Gold Exchange Standard
Bretton Woods Collapse
A gold exchange standard is a mixed system consisting of a cross between a reserve currency standard and a gold standard. In general it includes the following rules. First, a reserve currency is chosen. All non-reserve countries agree to fix their exchange rates to the reserve at some announced rate. To maintain the fixity, these non-reserve countries will hold a stockpile of reserve currency assets.
Second, the reserve currency country agrees to fix its currency value to a weight in gold. Finally, the reserve country agrees to exchange gold for its own currency with other central banks within the system, upon demand. One key difference in this system from a gold standard is that the reserve country does not agree to exchange gold for currency with the general public, only with other central banks. The system works exactly like a reserve currency system from the perspective of the non-reserve countries. However, if over time the non-reserve countries accumulate the reserve currency they can demand exchange for gold from the reserve country central bank. In this case gold reserves will flow away from the reserve currency country. The fixed exchange rate system set up after World War II was a gold-exchange standard, as was the system that prevailed between 1920 and the early 1930s. As a result, the exchange rate system after the war also became known as the Bretton-Woods system.
When was the gold exchange standard used?
In the decades following World War II, international trade was conducted according to the gold-exchange standard. Under such a system, nations fix the value of their currencies not with respect to gold, but to some foreign currency, which is in turn fixed to and redeemable in gold. Most nations fixed their currencies to the U.S. dollar and retained dollar reserves in the United States, which was known as the "key currency" country. At the Bretton Woods international conference in 1944, a system of fixed exchange rates was adopted, and the International Monetary Fund (IMF) was created with the task of maintaining stable exchange rates on a global level.
The Triffin dilemma, less commonly called Triffin paradox, is the fundamental problem of the United States dollar's role as reserve currency in the Bretton Woods system, or more generally of a national currency as reserve currency. By the early 1960s, an ounce of gold could be exchanged for $40 in London, even though the price in the U.S. was $35. This difference showed that investors knew the dollar was overvalued and that time was running out. There was a solution to the Triffin dilemma for the U.S.: reduce the number of dollars in circulation by cutting the deficit and raising interest rates to attract dollars back into the country.
Triffin Paradox pointed out the basic contradiction in the Bretton Woods system especially when dollar started losing its credibility to convert into gold at the promised rate of $35 per ounce of gold. The contradiction was that only when US ran deficits, could other countries build up forex reserves; but as soon as the US BoP deficits became unsustainably large, other countries lost faith, leading to demise of Bretton Woods in 1971. The Triffin dilemma is usually used to articulate the problems with the US dollar's role as the reserve currency under the Bretton Woods system, or more generally of using a national currency as an...
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