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History of Exchange Rate Regimes

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Since the late nineteenth century the history of the world economy has witnessed roughly four broad exchange rate regimes. These can be loosely characterized as the Gold Standard, the Inter-War Period or Gold Exchange Standard, the Bretton-Woods System, and the present Floating Currency System. The first three general periods each came with their own significant problems and inefficiencies which, combined with political influence, has led to our current free floating system. That is not to say, however, that the exchange rate regime in place today exists without its own troubles.

The exchange rate history of the nineteenth century highlights the importance of the gold standard in that era. From roughly 1880 to 1914, the exchange rate system was dependent on each respective currency's comparative convertibility to some metallic resource (almost always silver or gold) either directly or indirectly by means of convertibility to a currency that was convertible to a metal. The central countries of this pre-1914 era were the United States, Great Britain, France, the Netherlands and Germany. Each of these countries adhered strictly to the classical gold standard, which meant a credible commitment to sustained gold convertibility.

The credibility of this regime was derived from the prior monetary history of each of these core nations. The principle rule governing the assumed convertibility in place during the period of the gold standard was that each country would only depart from gold parity in the case of a clear and present emergency, such as a debilitating financial crisis or war. Under such circumstances, a short-term withdraw from the gold standard would be endured so long as its eventual return was seen after the crisis had been dealt with. This method of determination of the exchange rate, however, had to be reassessed when the gold standard was suspended during World War I and too many countries were simultaneously forced to depart from the gold standard, effectively ending this period.

The suspension of the gold standard in 1914 was followed by a collapse of the exchange rate market. In order to finance the costs of war, most belligerent countries went off the gold standard during the war, and suffered significant inflation. Currency exchange between states came to a virtual halt during the war and a real attempt to institute some kind of new system would not occur until 1925. Because inflation levels varied between states, when they attempted to return to the standard after the war at price determined by themselves (some, for example, chose to enter at pre-war prices), some countries' goods were undervalued and some overvalued.

In the early 1920s, some countries tried to revive the gold standard to get the old exchange system back into practice, but those attempts essentially proved futile. Every country desired some form of stabilization, as international trade and commerce were clearly being hindered by a lack of sound agreement on exchange rates. During this time of confusion, a type of free-floating system existed, but one that was tremendously ineffective. Many countries in Europe experienced rampant hyperinflation during this period, effectively rendering their currencies useless.

In 1925, however, Britain and most of her old dominions returned to the gold standard, at which point a type of gold exchange standard was put in place, whereby Central Banks began to supplement their own gold reserves with foreign currencies (almost always the pound sterling and the U.S. dollar). When the Great Depression hit the United States in 1929, however, this system practically disintegrated under the pressure of the widespread collapse of financial markets. The devastating effects of this were felt by most of the developed world. Although Britain left this new gold standard in 1931, the United States would fail to do so until 1933, a failure which many believe extended the depression. What followed was a period of strong capital controls and regional currency blocs or zones. By the time of the advent of World War II no advanced country remained on the gold standard and once again a period of severely limited international exchange gradually developed as countries were forced to enter the war.

The third general exchange rate regime period can be clearly defined as era of the Bretton Woods system, which began shortly after the agreements signed during the United Nations Monetary and Financial Conference of July 1944 were ratified, and ended on August 15, 1971 when the United States unilaterally ended the dollar's convertibility to gold. In practice, Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar, which was itself convertible into gold at fixed rate of $35 per ounce of gold. The U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. As the world's key currency, most international transactions were denominated in U.S. dollars.

Bretton Woods contributed largely to the United State's growing supremacy in the two decades following the end of the Second World War. By the mid-1960s, however, the United States began to see its hegemonic status slowly slip away as Japan and Western Europe narrowed the once large economic gap. This meant a rise in international dissatisfaction with the 'special' role of the U.S. dollar. Following the Vietnam war, the dollar was increasingly overvalued as the Johnson administration had chosen to pay for America's military action by printing more money instead of making any serious attempts to increase taxation. By the time Richard Nixon was sworn into office in 1968, the United



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