Devaluation? Have we forgotten? Reasons for fluctuating currency exchange rates, Gold standard, Breton Woods System and Nixon Shock

Table of Content

1. Introduction
2. The Bretton Woods Treaty in 1944
3. The Nixon Shock in 1971
4. The pursuit of self-interest
5. The inflation target regime
6. The Thucydides Trap
7. Reference

  1. Introduction

During the 2016 US election campaign, Donald Trump was the constant critic of China and Japan for the devaluation of their currencies. Whether out of guilt or his army of advisors gently nudged him towards a more diplomatic approach, his minutes-long handshake with the Japanese Prime Minister Shinzo Abe on the following day of the presidential election appeared to be uncanny to both Trump supporters and critics. In either case, he should have been guilty of historical ignorance, regardless whether it is his outright lack of knowledge or deliberate attempt to be coy, pretending to be unaware of the past.

Now, we talk much about ADHD, vitamin deficiencies, and all kinds of deficiencies allegedly prevalent amongst children, and perhaps to add to the list, we should think of memory deficit or short-memory syndrome, because the free-floating exchange currency markets were prompted by no country other than the United States. Let us refresh our memory.

  1. The Bretton Woods in 1944

In the summer of 1944, representatives of 44 Allied Nations with the “Big Four” such as the US, the UK, the Soviet Union, and China, gathered in a hotel in Breton Woods, New Hampshire, about 200km from Boston, and signed the treaty in an attempt to prevent the disaster of the Great Depression from recurring (Andrews, 2008). The treaty stated that the US dollar was technically on the gold standard and thereby exchange rates amongst other currencies were practically fixed. The International Monetary Fund, together with the World Bank, was set up to monitor and loosely regulate the international monetary system, independent of nation states. There was no scope for devaluation or overvaluation of currencies then. The US at that time was considered as a global hegemon, a state so powerful as the sun that all stars revolve around according to the law of gravity, and thus peace was maintained.

  1. The Nixon Shock in 1971

The post-war period saw the ascendance of the American economy to the unprecedented height, and to illustrate this, in 1950, America’s manufacturing output accounted for staggering 62% of all the major industrial countries put together (Rosenberg, 2002). Needless to say, nothing lasts forever, and once most households came to own all the major white goods, such as cars, washing machines, TVs, and refrigerators, naturally, the economic growth began to slow down. As is often the case, even if the earning goes down, it is difficult to cut back one’s spending. Hence, by the late 1960s, America’s dominance was becoming the relic of the foregone era.

Having embroiled in the prolonging war in Vietnam in an attempt to win the ideological battle against the Soviet Union and China, the bloody war was costing all participating nations of the anti-communist allies led by the United States atrocities and mountainous sums of money, all the while national debts were piling up (Gowa, 1983; Lind, 1999). In the light of it all, one way to artificially reduce debt owed to foreign countries was to devalue its currency, even though it was deceptive and amoral.

In 1971, not bilaterally or multilaterally, but unilaterally, the US broke off the Bretton Woods Agreement, which technically freed up the currency markets into free floating. Now, the central banks of all major countries are free to adopt their own fiscal policies in the pursuit of their own national interests, although the currencies of some nations are still pegged at other underlying currencies (Table 1). The then US president Richard Nixon made the famous speech on the national TV to announce the US decision to abandon the gold standard.

Table 1. Examples of circulating fixed exchange rate currencies
Fixed currencies Reference currencies Fixed Rate
Bhutanese Ngultrum Indian Rupee 1
Brunei Dollar Singapore Dollar 1
Caribbean Guilder USD 1.79
Cayman Islands Dollar USD 0.83333
CFA Franc, Central/West African Euro 655.957
Danish Krone Euro 7.46038
Falkland Islands Pound Pound Sterling 1
Hong Kong Dollar USD 7.80
Macanese Pataca Hong Kong Dollar 1.032
Nepalese rupee Indian Rupee 1.6
Venezuelan Bolívar USD 69,000
  1. The pursuit of self-interest

The political realist school of thought believes that we all act according to our own self-interests and any moral idealism and principles become either neglected or even ignored if the morality conflicts their self-interests, and particularly so in international relations (Mearsheimer, 2001). People often believe not what they ought to believe, but what they want to believe to service their self-interests.

The ancient Greek historian that recorded the Peloponnesian War, Thucydides, recounts in the famous “Melian Dialogue,” as the Athenian envoys reached the shore of the island of Melos and demanded the Melians to choose either to perish or surrender, insinuating that a dialogue about justice can only take place between two sides of equal power, and if one side is stronger than the other, the weaker must obey the stronger (Thucydides, Chapter 5).

A supranational rule-enforcing authority and treaty are usually designed to benefit all participating members, as they deter any potential aggressor from destabilising international relations by pursuing its self-interest. Needless to say, safety, security and stability are in their mutual interest. Hence, to break off from the Bretton Woods Agreement at that time was regarded as self-serving and amoral, however urgent and necessary it was.

  1. The inflation target regime

In recent years, though, the global currency markets have been in relative equilibrium, operating based on domestic inflation targets (Rose, 2007). As Rose (2007) argues, without relying on international coordination, the inflation target regimes adopted in many countries have been surprisingly effective in maintaining relative stability in global currency markets in terms regime durability, transparency, and volatility, with less involvement of IMF in coordination being required. Some may fear, nonetheless, that in the absence of any supranational enforcement means as such, an unhinged equilibrium could tip off at any point and the world may descend into chaos, although such scenarios are unlikely.

  1. The Thucydides Trap

Today, the devaluation of the Chinese Yuan has been much discussed and criticised by the US President. The genesis of fluctuating currency exchange rates, however, has been closely related to a series of foreign policies adopted by the US administrations that have frequently used their political leverage to serve the country’s economic interests. Nowadays, exchange rates of different currencies fluctuate according to various causes, ranging from the climate of international politics and geopolitical situations in the Middle East to decisions of central banks around the globe and trade imbalances.

The course of history has often been altered by the whim of a hegemon. The irony, however, is that the moral obligation cannot be enforced to a hegemon. If it is possible, it is only by way of usurpation. The Romans killed Jesus as the empire saw the rapidly growing cultic movement as a threat to Rome. Yet within centuries, the centre of gravity shifted from Rome to Constantinople, present-day Istanbul, as the new king, Great Constantine, adopted Christianity as its official religion since he was a devout Christian.

Now, China has grown almost as large as the US, and throughout the course of the trade war situations unfolding recently, China has acted rather cautiously and calculatingly. Political realists may ask: Is this a Thucydides trap? That is to say, when an arising power threatens to displace an old one, war is almost inevitable, although it can possibly be avoided. Thucydides explains the cause of the Peloponnesian War, “what made war inevitable was the growth of Athenian power and the fear that it instilled in Sparta.” (Thucydides, Chapter 1) In the past 500 years, there have been 16 cases in which a rising power threatened to displace a ruling power, and 12 of them ended up in war (Allison, 2017).

It remains uncertain as to whether the trade war between the US and China is going to drive China to devalue the Yuan further and exacerbate their relations. Moreover, it yet remains uncertain as to whether the two superpowers can stop themselves from falling into the deadly trap that Thucydides recounted almost two and a half thousand years ago.

  1. References
Allison, G. (2017, June 9). The Thucydides Trap. FP Magazine. May/June issue.  [Online] Available at:
Andrews, M, David. (2008). Chapter 1 Bretton Woods: System and Order. In: D.M, Andrews. Order Change: International Monetary Relations Since Bretton Woods. Ithica: Cornell University Press, pp.6-24.
Gowa, J. (1983). Closing the Gold Window: Domestic Politics and the end of Bretton Woods. Ithaca: Cornell University Press. Introduction. pp.13-33.
Lind, Michael. (1999). Vietnam. The Necessary War: A Reinterpretation of America’s Most Disastrous Military Conflict. Free Press.
Mearsheimer, John J.(2001). The Tragedy of Great Power Politics, New York: Norton.
Rose, K. Andrew. (2007). A stable international monetary system emerges. Inflation targeting is Bretton Woods, reversed. Journal of International Money and Finance26, pp.663-681.
Rosenberg, S. (2002). American Economic Development Since 1945: Growth, Decline and Rejuvenation. The Palgrave Macmillan.
Thucydides. (1982). The Peloponnesian War. (Trans). Richard Crawley (revised by T.E. Wick). New York: Modern Library.


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