the Bretton Woods system In retrospect

most economists judge the Bretton Woods System to have performed well from its implementation at the end of World War II until the mid-1960s. world trade grew relatively rapidly during this period, and the major European countries removed most of their postwar exchange restriction. in addition, Europe and Japan recovered from the World War II devastation, and growth in the world economy occurred with no major setbacks or recessions.
Despite this seeming success, some important problems emerged in the Bretton Wood system. economists see those problems as falling broadly into three principal areas, and these correspond to the important functions of an international monetary system with which we began this blog.
the Bretton woods international monetary system was thought to be facing an adequacy of reserve problem or liquidity problem. In general terms, this problems can be stated as follows: when world trade is growing rapidly, it is likely that the size of payments imbalances will grow in absolute terms. Hence, there is an increased need for reserve to finance BOP deficits. the framers of the Bretton woods agreement envisioned that gold would be the primary international reserve asset, but the supply of gold in the world economy was growing at a rate of only 1 to 1.5 percent per year while trade in the 1960s was growing at a rate of close to 7 percent per years. Hence, the fear was that reserves in the form of gold were not increasing rapidly enough to deal with larger BOP deficits. if reserve do not grow roughly apace with BOP deficits, the danger exists that countries will use trade and payments restrictions to reduce their deficits, and these policies could reduce the gains from trade and the rate of world economic growth.
The second problem, the confidence problems, was related to the liquidity problems. Because the supply of gold held by central banks was growing relatively slowly, the growing international reserves consisted mostly of national currencies that were internationally acceptable and were thus being held by the central banks. the two national currencies held in largest volume were the U.S. dollar and British pound.But,particularly with the dollar, this fact posed a danger to central banks. the dollar was the linchpin of the system because of the gold guarantee that the U.S. stood ready to buy and sell gold at $35 per ounce. however, the dollars held by non-U.S. central banks began to exceed by ac substantial margin the size of the U.S. official gold stock. This gold stock itself was also being depleted by U.S.BOP deficits. If all foreign central banks attempted to convert their dollars into gold, the United States did not have enough gold at meet all demands. In addition, there were even larger amounts of dollar deposit located outside the U.S. in foreign private hands (Eurodollar deposits). these dollars could also be a claim on the U.S. gold stock. There was thus a loss of confidence in the dollar, that is, loss of confidence in what had become the principal reserve asset of the monetary system. Further, if the U.S attempted to increase its ability to meet the conversion of dollars into gold by devaluing the dollar relative to gold (for example, by changing the price from $35to$70 per ounce), then central banks that held dollars would suffer a reduction in the value of their reserve in terms of golds. Such a devaluation would surely have started a massive "run" on gold and would have brought the Bretton woods system to a quick termination.
the third perceived problems of the Bretton woods system was the adjustment problems. this refers to the fact that in the actual operations of the Bretton woods system, individual countries had prolonged BOP deficits or surpluses. this was particularly true for the united states (deficits)and West Germany (surpluses). there did not seem to be an effective adjustment mechanism, since automatic forces were not removing the imbalances.Countries directed monetary policy and fiscal policies toward internal targets rather than external targets, and thus the contraction (expansion) in the money supply expected of a deficit (surplus) country did not occur (that is, sterilization was taking place). this was especially true with respect to the U.S. BOP deficits because of U.S. concern about slow economic growth and high unemployment. (in fact, the United states could sterilize without worrying excessively about a loss of reserves, since its own currency was being used as reserves.)In a similar vein, Germany‘ٍs concern a bout inflation prevented it from adjusting to a BOP surplus by expanding its money supply.