Within a decade of gaining independence from the colonial British Empire on July 6, 1785, the continental congress of the United States of America bestowed the responsibility of issuing a new currency, the US Dollar, as a part of the process of its economic reformation. The word ‘Dollar’ came from its Dutch origin ‘Daler’. Again, who would knew this new issuance currency would reign in the world economy! Around 60% of foreign exchange reserve currency in the world is in the US dollar which eventually constituted it as a ‘De Facto’ global currency. The evolution of this king currency occurred through accessing many phases as well as ups and downs turns. Exchange of Gold standard, emergence of Petrodollar, multi polar reserve currencies are some crucial factors that may come into the discussion of evolution of the US Dollar.
The discussion may start with the question: What is a Gold Standard? Gold Standard is a monetary system where the government links the value of paper money to the stock of gold reserves. An example can be drawn out that in a gold standard $20 can be equivalent to 1 ounce of Gold. Countries following gold standard can’t raise the amount of paper money without raising their gold reserves too. If we look back to the history of monetary system from late 1800s until 1930s, super economic power such as Great Britain, US, Ottoman Empire also preferred gold currency as their reserve currency. Hence gold has the most powerful intrinsic value at that time. Also the question arises here, what reserve currency does mean actually? According to Investopedia, a reserve currency or an anchor currency is a foreign currency or any standard of store value of money which has the most powerful intrinsic value. This reserve is held in significant quantities by central banks or other monetary authorities. The purpose of holding reserves is to smooth international transactions and investments in all aspects of global economy.
The advantage of following gold standard was that to ensure Fixed Exchange Rate (Home currency’s value in terms of the gold, for example 3000 taka will always have a exchange value of 1 gram of gold as long as fixed by the authority otherwise) which would derive economic stability. Economic stability is essential for taking investment decisions and policy making. It was like holding a debit card rather than a credit card. The debit card holder could spend what he or she had in the banks. However, exchange of gold standard in monetary system was abandoned in 1933. World was feeling the necessity of abandoning gold standard due to its slow process which eventually couldn’t cope up with the increasing economic growth. Firstly, gold supplies were unpredictable. If miners went on strike or new mine discoveries suddenly paused, economic growth could’ve faced grind in a halt. As the outputs of productions were rising significantly, thanks to industrialization, and also growing faster than gold supplies, the central banks specially Federal Reserves of US couldn’t put more money in circulation to keep pace with the growing productions. The US government had no option left to stimulate economy. Consequently, it led to the draining down of wages and throttling investments. That was the scenario of 1929, the starting year of great depression which lasted almost 10 years long.
To clarify it more, let’s look back to the WW I. For the first two and a half years of the Great War, the US remained a neutral party. Consequently it took the country out of a recession into three years economic boom. During the war, Europe imported goods, military equipments, medicines from the US. The US export grew from $2.4 billion in 1913 to $6.2 billion in 1917. But, the spending of the US increased when it decided to join the war itself. Moreover, the US provided loan to the allied countries of WW I which was of $7 billion in total. Though the allied nations were the winner of the war, the war ended up the allied in extreme debt and hindered the allies from repaying the loan. The US was then in huge deficit and debt. This also is considered as one of the foundation stones of great recessions of 1929.
To encounter the depression, with higher rate of unemployment and deflation in the early 1930s, then president of US, Franklin D. Roosevelt found it inevitable to cut the dollar’s tie with gold and gave permission the Federal Reserve to launch paper money into the economy and lower the interest rates. An international monetary conference was arranged in Bretton Woods, Hampshire in 1944. Delegates of 44 allied nations of WW II joined the conference and agreed upon the fact that central bank of those countries would maintain fixed exchange rates between their currencies and the dollar, instead of gold. That means currencies would be pegged to dollar and dollar would be pegged to gold. Gold was the basis for the US dollar. If a country’s currency value becomes too weak relative to the dollar that would mean that country’s currency depreciation. Thus, US Dollar became a super power currency. The demand for US dollar increased significantly. After the agreement was signed, the US was the only country with the ability to print dollars. The dominance of economic power of the US was officially established through this agreement. Why dollars? In narrow sense, the answer may be that the US held three-fourths of the world’s gold supply at that time. The Brettonwood Agreement established the International Monetary Fund (IMF) and the World Bank. Allied nations gave consent to keep a fixed amount of their national currencies and gold to be held by IMF. Each of the allied nations was given the right to borrow what it needed according to their contributions.
The Brettonwood countries set up World Bank to provide loan to the European countries so that they could revive their devastated economy led by WW II. Although the purposes of these monetary authorities have changed over time, the IMF monitors the stability of the world’s monetary system while the World Bank switched to one of the loan providing authority to economic development projects of potential economic countries. Above all, the common goal they cherish raising their living standards in member countries. 188 countries around the world fund the World Bank and have equity share of $252.8 billion until now. In 1995, it was recorded about 180 countries holding $176 billions of capital amount stored in World Bank.
The impact of the Bretton Woods System was very remarkable. It brought salient change and stability in economic performances in the 1950s to 1960s. Though the agreement was held in 1944, it took about 12 years to materialize and fully operating this negotiation. Brettonwoods Agreement led to an era of novel growth of trade and income for the Western industrialist nations and Japan with its loan funding ability, stability in the monetary tools and robust growth to the economy of these countries without any large fluctuations. Global trades were boosted up rigorously. It grew annually at a rate more than 8 percent from 1950s to 1970s. It also successfully controlled unemployment rate keeping under 5 percent in most industrial nations. Widespread use of advanced technologies and huge spread of business enterprises were giving the opportunities of employment to many job seekers. Worldwide investments and trades rose highly to an extent as developing countries invested vast amounts of capitals to import the plans and machineries of modern technology in order to catch up with the developed countries that were technologically advanced in some way. The devastated economy of Japan and Germany almost revived due to these technological advancements. But the Brettonwoods Agreement was short-lived. Some vital issues emerged in the way. In the Bretton Woods Agreement, the price of gold was undervalued as supplies of goldmine were unreliable. This shortfall of gold supplies would be recaptured by capital outflows by the US. As the US holding the power of printing money and inflationary idea was very new then. US dollar supply flooded the market therefore mounting the liabilities of the dollar. As the US served as a central reserve country, it averted its eyes on the adjustment of BOP deficits or balance of payments deficits (BOP deficits means country’s import costs are greater than export earnings). This led the US to huge debt. Thus, mounted up external liabilities of US dollar equaled the US monetary gold stock in 1959. Not only this, the rest of the world’s monetary gold stock exceeded than the US. Rest of the world then started converting their dollar holdings to gold. At the worst point of economy, the US monetary authorities hardened the monetary policy on the regulation of printing money. This led to the global deflationary pressure. (Deflation means a trend of declination on the prices of goods and services). To stabilize the deflationary situation, Federal Reserve took up an inflationary policy in early 1965 which continued till the early 1980s. In 1970s the economic environment hooked up with stagflation (Persistent high price level situation with higher unemployment and stagnation or fixed demand) later known as Great Inflationary Period. These random changes in US monetary policies also affected the Bretton Woods following countries’ economy. As a matter of fact, the countries started converted the dollar reserves into gold reserves due to uncertainty of US economy in years between 1967-1970 although the US government put pressures on the following nations not to convert dollar for gold. The US government then suspended the convertibility of Bretton Wood System. This decision was triggered on 15th August, 1971 by President Richard Nixon eventually ended up the key aspect of Bretton Woods Agreement. Almost three decades long accord collapsed therefore. It was officially declared an obsolete system in 12th March, 1973. The countries then generally adopted the managed floating exchange rate system. The legacy of Bretton Woods Agreement therefore remained within the idea of establishment of authorized monetary system. Not surprisingly, the chapter after the Bretton Wood reshaped the era.
The author of this article is a post graduate student, University of Dhaka