The Smithsonian Agreement was a revision of the Bretton Woods Agreement of 1944, which provided for changes in fixed exchange rates. This agreement has also contributed to the emergence of Forex markets. As a result of the Smithsonian agreement, the US dollar was partially devalued because it was pegged to the currencies of the countries that had signed the agreement. This agreement devalued the US dollar against gold by 8.5%. The inadequacy of gold to meet global demand for international reserves in the 1960s was an important factor that led to the Smithsonian Agreement. However, this agreement became binding in 1971 when then-US President Richard Nixon banned the exchange of US dollars for gold. The Smithsonian Agreement was signed by a group of ten countries known as the G10. The failure of the world`s governments to create a system in which the exchange rates of currencies would be fixed and stable left no choice but to have a market for freely fluctuating currencies. That is the phase we are in today. The Forex market as we know it today is the result of the failure of the Bretton Woods and Smithsonian agreements. Fixed exchange rates: The United States persuaded the G-10 countries to enter into an agreement in which they would peg their exchange rates to the dollar. However, the dollar would not be pegged to gold.
Therefore, it was essentially a Bretton Woods agreement minus the gold support. In addition, central banks enjoyed certain freedoms, as the value of their currency could fluctuate at 2.5% plus or minus the value of the dollar before their central banks conducted open market operations. The deal devalued the U.S. dollar by 8.5% against gold, pushing the price of an ounce of gold from $35 to $38. The other G-10 countries have agreed to also appreciate their currencies against the US dollar. President Nixon hailed the deal as “the most important monetary deal in the history of the world.” The Smithsonian Agreement was an agreement signed in 1971 by 10 major industrialized countries to regulate international payments and trade at that time. The agreement changed the fixed exchange rates set out in the Bretton Woods Agreement of 1944. When the Smithsonian Agreement was signed in 1971, it created a new standard for the U.S. dollar in which the currencies of the other nine countries that signed the agreement were pegged to the U.S. dollar. The 10 countries that signed the Smithsonian Agreement were; Netherlands, Japan, Belgium, Sweden, France, Canada, Germany, Italy, United Kingdom and United States.
As stated in the agreement, the currencies of the above countries are allowed to fluctuate by 2.25% against the US dollar. The Smithsonian agreement became relevant when President Richard Nixon stopped exchanging U.S. dollars for gold, which meant the end of the gold standard. With ten major developed countries signing the agreement, the US dollar has become a fiat currency pegged to other currencies. The Smithsonian agreement lasted only 15 months, as most major currencies had moved from a fixed rate to a variable exchange rate beginning in 1973, just like the US dollar. The informal system of swap arrangements provides for a reciprocal agreement between central banks for reserve loans, which aims to guide countries through difficulties during large currency movements. These are only intended to offset private international capital flows on a precautionary or speculative basis, not even temporary deficits in countries` balance of payments. They are agreed on an ad hoc and informal basis and depend on the mutual goodwill and trust of the central banks concerned. The loan system, although informal, should be seen as important because it is high-rise. The Smithsonian Agreement was a temporary agreement negotiated in 1971 between the world`s top ten industrialized countries, namely Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom and the United States.
The agreement made adjustments to the fixed exchange rate system introduced under the Bretton Woods agreement and effectively created a new standard for the dollar, as other developed countries tied their currencies to the US dollar. Many of the steadfast economic institutions we see today were created as a result of the Bretton Woods Agreement. Institutions such as the International Monetary Fund (IMF) and the World Bank were created as a result of this agreement. President Nixon removed the world from the gold standard in 1971. However, he feared that free market transactions in foreign exchange markets would lead to difficulties and devaluation of many currencies. Therefore, he convinced many countries to enter into an agreement called the Smithsonian Agreement. This agreement was largely a failure, as it lasted less than a few years and resulted in the complete suspension of the foreign exchange markets! This arrangement seemed weak on paper. However, it has completely collapsed under pressure from real-world markets.
The U.S. trade deficit continued to widen, and as a result, the value of gold rose to $210 per ounce in 1972. As a result, all members of the G-10 abandoned the Smithsonian agreement. This ended with the Forex markets closing for a while! On August 15, 1971, U.S. President Richard Nixon unilaterally suspended the convertibility of U.S. dollars into gold. The United States had deliberately offered this convertibility in 1944; it has been put into practice by the US Treasury. The suspension effectively turned the dollar into fiat currency. Situation: European countries fought in World War 2. As such, the world`s economies have been destroyed. Many countries had resorted to printing money to finance the enormous expenses of war.
Therefore, there was a danger that once the war was over, many economies in Europe would implode simply because of the inherent instability of their foreign exchange markets. To avoid such an outcome, every country in the world held a conference in Bretton Woods in the United States with all the prominent political leaders and economists. This became known as the Bretton Woods Conference and had a huge impact on the future monetary system and the development of the Forex market. Since the United States owned most of the world`s gold, the value of the U.S. dollar was pegged to gold. The price was set at $35 for an ounce of gold. There was a federal gold window where anyone holding a dollar bill could go and exchange it for gold. The Bretton Woods Conference of 1944 established an international system of fixed exchange rates based on the gold standard, in which currencies were pegged to the U.S.
dollar, which itself was convertible into gold at $35 per ounce. On December 17 and 18, 1971, representatives of the Group of Ten met at the Smithsonian Institution in Washington, D.C., and agreed on a realignment of currencies and a new set of fixed exchange rates. The dollar depreciated against gold, while other currencies appreciated against the dollar. Overall, the dollar depreciated by almost 10% against other Group of Ten currencies (Great Britain, Canada, France, West Germany, Italy, the Netherlands, Belgium, Sweden and Japan). A few months after the Smithsonian Agreement, the six members of the European Economic Community (EEC) agreed to keep their exchange rates within a 2.25% parity range. Objective: The objective of the conference was to create a new monetary system capable of withstanding the possible shocks it would receive after the end of the war. This meant that the conference had to create a system that would allow nations to avoid rapid devaluation and full fallout from their monetary systems. The Smithsonian agreement turned out to be only a temporary solution to the international monetary crisis. .