In the 1940s the overall condition of the economy was characterized by significant instability. Guided by the need to reestablish the stable state of the economy, 44 countries held a meeting in Bretton Woods, New Hampshire. The major goal of the meeting was to set a fixed exchange rate, at which currencies to be traded. Other goals desired to be achieved included:
- Financial stability
- Free trade
- Convertible currency
- Economic growth
- Full employment
The fixed exchanged rate system that resulted from the Bretton Woods meeting was centered on the US dollar. It was tied to gold at a value of $35 per ounce. In turn the other currencies were attached to the dollar.
As a result of the meeting, the US dollar became the major reserve currency. This led to the ability of countries to sell currency to the Federal Reserve. In return they received the corresponding amount of gold.
Another outcome of the Bretton Woods meeting was the creation of the International Monetary Fund (IMF). Additionally, the International Bank for Reconstruction and Development (the World Bank) was established. The major purpose of these organizations was the supervision of the proper functioning of the Bretton Woods system.
The establishment of the Bretton Woods system changed the nature of the trading activity, which was mainly caused by the set fixed exchange rates. The so called creeping pegs were observed, which included devaluations and revaluations.
The results of the implemented system included speculation actions, especially with the Bank of England, which called for intervention in order to give support to the pound. These protectionist actions were in vain since the pound experienced a significant decrease in its value. This case is of significant importance since it represented the first occurrence of government intervention failure under the system of Bretton Woods.
The dollar suffered the same devaluation despite the actions of the US government to protect it. Since the Bretton Woods system was entirely based on the value of the US dollar, these events led to the questioning of the viability of the system. In 1971 the value of the dollar significantly dropped.
At the end of the same year, actions were taken to fix the occurring problems. This was done through the signing of the Smithsonian Agreement. The outcome of this agreement was the widening of the fluctuation band of currencies, which resulted in the increase of the price of the gold to $38 per ounce.
Even though the Smithsonian Agreement was beneficial to certain extent, it didn’t manage to cope with speculations with the dollar, which persisted over the following year.
In 1973, freely fluctuating European and Japanese currencies was observed. A new method was implemented, which included the placement of value on currency. As a result, the room for speculations was further increased. This system still works nowadays. This has led to the trading of currencies for the purpose of gaining profits instead of buying or selling goods and services.
In 1979 the European Monetary System (EMS) was created by the nine of the members of the European Community. Its major purposes included:
- The creation of a common currency.
- The establishment of a central reserve fund.
- Currency fluctuation supervision and regulation.
Regarded as the first step toward achieving liberalization and integration, the EMS led to the creation of the EC after the World War II. Other important events include:
- 1993 – Maastricht Treaty
- 1998 – Establishment of the European Central Bank
- 1999 – Introduction of the Euro
- 2002 – Introduction of Euro banknotes