Bretton Woods System
Also written Bretton Woods · Bretton Woods Agreement
The 1944–1971 exchange rate system in which currencies were pegged to the US dollar within ±1% and the dollar was pegged to gold; it collapsed by 1973, giving way to floating rates.
In plain language
Before modern currency markets, exchange rates were not discovered by trading. They were fixed by agreement.
Under the gold standard, from around 1870, central banks held gold against their paper currency, and the exchange rate between any two currencies followed from their gold values. Wars, political upheaval and trade imbalances pushed countries off it.
The Bretton Woods System, adopted for 1944–1971, was a blend of the gold standard and a floating system. The workbook describes its design:
- All currencies were pegged to the US dollar at a fixed rate.
- The US dollar was pegged to gold.
- The US guaranteed other central banks they could convert their currency into USD at any time.
- Countries agreed to keep exchange rates within plus or minus 1% of the fixed parity with the dollar.
With it, the US dollar became the dominant currency of the world — a position visible in currency markets to this day.
How it works
What it created. The Bretton Woods Agreement set up the International Monetary Fund and the World Bank, which the workbook notes played an important part in rebuilding Europe after World War II.
How it ended. By 1973 the system had collapsed. Countries were then free to choose any exchange arrangement except pegging to gold: link to another currency, to a basket, or float.
Why that mattered for FX markets. The workbook makes a sharp point: during the gold standard there were no exchange rates to determine. Only after gold stopped being the common denominator did currencies need to be valued against one another continuously — which is why the forex market came into prominence.
What followed:
| Regime | Meaning (Chapter 1, section 1.1) |
|---|---|
| Free / clean float | Rate set purely by supply and demand |
| Pegged | Value fixed to another currency or a basket |
| Managed / dirty float | Neither free nor fixed; central bank intervenes, capital controls common |
Developed countries (USD, EUR, JPY) moved to market-determined rates; developing countries generally adopted pegs or managed floats. The workbook describes the rupee as having a market-determined rate with active RBI intervention — a de facto managed float.
Gold and fiat. Britain left the gold standard in 1931, the US in 1933, abandoning the remnants in 1973. It was replaced by fiat money — currency accepted because a government orders it, not because it is backed by gold. The US dollar and the Indian rupee are both fiat money.
A worked example
1. Gold standard arithmetic (the workbook's figures). One unit of gold is worth INR 10,000 and USD 500.
1 USD = 10,000 / 500 = INR 20
No trading needed: the rate is fixed by the two gold prices.
2. The Bretton Woods band. Illustrative: a hypothetical currency with a parity of 20 units per USD, not a historical rupee rate. The ±1% band set the limits:
Upper limit = 20 × 1.01 = 20.20 per USD
Lower limit = 20 × 0.99 = 19.80 per USD
If market pressure pushed the rate towards 20.20, that country's central bank had to sell dollars and buy its own currency to hold the band.
3. A managed float today. The workbook's own illustration of a dirty float: a central bank lets its currency move between an upper and lower boundary, and if the domestic currency depreciates quickly against USD, it may sell dollars and buy local currency to rein in the move.
Why NISM asks about it
Chapter 1, section 1.1 (Brief History of Foreign Exchange Markets), covers the gold standard, fiat money, Bretton Woods, its collapse and the post-1973 regimes (clean, pegged, managed float). Section 1.2.1 describes the rupee as a managed float. The dates and the ±1% band are the most likely recall questions.
Common exam traps
- 1944–1971 for the system; collapsed by 1973.
- Currencies were pegged to USD, and USD to gold — not every currency to gold directly.
- The band was ±1% of parity with the dollar.
- It created the IMF and the World Bank.
- After Bretton Woods, countries could choose anything except a gold peg.
- The gold standard dates from around 1870; Britain left in 1931 and the US in 1933. Do not confuse those with the Bretton Woods dates.
- A dirty float is the same thing as a managed float; a clean float is a pure market rate.
Check yourself
1.Under the Bretton Woods System (1944–1971), how were exchange rates organised?
- a)All currencies floated freely against gold
- b)All currencies were pegged directly to gold within plus or minus 5%
- c)All currencies were pegged to USD at a fixed rate, USD was pegged to gold, and countries kept rates within plus or minus 1% of the parity with the US dollar
- d)USD was pegged to a basket of currencies, and others floated against USD
Show the answer
Answer: (c) All currencies were pegged to USD at a fixed rate, USD was pegged to gold, and countries kept rates within plus or minus 1% of the parity with the US dollar
"During 1944-1971, countries adopted a system called Bretton Woods System. This system was a blend of gold standard system and floating rate system. As part of the system, all currencies were pegged to USD at a fixed rate and USD value was pegged to gold... Countries also agreed to maintain the exchange rate in the range of plus or minus 1% of the fixed parity with US dollar."
The result: "With adoption of this system, USD became the dominant currency of the world."
Free floating came after its collapse — "By 1973 the Bretton Woods System had collapsed."
Other currencies were pegged to USD, not directly to gold, and the band was 1%, not 5%.
Its institutions: "the International Monetary Fund and the World Bank."
Where this is taught
Free preparation for NISM Series IRelated terms
- Clean floatAn exchange rate regime in which a currency's value is set purely by supply and demand in the market, with no government rule or central bank action affecting its price.
- Fiat moneyGovernment-issued currency that is not backed by a physical commodity such as gold or silver; its value rests on supply and demand and on the stability of the issuing government.
- Gold standardThe system, dating from around 1870, under which a central bank held gold against its paper currency, so the rate between any two currencies followed from their gold prices instead of from trading.
- Vehicle currencyA common third currency — most often the US dollar — through which two other currencies are traded, instead of trading them directly against each other.
- Exchange Rate RiskThe risk that an investment’s value, measured in the home currency, changes because foreign exchange rates move. A falling rupee raises returns on foreign assets; a rising rupee cuts them.