantee, there was no anchor to the value of the dollar. This action
amounted to an abandonment of the Bretton Woods system.
After that, there was considerable turbulence in the international monetary system. Trying to
work out a new set of exchange rate arrangements that would neutralize the speculation and
uncertainty of the moment, the chief monetary officials of the leading industrial nations
convened in Washington at the Smithsonian Institute in December 1971. This meeting led to
the Smithsonian Agreement, which established a new set of par values, but further
speculation against the dollar led to other changes. Britain began floating the pound in June
1972. In February 1973, the U.S. dollar was again devalued against gold and than other
currencies began floating14.
On January 1976, with the Jamaica Accords, the IMF made a series of changes that were
incorporated into IMFs Articles of Agreements altering officially the international monetary
system. The most important of these changes were: Each member country was free to adopt
its own preferred exchange rate arrangements. The role of gold was downgraded in the
international monetary system. By these measures the IMF itself sold one-third of its gold
holdings.
The role of the SDR (unlike gold and other international reserve assets, the Special Drawing
Rights-SDR is a paper asset created by the IMF to provide additional world liquidity to the
international monetary system) was to be enhanced. It was anticipated that SDRs would
become very important in the reserve assets portfolios of central banks, although this
objective has not been achieved.

13< http://archives.chicagotribune.com/1968/08/11/page/62/article/two-tier-gold-system-termed-lossfor-west/>, last visited on 29th July 2016.

14 Ibid.

The IMF was to maintain surveillance of exchange rates behaviour. In general terms the IMF
would examine all aspects of the members economy willing to avoid exchange rates
manipulation, to prevent effective balance of payments adjustments and promote an orderly
economic and financial conditions and a monetary system that does not tend to produce
erratic disruptions.
In practice these measures essentially mean that the IMF advises its members, through
regular consultations, on their exchange rate actions so that the international monetary system
does not become subject to considerable uncertainty and instability.
As we can observe, the IMF has been playing an important role in determining the rules for
the international monetary system, and by taking actions (some of them financial) towards its
sustainability. Never the less, its role is constantly been adapted as the system develops and
the yesterdays needs do not fit in todays reality15.

POST BRETTONWOODS: BRETTONWOODS II

The demise of the post-war Bretton Woods agreement in the 70s marked the beginning of a
period of exchange rate volatility, inflation, low growth, trade conflicts and crises of more
than two decades. The creation of the common European currency as well as other currency
related crisis can be attributed to this.
The collapse of the Bretton Woods system introduced the developing countries to a new
territory i.e of floating currencies. For the first currencies derived their value solely from the
amount of confidence the currency enjoyed (though they were nominally backed by gold or
silver values. This taught the market the importance the enjoying the confidence of investors.
These lessons were learned painfully during the Great Inflation years in the 70s and early
80s16.
The economic strategy is to sustain this process is based on the build-up of official reserves in
the form of dollar-denominated assets. The goal of these reserves is to constitute valid
15 <http://www.levyinstitute.org/pubs/wp_597a.pdf>, last visited on 29th July 2016.
16 Obstfeld, Maurice. "The Global Capital Market: Benefactor or Menace?"National Bureau of
Economic Research, Working Paper 6559, Cambridge, MA, May 1998.

collateral as no other enforcement mechanisms is available to foreign investors to guarantee

that the developing country will not default or nationalize the new industries that are created.
The only way to accumulate these reserves is to run a current account surplus, so that the net
inflow of foreign exchange is positive. To do so, emerging countries should peg their
currencies to the U.S. dollar at an undervalued rate, backed by a surplus of aggregate savings
over aggregate investments. To avoid importing the monetary policy of the United States due
to the Impossible Trinity, some countries may impose capital controls and sterilize the
dollar inflows from their monetary bases.Something relatively easy in economies under
heavy government intervention and limited openness to imports and underdeveloped financial
markets17. This new economic system was eventually popularized as Bretton Woods II18.
Over the years this system has been criticized for making the world economy even more
reliant on the US Dollar and hence the world economy has become even more susceptible to
the US governments domestic economic policy.

17 <https://www.bbvaresearch.com/KETD/fbin/mult/WP_0803_tcm348-212969.pdf?ts=2792012>,
last visited on 29th July 2016
18 Dooley, Folkerts-Landau and Garber (2005).

CRITICISM OF BRETTONWOOD II
There are three major complaints. The first concerns with dominance of the dollar as a global
currency and Americas management of it. The bulk of foreign-exchange transactions and
reserves are in dollars, even though the United States accounts for only 24% of global GDP.
A disproportionate share of world trade is conducted in dollars. To many people the
supremacy of the greenback in commerce, commodity pricing and official reserves cannot be
sensible. Not only does it fail to reflect the realities of the world economy; it leaves others
vulnerable to America's domestic monetary policy.
The second criticism has been that the system has encouraged large foreign exchange
reserves especially by emerging economies. Global reserves have risen from $1.3 trillion (5%
of world GDP) in 1995 to $8.4 trillion (14%) today. Emerging economies hold two-thirds of
the total. Most of which has been accumulated over the past ten years. These huge reserves
offend economic logic, since they mean poor countries, which should have abundant
investment opportunities of their own, are lending cheaply to richer ones, mainly America.
Such lending helped precipitate the financial crisis by pushing down America's long-term
interest rates. Today, with Americans saving rather than spending, they represent additional
thrift at a time when the world needs more demand.
The third problem has been in the constant fluctuation in the scale of capital flows.Financial
meltdowns have become more frequent over the past three decades. Many politicians argue
that a financial system in which emerging economies can suffer floods of foreign capital or
sudden droughts (as in 1997-98 and 2008) cannot be the best basis for long-term growth19.

CONCLUSION
Over the course of the project we have learned that politics plays a major role in the creation
and running of major institutions such as the World Bank and the International Monetary
Fund (IMF). Often these institutions have been used by the dominant economies to exert their
soft power. This has been shown through numerous examples in this project such as how
the United States used the Bretton Wood system to exert significant influence on the global
19 Chang, Roberto and Andres Velasco. "The Asian Liquidity Crisis." National Bureau of Economic
Research, Working Paper 6796, Cambridge, MA, November 1998.

economy, used the International Monetary Fund (IMF) to make countries fall in line with
their ideology. Power politics can also be seen to play a major role in deciding which
individuals will head these institutions. It has been seen over the years that the United States
has a virtual veto over deciding the Chief of the World Bank. It has also been witnessed that
the Chief of the International Monetary Fund (IMF) is generally from a dominant European
economy especially France. This shows that politics plays a huge role in such institutions and
that politics and economics in todays day and age are intermixed.