External Balance Problem of the United States

1. External Balance Problem of the United States

2. Bretton Woods System • A system where foreign countries’ central banks pegged their currency against the U.S. dollar. • U.S. Federal Reserve held the dollar price of gold at a constant $35/oz. to allow for a stable rate of exchange. • This allowed foreign central banks to exchange their dollars for gold.

3. U.S.: the Nth currency Problems • The U.S. was responsible for holding gold @ $35/oz, but gold supplies were not growing fast enough. • Foreign central banks would hold onto dollars, since they accumulated interest. • Good business from an investment point of view. • Dollar represented international money par excellence

4. Confidence Problem • Central Banks and world economic growth trends showed a long-run problem with Bretton Woods. • Central banks would stop accumulating dollars. • A feared “run on the bank” by foreign banks would deplete all reserves.

5. Bretton Woods: Decline • 1965-1968 Macroeconomic package • Government purchases expanded greatly • Military ( Vietnam) • Great Society Programs: public education and urban redevelopment. • Taxes were never raised. • There was no offset to the government spending that occurred. • 1966 mid-term election: Pres. Johnson avoided asking for tax increase, for fear of congressional scrutiny on spending.

6. Bretton Woods: Fall • Substantial fiscal expansion policy • Sharp fall in current account’s surplus • Rising domestic prices: inflation increased • Monetary policy • It was contractionary as output expanded • High interest rates caused Fed. to expand its monetary policy, as a remedy. • Inflation rate was close to 6% per year by the end of the 60’s

7. Bretton Woods: Fall (cont.) • Speculation of Gold: late 1967 and 1968 • The gold bought up on London gold market: • Pushed gold prices up. • Caused speculation • Creation of two-tier gold market ( turning point) • Private market: gold’s price was allowed to fluctuate • Official tier: Central banks kept gold at an official $35/oz. • Link severed • Supply of dollars tied to a fixed market price of gold. • Official price of gold became an arbitrary number to balance accounts between among central banks.

8. 1970’s Recession • Devaluing the Dollar • Increase employment • Balance U.S. current account • Two options • Depreciate domestic prices, while increase in foreign prices • OR, depreciate Dollar’s nominal value against foreign currencies

9. U.S. cuts final tie to gold • Option two choosen: depreciating Dollar against foreign currencies. • Multilateral agreement would be needed. • Foreign currencies are pegged to Dollar, but Dollar is fixed to gold’s set price. • Many countries were resistant to the idea • Hurt their import/export competing industries with revaluation. • Nixon arrangement: August 1971 • Ended the selling of gold for Dollars. • Last connection to gold. • Imposed 10% tax on imports, until trading partners agreed to revalue their currency.

10. Dollars Loss of Value: 1970's http://www.nationmaster.com/encyclopedia/U.S.-dollar

11. 1971 International agreement • International exchange rate agreement • Smithsonian Realignment: Dec. 1971 • Dollar was devalued against foreign currencies by 8%. • The 10% import-surcharge was lifted. • Gold was raised to a new official price of $38/oz. • No significance: The U.S. never sold gold for Dollars after this arrangement. • 15 months later: Feb. 12, 1973 & Mar. 1, 1973 • Speculation attacks against Dollar closed exchange markets • Dollar was devalued 10% more. • Floating exchange rates • March 19, 1973: Exchange rates of Japan and most European countries were floating against the Dollar. • A temporary fix that has become permanent solution for now.