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Today’s crisis stems from policies accepted decades ago. Granted, by rescinding this policy had prevented the World Powers to fall back into time of the 1920′s Depression. The dollar has no official collateral other than the strong economy. But what happens when the economy begins to sputter? It’s as if we applied for a Stated Income loan to pull out a mortgage without a reliable income or collateral. The dollar used to be backed by the Gold.

The Policy commonly known as The Bretton Woods system referred to the international monetary regime that prevailed from the end of World War II until the early 1970s. Taking its name from the site of the 1944 conference that created the International Monetary Fund (IMF) and World Bank, the Bretton Woods system was history’s first example of a fully negotiated monetary order intended to govern currency relations among sovereign states. In principle, the regime was designed to combine binding legal obligations with multilateral decision-making conducted through an international organization, the IMF, endowed with limited supranational authority. In practice the initial scheme, as well as its subsequent development and ultimate demise, were directly dependent on the preferences and policies of its most powerful member, the United States.

Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group.

Four points in particular stand out. First, negotiators generally agreed that as far as they were concerned, the interwar period had conclusively demonstrated the fundamental disadvantages of unrestrained flexibility of *exchange rates. The floating rates of the 1930s were seen as having discouraged trade and investment and to have encouraged destabilizing speculation and competitive depreciation’s. Yet in an era of more activist economic policy, governments were at the same time reluctant to return to permanently fixed rates on the model of the classical *gold standard of the nineteenth century. Policy-makers understandably wished to retain the right to revise currency values on occasion as circumstances warranted. Hence a compromise was sought between the polar alternatives of either freely floating or irrevocably fixed rates – some arrangement that might gain the advantages of both without suffering the disadvantages of either.

A high level of agreement among the powerful on the goals and means of international economic management facilitated the decisions reached by the Bretton Woods Conference. Its foundation was based on a shared belief in capitalism. Although the developed countries’ governments differed in the type of capitalism they preferred for their national economies (France, for example, preferred greater planning and state intervention, whereas the United States favored relatively limited state intervention), all relied primarily on market mechanisms and on private ownership.

Thus, it is their similarities rather than their differences that appear most striking. All the participating governments at Bretton Woods agreed that the monetary chaos of the interwar period had yielded several valuable lessons.

The experience of the Great Depression was fresh on the minds of public officials. The planners at Bretton Woods hoped to avoid a repeat of the debacle of the 1930s, when intransigent American insistence as a creditor nation on the repayment of Allied war debts, combined with an inclination to isolationism, led to a breakdown of the international financial system and a worldwide economic depression.^[1] The “beggar thy neighbor” policies of 1930s governments—using currency devaluations to increase the competitiveness of a country’s export products to reduce balance of payments deficits—worsened national deflationary spirals, which resulted in plummeting national incomes, shrinking demand, mass unemployment, and an overall decline in world trade. Trade in the 1930s became largely restricted to currency blocs (groups of nations that use an equivalent currency, such as the “Sterling Area” of the British Empire). These blocs retarded the international flow of capital and foreign investment opportunities. Although this strategy tended to increase government revenues in the short run, it dramatically worsened the situation in the medium and longer run.

Previous regimes

In the 19th and early 20th centuries gold played a key role in international monetary transactions. The gold standard was used to back currencies; the international value of currency was determined by its fixed relationship to gold; gold was used to settle international accounts. The gold standard maintained fixed exchange rates that were seen as desirable because they reduced the risk of trading with other countries.

Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be rectified. Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend. This decrease in the amount of money would act to reduce the inflationary pressure. Supplementing the use of gold in this period was the British pound. Based on the dominant British economy, the pound became a reserve, transaction, and intervention currency. But the pound was not up to the challenge of serving as the primary world currency, given the weakness of the British economy after the Second World War.

The architects of Bretton Woods had conceived of a system wherein exchange rate stability was a prime goal. Yet, in an era of more activist economic policy, governments did not seriously consider permanently fixed rates on the model of the classical gold standard of the nineteenth century. Gold production was not even sufficient to meet the demands of growing international trade and investment. And a sizeable share of the world’s known gold reserves were located in the Soviet Union, which would later emerge as a Cold War rival to the United States and Western Europe.

The only currency strong enough to meet the rising demands for international currency transactions was the U.S. dollar. The strength of the U.S. economy, the fixed relationship of the dollar to gold ($35 an ounce), and the commitment of the U.S. government to convert dollars into gold at that price made the dollar as good as gold. In fact, the dollar was even better than gold: it earned interest and it was more flexible than gold.

Another view is that in the time of discount banks, discount was the interest earned on gold, and that the only way to repay interest on government bonds is by printing more dollars, thus raising the price of gold. If gold is fixed at $35 then other countries will demand gold and not accept dollars. The closing of the gold window in 1971 was the result.

Nixon Shock

In 1971 more and more dollars were being printed in Washington, then being pumped overseas, to pay for government expenditure on the military and social programs. In the first six months of 1971, assets for $22 billion fled the U.S. In response, on August 15, 1971, Nixon unilaterally imposed 90-day wage and price controls, a 10% import surcharge, and most importantly “closed the gold window”, making the dollar inconvertible to gold directly, except on the open market. Unusually, this decision was made without consulting members of the international monetary system or even his own State Department, and was soon dubbed the “Nixon Shock”.

The surcharge was dropped in December 1971 as part of a general revaluation of major currencies, which were henceforth allowed 2.25% devaluations from the agreed exchange rate. But even the more flexible official rates could not be defended against the speculators. By March 1976, all the major currencies were floating—in other words, exchange rates were no longer the principal method used by governments to administer monetary policy.

Today’s Issues

As gold hits a succession of all-time highs and the euro struggles for mere survival, debt overloads at the base of the recent currency trends can be traced directly to the US central bank. The Federal Reserve’s in both the US and Europe, practice of indiscriminately printing money is the chief culprit that has led to the surge in gold and demise of the euro. The Federal Reserve behind the scenes has the power to create money out of thin air. They can bail out their friends and let the people they don’t like fail, and create a trillion dollars or more, out of thin air in order to prop up some companies at the expense of the tax payers. The Fed thinks they can keep doing what they’re doing, because the new economic laws will bring this to an end and probably in the not-too-distant future.