Here is previous part 2 of trilogy.
The decline of the Bretton Woods began in 1971 when US President Richard Nixon took the US off decline the Golden Standard to stop the loss of gold. Finally, the USA abandoned the fixed value of dollar making it inconvertible to gold directly and let it “float” – to fluctuate against other currencies. What is significant is that Nixon made this decision not having consulted with the members of the international monetary system, that’s why it was called “Nixon Shock”.
The dollar fell. However, the same year world leaders made an attempt to save the Bretton Woods system with the Smithsonian Agreement. According to the Smithsonian Agreement, the dollar was devalued to the rate of 38$ per ounce of gold in an attempt to balance the world financial system. Nevertheless, the problem with all this was the fact that dollar was no longer suitable for the role of the sole international currency. Thus, the efforts to develop a new system of international monetary management failed. By 1973, The USA and other nations decided to let exchange rates float. Bretton Woods system was abandoned altogether. Though, it didn’t generate a chaos as did the collapse of the international gold standard in the 1930s.
That was the rise of floating exchange rate – the monetary system where the rate of exchange is determined by market forces – the supply and demand for the currency in the market. For example, the higher the demand for a certain currency, let’s say, US dollar, the higher its value will be. If the demand for the currency decreases, its price decreases, too. The floating exchange rate is changing continuously… A floating rate is often called “self-correcting”, as any variations in supply and demand will automatically be adjusted in the market.
In real-world conditions, no currency is absolutely fixed or floating. In a fixed exchange rate regime, market pressures can also affect changes in the exchange rate. Sometimes when a local currency does not reveal its true value against its pegged currency, a “black market”, which is more revealing of actual supply and demand, may appear. Then a central bank often will have to revalue or devalue the official rate for the rate to comply with the unofficial one, stopping the black market activity. In a floating regime, the central bank can also make interventions in the market when it is necessary to guarantee stability and to escape inflation; however, it is less often that the central bank of a floating regime will step in. Such notions as Dirty Float and Clean float are often associated with the floating exchange rate regime. Clean Float currency means a minimum of official intervention, except for the purpose of maintaining market stability, and its exchange rate is mostly determined by market demand. On the contrary, Dirty Float implies a changeable amount of official intervention to keep a nation’s currency in the line of a desired range of currency prices concerning other currencies.
Though a floating exchange rate regime is not absolutely flawless, it has appeared to be a more efficient means of shaping the long-term value of a currency and generating balance and stability in the international market. For the most part, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates are corrected automatically, they allow a country to reduce the impact of shocks and foreign business cycles, and to prevent the risk of having a balance of payments crisis.
What was after the Bretton Woods System?
Another consequence of Bretton Woods collapse was that it accelerated European Community preparation for monetary union. European Monetary System (EMS) was established in 1979. This system was designed to bring exchange rate stability to Europe by introduction exchange rates regime in which the currencies of participating European states would be regulated against one another within a fixed range rather than simply floating. EMS included 15 countries of Europe and offered the fixation of exchange rates of one currency compared to another one; the rates for the pairs of currencies varied which was more flexible than simply fixing exchange rates. This system also allowed the change of the exchange rate in certain situations; for weaker countries the fluctuation limit has been made wider than for dominating countries As a development of this system, euro has been created; in 1999 all currencies have been fixed against euro and finally in 2002 all currencies were replaced by euro.
The countries of Asian region in their majority chose the stability of their exchange rate and introduced the policies that connected the national currency to the dollar value and let it fluctuate only in small range around the dollar value.
So, there have been many changes in the world monetary systems since 1970s till present. The most significant is the introduction of Euro as the single European currency and the creation of a single monetary authority for Europe (the European Central Bank) in 1999. Since then Euro has become one of the most popular and most traded currencies. But now when Eurozone in crisis, you may be interested in article about: How to make money with the EUR/USD during the EU crisis.
It is impossible to overestimate the importance of the Bretton Woods system for the Forex market. Bretton Woods is a very significant event since it has marked the true founding of Forex trading.
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