Introduction to Finance

Bretton Woods system 
system 
in which individual currencies 
would be tied to gold through the 
U.S. dollar via fi xed, or pegged, 
exchange rates

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6.2 European Unification
133
$35. Each participating country’s currency was then set at a “par,” or fi xed value, in relation to 
the U.S. dollar. For example, one French franc might be one-seventh of a U.S. dollar, or $.1429. 
Thus, a franc would “indirectly” be worth $5 in gold (i.e., $35 ÷ 7). In essence, one franc could 
be exchanged for $.1429, which could be exchanged for $5 in gold (.1429 × $35). 
Countries adopting the Bretton Woods system could hold their reserves either in gold or 
U.S. dollars, because the dollar was the only currency on the gold standard. This eliminated 
one of the criticisms associated with all currencies being on a gold standard system in that 
world economic growth was restricted to the rate of increase in new gold production, since 
gold was the only monetary reserve. Since the Bretton Woods system allowed for the holding 
of both gold and U.S. dollars as foreign exchange reserves, this new monetary system allowed 
for less restrictive world economic growth. The negative side of the Bretton Woods system 
was that the U.S. government had to produce balance-of-payments defi cits so that foreign 
exchange reserves would grow. 
Unfortunately, by the 1960s the value of the U.S. gold stock was less than the amount of 
foreign holdings of dollars. This, of course, caused concern about the viability of the Bretton 
Woods system. To help keep the system operating, in 1970 the International Monetary Fund 
(IMF) created a new reserve asset called 
special drawing rights (SDRs)
,
 
a basket, or port-
folio, of currencies that could be used to make international payments. At fi rst the SDR was 
made up of a weighted average of 16 currencies. At the beginning of the 1980s, the SDR 
basket was reduced to include only fi ve major currencies. The current SDR basket includes 
the U.S. dollar (41.9 percent weight), euro (37.4 percent weight), Japanese yen (9.4 percent 
weight), and British pound (11.3 percent weight).
Attempts were made to save the Bretton Woods system in 1971 when representatives of 
major central banks met at the Smithsonian Institution in Washington, D.C., and raised the 
price of gold to $38 per ounce. In early 1973, the price of gold was further increased to $42 
per ounce. However, the end of fi xed exchange rates was at hand.