A system where foreign countries’ central banks pegged their currency against the U.S. dollar. U.S. Federal Reserve held the dollar price of gold at a constant $35/oz. to allow for a stable rate of exchange. This allowed foreign central banks to exchange their dollars for gold.

The U.S. was responsible for holding $35/oz, but gold supplies were not growing fast enough. Foreign central banks would hold onto dollars, since they accumulated interest. Good business from an investment point of view. Dollar represented international money par excellence

Central Banks and world economic growth trends showed a long-run problem with Bretton Woods. Central banks would stop accumulating dollars. A feared “run on the bank” by foreign banks would deplete all reserves.

Macroeconomic package Government purchases expanded greatly Military ( Vietnam) Great Society Programs: public education and urban redevelopment. Taxes were never raised. There was no offset to the government spending that occurred mid-term election: Pres. Johnson avoided asking for tax increase, for fear of congressional scrutiny on spending.

Substantial fiscal expansion policy Sharp fall in current account’s surplus Rising domestic prices: inflation increased Monetary policy It was contractionary as output expanded High interest rates caused Fed. to expand its monetary policy, as a remedy. Inflation rate was close to 6% per year by the end of the 60’s

Speculation of Gold: late 1967 and 1968 The gold bought up on London gold market: Pushed gold prices up. Caused speculation Creation of two-tier gold market ( turning point) Private market: gold’s price was allowed to fluctuate Official tier: Central banks kept gold at an official $35/oz. Link severed Supply of dollars tied to a fixed market price of gold. Official price of gold became an arbitrary number to balance accounts between among central banks.

Devaluing the Dollar Increase employment Balance U.S. current account Two options Depreciate domestic prices, while increase in foreign prices OR, depreciate Dollar’s nominal value against foreign currencies

Option two choosen: depreciating Dollar against foreign currencies. Multilateral agreement would be needed. Foreign currencies are pegged to Dollar, but Dollar is fixed to gold’s set price. Many countries were resistant to the idea Hurt their import/export competing industries with revaluation. Nixon arrangement: August 1971 Ended the selling of gold for Dollars. Last connection to gold. Imposed 10% tax on imports, until trading partners agreed to revalue their currency.

International exchange rate agreement Smithsonian Realignment: Dec Dollar was devalued against foreign currencies by 8%. The 10% import-surcharge was lifted. Gold was raised to a new official price of $38/oz. No significance: The U.S. never sold gold for Dollars after this arrangement. 15 months later: Feb. 12, 1973 & Mar. 1, 1973 Speculation attacks against Dollar closed exchange markets Dollar was devalued 10% more. Floating exchange rates March 19, 1973: Exchange rates of Japan and most European countries were floating against the Dollar. A temporary fix that has become permanent solution for now.