The Bretton Woods period is a currency regime that actually started around the year 1944. Before this coming into existence, the value of gold was in dispute, because of the way in which currencies were trading roughly against each other in markets that were plagued by competitive devaluation. With all the backlash associated with Beggar Thy Neighbor policies destroying comparative currency values in an attempt to attract export business, countries began reverting back to gold-backed currency regimes that would establish some form of fundamental order over their monetary policies.
More often than not, these policies would involve ‘dirty float’ policies, which involved holding a rough amount of gold to back up the fundamental value of the actual currency, but with a bit more flexibility. Worse yet, because some currencies were tied to gold and others weren’t, they still maintained an implied relationship to the value of gold through cross-currency exchange. The surmounting confusion resulted in the Bretton Woods period of currency management.
The Bretton Woods period got its name from the 1944 conference held to introduce the International Monetary Fund and the World Bank, in the hopes of standardizing currency practices on a global basis. In establishing these institutions, governments were involved in collective bargaining arrangements that helped them to support their economies and currency values through loans and exchange venues. However, the partners involved were required to participate in an agreement that forced them to maintain a currency standard in relation to the US dollar.
The end result of such an agreement was then the establishment of predictability in free currency markets, without reliance on gold to determine cross-asset exchange rates. It also established the USD as being the major currency of business around the world, as it was the reference point for all other currency prices to be traded. However, because of the way in which the USD was backed by the physical gold that was being held by the US government to maintain the fundamental value of the currency itself, it meant that the currencies of the world were still being valued relatively to the value of gold.
While the Bretton Woods agreement might at first appear as being a boring political agreement that was reached by politicians to make currency exchange rates easier to manage, it is very interesting to note how it is that the policy placed a tremendous amount of economic power into the hands of American politicians. Specifically, because of the way in which all involved currencies now pegged their values against the USD, they became tied to the ability of the American economy’s performance, and its ability to maintain a reserve of physical gold to meet its standards of value.
If the American government had taken the opportunity to be dishonest about its gold holdings or inflation rates, it could have used this agreement to its advantage to manipulate currency values to its favor, and promote its own growth at the detriment of partnered countries. Alternatively, if the country entered a state of extreme growth from financial leveraging, it would likely force other countries to issue great deals of debt so that they could buy up the value of their currencies, and therefore wind up in a situation where they are over-leveraged without income.
This essentially means that America essentially controlled the currency markets to the extent of the willingness of partner nations to follow the Bretton Woods agreement. Interestingly enough, the termination of the agreement in the 1970’s was actually the result of the exact opposite effect, meaning that the US economy’s volatility was forcing it to move off on its own diplomatically, rather than destructively.