Smithsonian Agreement and the Bretton Woods Agreement

Smithsonian Agreement and the Bretton Woods Agreement

It was anything but easy for the global monetary system to switch from the gold standard to the current Forex markets. Two pacts that would serve as the cornerstone of the current monetary system were created in cooperation by governments from all over the world. However, neither arrangement worked out. We shall examine those arrangements in more detail in this essay.

Bretton Woods

Situation: World War II was being fought by the European nations. As a result, the global economies had been decimated. To be able to pay for the enormous war costs, many nations had turned to create money. Because of the intrinsic volatility in their currency markets, many European economies faced the looming possibility of just imploding once the war was finished. Therefore, in order to avoid such a result, all the nations of the world, along with all the key political figures and economists, met in Bretton Woods in the United States. The future monetary system and development of the Forex market were significantly impacted by this meeting, which became known as the Bretton Woods conference.

Objective: The conference's goal was to develop a new monetary system that could withstand any shocks that might come after the war. This indicated that the goal of the meeting was to develop a system that would allow the countries to prevent a complete collapse of their monetary systems and a sharp depreciation of their currencies.

Arrangement: Compared to the gold standard that was already in existence, the arrangement decided at the Bretton Woods system was a little more complicated.

• Dollar-Gold Pegged: After World War II, the United States held the greatest gold reserve in the entire world. Many estimates claim that it contained more gold than all of the European economies combined. Because of this, at this time the US dollar surpassed the British pound sterling as the dominant currency.
• The value of the US dollar was tied to gold because the US possessed the majority of the world's supply of gold. An ounce of gold was sold for a set price of $35. Anyone with a dollar bill could go to a Federal gold window to exchange it for gold.
• Peg to the Dollar: The dollar was the benchmark against which all other currencies were measured. This meant that if the dollar's value changed by 5%, the value of the other currencies would similarly only move by 5%. The dollar's value in relation to other currencies was subject to 1-percent volatility. The Central Banks were directed to conduct open market buying and selling activities to bring the currency into the appropriate range if there was a higher than 1% disparity between the value of the dollar and other currencies.
• Reserve Currency Concept: The Bretton Woods system ultimately led to the dollar being the world's reserve currency. The price of critical commodities like gold and oil began to be determined in terms of US dollars rather than gold as a result of all the countries now transacting in US dollars instead of gold. The dollar consequently became a reserve currency. This means that regardless of whether they wanted to trade with the United States or not, every nation that wanted to engage in international trade had to possess some US dollars.

Institutions

The Bretton Woods accord led to the formation of many of the enduring economic institutions that exist today. As a result of this agreement, organizations like the World Bank and the International Monetary Fund (IMF) were established.

One of the most well-liked international agreements to create a formal monetary system was the Bretton Woods system. However, it was only able to last for 27 years, or until 1971. After the Nixon Shock, when the United States unilaterally removed the globe from the gold standard, the Bretton Woods system was declared dead.

Smithsonian Agreement

In 1971, President Nixon ended the global use of the gold standard. He was worried, nevertheless, that unrestrained trading on the foreign exchange markets would cause many currencies to suffer and lose value. He thus succeeded in convincing other nations to sign the Smithsonian agreement. Given that it only lasted a few years and resulted in the entire suspension of the foreign exchange markets, this agreement was mainly a failure.

Fixed Exchange Rates: The G-10 nations agreed to retain their exchange rates tied to the dollar after being urged by the United States to do so. The dollar would not, however, be linked to gold. As a result, it was basically a Bretton Woods accord without the gold underpinning. Additionally, Central Banks were given some latitude because their currencies' values might vary by up to 2.5 percent, plus or minus, of the dollar's value before their Central Banks were required to engage in open market operations

US Trade Deficit

On paper, this arrangement seemed unsound. The strain of the real-world markets, however, caused them to utterly collapse. The value of gold increased to $210 per ounce in 1972 as a result of the persistently growing US trade deficit. As a result, the Smithsonian agreement was denounced by all G-10 members. The result of this was the temporary closure of the forex markets!

There is no other solution available because the governments of the world failed to establish a system in which the exchange rates of the currencies would be fixed and stable. This is the predicament we are in right now. The breakdown of the Bretton Woods and Smithsonian agreements led to the creation of the forex market as we know it today.