Money
Matters: An IMF Exhibit -- The Importance of Global Cooperation
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System
in Crisis (1959-1971)
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Part
6 of 7
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Searching
for Solutions
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In
the early 1960s, the world searched for ways to remedy the flawed
Bretton Woods system of
a fixed dollar-gold exchange rate:
- Western
Europe and the United States cooperated to try to support the
price of gold in the face of strains caused by speculators and
hoarders.
- The
United States adopted policies aimed at slowing the flow of dollars
abroad.
- The
IMF focused on adding liquidity without relying on gold or dollars.
A new reserve asset, the SDR, was
created to increase the total world money supply.
Could
these efforts save the Bretton Woods international monetary system,
or were its flaws so fundamental that a complete overhaul was needed?
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The
International Response
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Europe
and the United States Cooperate: The Gold Pool
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In
1961, Belgium, France, West Germany, Italy, Switzerland, the Netherlands,
the United States, and the United Kingdom agreed to contribute gold
to a fund that could be used to support the price of gold at $35
per ounce, as decided at Bretton Woods. Gold could be sold from
the pool if high demand threatened to raise its price on the open
market.
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The
End of the Gold Pool
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After
1966, dramatic increases in private gold buying by hoarders, speculators,
and industrial users exhausted the gold pool supply. Member countries
were forced to dip into their own gold reserves to meet the demand.
A
rush to purchase gold from November 1967 to March 1968 finally caused
the pool to disband.
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The
American Response
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Decreasing
the Dollar Drain
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Alarmed
at the flow of dollars abroad, the United States enacted policies
designed to stem the flood.
- Tied
Aid:
More aid dollars were required to be spent on U.S. exports. In
1960, less than half of U.S. laid money was spent on U.S. products
and services. By the mid-1960s, the proportion was close to 90%.
- Interest
Equalization Taxes: Special taxes passed in 1963 and 1964
made it more expensive for non-U.S. citizens to buy U.S. stocks
and bonds or borrow U.S. dollars.
- Voluntary
Capital Control Program: In 1965, President Johnson launched
a program to discourage U.S. corporate investing and spending
abroad.
Initially,
these and other efforts helped reduce the U.S. balance of payments
deficit. In 1965, it reached its lowest level since the 1950s.
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U.S.
Policy Failure
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The
balance of payments deficit continued, despite government efforts
to eliminate it.
- U.S.
military spending abroad soared due to new involvement in Vietnam
and continuing NATO responsibilities.
- U.S.
tourists were spending several billion more dollars abroad than
foreign tourists spent in the United States.
- U.S.
private investment abroad continued to grow. Income from previous
investment abroad continued to grow. Income from previous investments
provided a substantial dollar inflow, but not enough to offset
the overall balance of payments deficit.
- The
U.S. trade surplus was rapidly diminishing, finally becoming a
deficit in 1971.
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The
IMF Response
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The
Debate
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Beginning
in 1963, discussions on how to solve the international liquidity
problem took place within the IMF and among its member nations.
- Some
countries, such as France, wanted to set up additional international
credit with strict rules for its use and payment - but continue
to rely on gold as the main reserve asset.
- Others,
such as the United States and the United Kingdom, wanted to create
a new reserve unit to be used as freely as gold or the reserve
currencies.
Which
countries would receive the new reserve unit?
- The
leading industrial countries favored a limited participation.
- The
IMF and developing countries advocated giving all members - industrial
and developing - a proportional amount of the new reserve unit.
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The
Decision
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The
Special Drawing Right (SDR) that was finally adopted in 1968 represented
a compromise. It was essentially a new reserve unit, rather than
additional credit, but because of certain restrictions, it could
not be used as freely as gold.
SDRs
were to be allocated to all participating IMF members, according
to the size of their IMF quotas.
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The
SDR: Mixed Success
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The
additional liquidity provided by the SDR was quickly assimilated
into the international monetary system. However, by the time the
first SDRs were allocated in 1970, the world did not need more liquidity,
since the United States had not reduced its balance of payments
deficit. In fact, precisely in 1970-72, a big jump in the U.S. deficit
caused a tenfold increase in members’ currency reserves. The
SDR was designed to offset a dollar shortage that never materialized.
"...the
first creation of international paper money, literally out of thin
air."
The
Economist, 1970
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Problem
Persists
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credits |
Flight
from the Dollar
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The
efforts to mend the Bretton Woods exchange-rate system were no match
for the severe exchange-rate crises of the late 1960s. Continual
balance of payments deficits finally forced Britain to devalue the
pound in 1967. People speculated that the dollar might soon follow.
Private holders rushed to exchange their dollars for gold.
As a result, in 1968, the United States stopped redeeming privately
held dollars for gold. Only central banks could still redeem their
dollars at the fixed rate of $35 per ounce. Unable to get gold,
private holders now sold their dollars for stronger currencies,
such as the German mark, the Japanese yen, the Swiss franc, and
the Dutch guilder.
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For a time, many central banks, particularly the West German Bundesbank
and the Bank of Japan, bought dollars to defend the U.S. currency
and keep their own currencies from appreciating. This ended in May
1971, when the central banks began to redeem their dollar reserves
for ever greater quantities of U.S. gold.
U.S.
gold reserves were vanishing. If dollar redemption continued, they
would soon be gone!
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