In essence, the Bretton Woods agreement introduced a fixed exchange rate system and the formation of financial institutions that regulate the stability of the world economy, one of which is the IMF. Where one of the provisions of the law stipulates that each member of the IMF must comply with:
- Hard currency or strong currency must be associated with a certain amount of gold. In other words the issuance of hard currency must be guaranteed with gold reserves. For example, US dollars, to create $ 35 worth of Federal Reserve Bank (Central Bank of America) must back up with gold worth 1 ounce or 28,3496 grams.
Currencies that include hard currency are US dollars, Euros, Pounds Sterling, Swiss francs and Japanese yen.
- Soft currency or weak currency must be associated with a hard currency. In other words, the issuance of soft currency must be based on the value of state assets valued by the hard currency.
- Exchange rate fluctuations are expected to be limited to 1% -2.5% above or below the prevailing exchange rate.
Looking at history like that with the enactment of a fixed exchange rate system, since the enactment of the Bretton Woods agreement in 1944 if the currency exchange rate was described in graphical form, it would form a relatively flat trend because each currency is basically worth a certain amount of gold.
curency is based on gold
Then when does the uptrend and the downtrend begin?
What is clear at the end of the fixed exchange rate system period. The chronology starts with a weakening of confidence in the US dollar as a result of:
1. Dollar Shortage / Scarcity of dollars
After World War II international trade began to grow and grow rapidly so many were looking for dollars for liquidation of transactions between countries because at that time the dollar was an international trade currency. But apparently the amount of dollars at that time was not able to support all the transaction needs. The result is a liquidity crisis caused by the scarcity of dollars. This began to give rise to the idea that the dollar was no longer appropriate as an international trade currency because it could not support all the liquidation needs of international transactions.
2. Dollar Gult / Excess dollar
Seeing the condition of scarcity of dollars, Americans print dollars whose total value exceeds the total value of gold reserves held. Even though according to the Bretton Woods agreement the amount of money issued should be in accordance with the gold reserves owned. Of course this decreases trust in America.
In addition, as a world police officer, America at that time provided development assistance to European countries victims of World War II. As a result, too many dollars are coming out of America. That indirectly makes excess circulation of dollars outside the United States. With the amount of money circulating too much, inflation can no longer be avoided. The effect of this inflation certainly makes the US Dollar less valuable.
Of the 2 things that arise a decrease in confidence in the US dollar as an international monetary standard. The concrete action of the decline in trust is reflected in the large-scale exchange of dollars by European countries.
Francis was the country that first did this by exchanging US $ 150 million with gold. The French action was then followed by Spain which exchanged a total of 60 million US dollars with gold which was then followed by other countries. Practically, the amount of gold reserves at Fort Knox (America) has drastically reduced.
Can you imagine that America had issued a lot of dollars at the time but the gold reserves that guaranteed it were drastically reduced or were low. Even though once again according to the bretton woods agreement, the amount of US dollars in circulation the value must be the same as the gold reserves owned by America.
The US unilaterally canceled the Bretton Woods agreement through President Nixon's Decree on August 15, 1971, which contained among other things that the USD was no longer guaranteed by gold. But the US dollar remains an international currency to assess foreign exchange reserves in the world. Since then, the new system has come to be called the floating exchange rate.
Floating exchange rate or floating exchange rate system is a system that is determined through the mechanism of the strength of demand and supply on the foreign exchange market, which is not guaranteed by precious metals at all.
So since then the forex market began to move up and down to form trends in accordance with market demand and supply. Whatever happens next with the forex market is determined by the size of market demand and supply.
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