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The Gold Standard also required that each country adjust its domestic money supply in direct relation to the amount of gold it held.
Increase in gold would increase the domestic money and a reduction in its gold supply would reduce the money supply.
In July of 1944, as World War II is coming to an end, all 44 allied countries meet in Bretton Woods, New Hampshire for the purpose of establishing a new international monetary system. At Bretton Woods, countries agree that fixed exchange rates were necessary for restarting world trade and global investment (both of which had fallen dramatically). It is also obvious that the US dollar would become the cornerstone of any new international monetary system. Key points of the Bretton Woods were: Pegging the U.S. dollar to gold at $35 per ounce (with the USD the only currency convertible into gold). All other countries peg their currencies to the U.S. dollar. Their par values are set in relation to the U.S. dollar GBP = $2.80; JPY = 360 (1in 1949) Countries agreed to support their exchange rates within + or 1% of these par values. This is done through the buying or selling of foreign exchange when market forces needed to be offset.
361
Exchange Rate
360.5
360
359.5
359
1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970
Exchange Rate
2.1
1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970
As a result, the United States balance of payments moves from a surplus into a deficit.
Dollar is seen by the market as overvalued. Foreigners become concerned about holding overvalued U.S. dollars at a rate of $35 an ounce.
Markets are suggesting it should take more than $35 to buy 1 oz of gold.
U.S. Balance of Payments: 1965 By the mid-1960, the U.S. balance of payment (e.g., trade balance) started to deteriorate (a declining surplus). By 1971, the U.S. merchandise trade balance moved into deficit.
As a result, foreign holdings of dollars increase dramatically and eventually exceed U.S. gold holdings.
By 1971, gold coverage for U.S. dollars had dropped to 22%. In August 1971, President Nixon suspends dollar convertibility into gold. In response, more dollars are sold on foreign exchange markets pushing the dollar lower (and foreign currencies higher).
In December 1971, ten major counties meet in Washington, D.C. with the aim of restoring stability to the international monetary system. Meeting concludes with the Smithsonian Agreements, whereby:
Key countries agree to revalue their currencies and in essence set new par values against the US dollar (e.g., yen +17%, mark +13.5%, pound and franc +9%) The U.S. also agrees to raise the dollar price of gold from $35 to $38 an ounce (represents a further devaluation of the dollar).
It was also agreed that currencies could now fluctuate + or 2.25% around their new par values.
13 months after the Smithsonian Agreements, the dollar comes under renewed attack for being overvalued.
In February 1973, markets sell off dollars again. As before, central banks intervene and buy dollars.
On February, 12th, 1973 the dollar is devalued further to $42 per ounce.
But the price of gold on the London gold markets trades at $70 per ounce. Japan and Italy finally let their currencies float on February 13th. France and Germany continue to manage their currencies in relation to the dollar. In response to mounting speculative currency flows, foreign exchange markets are closed on March 1, 1973, and reopen on March 19, 1973.
The Bretton Woods fixed exchange rate system effectively ends on this date.
Approximately 3 months later, by June 1973, the dollar has floated down an average of 10% against the major currencies of the world.
Exchange Rate
250 200
150
100 50 0
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
Exchange Rate
1.5
0.5
0
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
In addition to the major currencies of the world, a growing number of other developing country currencies have also moved to a floating rate system.
Thus: more and more, market forces are driving currency values. The post Bretton Woods period has resulted exchange rates become much more volatile and , perhaps, less predictable then they were during previous fixed exchange rate eras. This currency volatility complicates the management of global companies.