Globalisation
What is Globalisation ?
Globalization refers to the spread of the flow of financial products, goods,
technology, information, and jobs across national borders and cultures. In
economic terms, it describes an interdependence of nations around the
globe fostered through free trade.
Bretton woods system
The Bretton Woods agreement of 1944 established a new international
monetary system. It replaced the gold standard with the U.S. dollar as
the global currency. By so doing, it established America as the
dominant power in the world economy. After the agreement was
signed, America was the only country with the ability to print dollars.
The agreement created the World Bank and the International Monetary
Fund (IMF), U.S.-backed organizations that would monitor the new
system.
The Bretton Woods Agreement
The Bretton Woods agreement was created in a 1944 conference of all of the World War
II Allied nations. It took place in Bretton Woods, New Hampshire.
Under the agreement, countries promised that their central banks would maintain fixed
exchange rates between their currencies and the dollar. If a country's currency value
became too weak relative to the dollar, the bank would buy up its currency in foreign
exchange markets. Members of the Bretton Woods system agreed to avoid trade wars.
For example, they wouldn't lower their currencies strictly to increase trade. But they
could regulate their currencies under certain conditions. For example, they could take
action if foreign direct investment began to destabilize their economies. They could also
adjust their currency values to rebuild after a war.
Replacing the Gold Standard
Before Bretton Woods, most countries followed the gold standard.6 That meant
each country guaranteed that it would redeem its currency for its value in gold.
After Bretton Woods, each member agreed to redeem its currency for U.S. dollars,
not gold.
Why dollars? The United States held three-fourths of the world's supply of gold. No
other currency had enough gold to back it as a replacement. The dollar's value was
1/35 of an ounce of gold. Bretton Woods allowed the world to slowly transition
from a gold standard to a U.S. dollar standard.
The transition created more demand for dollars, even though its worth in gold
remained the same. This discrepancy in value planted the seed for the collapse of
the Bretton Woods system three decades later.
Why the Agreement Was Needed
Until World War I, most countries were on the gold standard. However, they cut the
tie to gold so they could print the currency needed to pay for their war costs. This
inflow of currency caused hyperinflation, as the supply of money overwhelmed the
demand. After the war, countries returned to the safety of the gold standard.
All went well until the Great Depression. After the 1929 stock market crash, investors
switched to commodities trading. It drove up the price of gold, resulting in people
redeeming their dollars for gold. The Federal Reserve made things worse by
defending the nation's gold reserve by raising interest rates.
The Bretton Woods system gave nations more flexibility than strict adherence to the
gold standard. It also provided less volatility than a currency system with no standard
at all. A member country still retained the ability to alter its currency's value, if
needed, to correct a "fundamental disequilibrium" in its current account balance, the
Federal Reserve noted.
Role of the IMF and World Bank
The Bretton Woods system could not have worked without the IMF. Member countries
needed it to bail them out if their currency values got too low. They'd need a kind of
global central bank they could borrow from if they needed to adjust their currency's
value and didn't have the funds themselves. Otherwise, they would just slap on trade
barriers or raise interest rates.
The Bretton Woods countries decided against giving the IMF the power of a global
central bank. Instead, they agreed to contribute to a fixed pool of national currencies and
gold to be held by the IMF. Each member country of the Bretton Woods system was then
entitled to borrow what it needed, within the limits of its contributions. The IMF was
also responsible for enforcing the Bretton Woods agreement.
The World Bank, despite its name, was not the world's central bank. At the time of the
Bretton Woods agreement, the World Bank was set up to lend to the European countries
devastated by World War II. The purpose of the World Bank changed to loaning money
to economic development projects in emerging market countries.
The Collapse of the Bretton Woods System
In 1971, the United States suffered from massive stagflation—a combination
of inflation and recession, which causes unemployment and low economic growth.
In response to a dangerous dip in value caused by too much currency in
circulation, President Nixon started to deflate the dollar's value in gold. Nixon
devalued the dollar to 1/38 of an ounce of gold, and then to 1/42 of an ounce.
The devaluation plan backfired. It created a run on the U.S. gold reserves at Fort
Knox as people redeemed their quickly devaluing dollars for gold. In 1971, Nixon
unhooked the value of the dollar from gold altogether. Without price controls, gold
quickly shot up to $120 per ounce in the free market, ending the Bretton Woods
system.
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