Smithsonian Agreement Investopedia

After World War II, the Bretton Woods system (1944-1973) replaced gold with the U.S. dollar as an official reserve. The scheme aimed to link binding legal commitments to multilateral decisions on the International Monetary Fund (IMF). The rules of this system have been set out in the articles of the IMF and the International Bank for Reconstruction and Development. The system was a monetary order designed to regulate monetary relations between sovereign states, with the 44 member countries required to set parity of their national currencies against the U.S. dollar and to keep exchange rates within 1% of parity (a “band”) by intervening in their foreign exchange markets (i.e. by buying or selling foreign money). The U.S. dollar was the only currency strong enough to meet the growing demands of international currency transactions, so the United States agreed to link the dollar to gold over the gold ounce and convert the dollar into gold at that price. [6] However, the members of the European Economic Community wanted a foreign exchange agreement that complements their customs union. A step in this direction was taken earlier when nations set up what is called the “snake in a tunnel.” Exchange rate fluctuations between EEC members were limited and currencies were in a narrow, undulating, snake-like pattern against the U.S. dollar and others outside currencies. the ten countries that signed the Smithsonian agreement; Netherlands, Japan, Belgium, Sweden, France, Canada, Germany, Italy, United Kingdom and Usa. As stipulated in the agreement, the currencies of the aforementioned countries can fluctuate by 2.25% against the U.S. dollar. If both occurred at the same time, currency A would appreciate by 9% against currency B. This was deemed excessive, and the 1972 Basel Agreement[4] between the six current EEC members and three about to join queued in the tunnel with bilateral margins between their currencies, limited to 2.25%, implying a maximum variation between two currencies of 4.5% and all currencies tend to be closer to the dollar. [5] This agreement also led to the formal end of the sterling zone. The Smithsonian agreement became relevant when President Richard Nixon suspended the exchange of U.S. dollars for gold, ending the gold standard. With ten major industrialized countries signing the agreement, the U.S. dollar has become a Fiat currency linked to other currencies. The Smithsonian agreement lasted only 15 months, with most major currencies moving from a fixed price to a fluctuating exchange rate such as the U.S. dollar from 1973.

The agreement devalued the U.S. dollar by 8.5% against gold and increased the price of one ounce of gold from $35 to $38. Other G10 countries also agreed to revalue their currencies against the U.S. dollar. President Nixon hailed the agreement as “the most important monetary agreement in the history of the world.” The Smithsonian Agreement was a revision of the 1944 Bretton Woods Agreement, which aimed to change fixed exchange rates. This agreement has also contributed to the emergence of Forex markets. As a result of the Smithsonian agreement, the U.S. dollar depreciated partially because it was tied to the currencies of the countries that signed the agreement. The agreement devalued the U.S. dollar by 8.5% against gold. Far from being a period of international cooperation and a global order, the years of the Bretton Woods Agreement revealed the difficulties inherent in creating and maintaining an international order that pursued both free and unfettered exchanges, while allowing nations to pursue autonomous political objectives.

The discipline of a gold standard and fixed exchange rates proved too strong for fast-growing economies with different levels of competition. With the demonization of gold and the transition to fluctuating currencies, the Bretton Woods era should be seen as a transition from a more disciplined international monetary order to a much more flexible period.