Bretton Woods and Dollar Standard
The mechanics of the Bretton Woods system
We have seen tat with a gold standard, exchange rates are determined indirectly via the conversion price of each currency into gold. When the gold standard cam to an end with the onset of the Great Depression, 1929-1933, the exchange-rate system that eventually replaced it involved determination of exchange rates vis-a-vis the US Dallor. Rather than each currency being freely exchangeable into gold at an official price, currencies were mande exchangeable into US dollars at an offical rate. This in turn set the exchange rate between the currencies in much the same way as under the gold standard. (...)
The new system, adopted in 1944, is called gold-exchange standard. It is also caled the Bretton Woods system after the town in New Hampshire at which the exchange-rate arragements were agreed. This method of determining exchange rates did, in fact, allow exchange rates to move within a narrow range, the end points of which are referred to as support points. Support points were the exchange rates at which foreign central banks purchased or sold their currency for US dollars to ensure that the exchange rate did not move beyond these points. In return for foreign central banks fixing, or pegging, their currencies to the US dollar, the United States fixed the price of the US dollar to gold by standing ready to buy or sel gold at an official US dollar price. Therefore, the gold-exchange standard involved:
1. The U.S. being willing to exchange US dollars for gold at an official price.
2. Other countries being willing to exchange their currencies for dollars around an offical, or parity, exchange rate.
We shall deal with the history of the international financial system in the next chapter, but we can note that the ability to convert foreign-held gold into US dollars became restricted after 1968. With only the second pard of the gold-exchange standard remaining in effect after 1968--that part involving the pegging of foreign currencies against the dollar--the exchange rate system from 1968 until the end of the Bretton Woods standard in 1973 is best described as a dollar standard. Only the remaining years of Bretton Woods, 1944-1968, are properly described as being in the gold-exchange era.
Under the gold-exchange standard and the dollar standard, which together constitute the Bretton Woods era, countries which pegged their exchange rates to the US dollars were required to keep exchange rates within 1% of the selected parity value. In order to ensure that the exchanges vis-a-vis the dollar remained within 1% of official parity, it was necessary for central banks to intervene whenever free market forces would have created an exchange rate that was outside of +/- 1% range. This intervention took the form of buying and selling the local currency for US dollars at the upper and lower support points around the official par value. The support points meant adding to or reducing central bank official reserves whenever the exchange rate would have moved beyond the official limits. We can illustrate the way these fixed exchange standards operated with the hekp of a diagram.