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After the Second World War, 730 delegates from all 44 Allied nations gathered at the Mount Washing Hotel in Bretton Woods, New Hampshire, USA for the United Nations Monetary and Financial Conference.
This event happened while the Second World War was still being fought in Europe and Asia.
The intent of this meeting was to discuss plans to rebuild the international economic system after the war and establish rules for commercial and financial relations among the world’s major industrial states.
A system of rules, institutions, policies and processes were drafted up to regulate the international monetary system. The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (part of the World Bank Group) were established as a result and they became operational in 1945, after the war.
The rules of Bretton Woods, provided for a system of fixed exchange rate among the global community, was to encourage an open system by committing members to the convertibility of their respective country’s currency into other currencies and to free trade. A key goal was to avoid a recurrence of closed markets and economic warfare during the Great Depression and its proceeding years in the 1930s.
Member nations were required to establish a parity of their national currency in terms of the reserve currency or peg. They have to adopt monetary policies to maintain exchange rates to the peg within plus or minus 1 %. This is done by intervening in their foreign exchange markets, buying and selling foreign currency as needed.
Instead of creating a new world currency as its reserve currency, the United States objected to the idea and pushed for the US dollar to be the reserve currency of the world. This was ultimately approved and all other countries were obliged to peg their currency to the US dollar and have to buy and sell US dollars to keep market exchange rates within 1 % of agreed parity.
The US agreed separately to link the US dollar to gold at the rate of $35 per ounce, hence giving the international community more faith in the US currency.
This bold move effectively resulted in the US dollar overtaking the role that gold had played in the international financial system under the gold standard. It was now the world’s currency, the globally accepted reserve currency for all other countries. As a result, most international transactions are done in US dollars.
As the only currency backed by gold, the US dollar has the most purchasing power.
Because the United States was the major creditors for the European nations in World War II, huge amount of gold were transferred into the United States as payment for debt. This resulted in the US dollar getting stronger and stronger.
You can find out more about the Bretton Woods System here:
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