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f increasing the stock of international reserves. Originally defined in terms of gold, with 35 SDRs being equal to one ounce of gold (the dollar-gold rate of the Bretton Woods system), it has been redefined several times since 1974. At present, it is calculated daily as the weighted sum of the values in dollars of four currencies (euro, dollar, Japanese yen, and pound sterling) of the five countries (France, Germany, Japan, the UK and the US). It derives its strength from IMF members being willing to use it as a reserve currency and use it as a means of payment between central banks to exchange for national currencies. The original installments of SDRs were distributed to member countries according to their quota in the Fund (the quota was broadly related to the country’s economic importance as indicated by the value of its international trade).

Structural problem also exist in this system. Over time the world economy grew and needed more liquidity, which meant that US had to maintain increasing trade deficits. But the US was not able to devalue the dollar. The dollar was the numeraire of the system, for instance, it was the standard by letting other currencies to peg with. Accordingly, the U.S. did not have the power to set the exchange rate between the dollar and any other currency. Changing the value of dollar in terms of gold has no real effect, because the values of other currencies were pegged to the dollar. This problem would not have existed if most of other currencies were pegged to gold. However, none of these currencies were pegged to gold because they were not convertible into gold with the limited supply of gold.

The breakdown of the Bretton Woods system was preceded by many events, such as the devaluation of the pound in 1967, flight from dollars to gold in 1968 leading to the creation of a two-tiered gold market (with the official rate at $35 per ounce and the private rate market determined) and finally in August 1971, the British demand that US guarantee the gold value of its dollar holdings. This led to the US decision to give up the link between the dollar and gold.

Crisis of Bretton Woods System

The enduring imbalances of payments between the Western industrialized countriesIn the 1960s and 1970s had weakened the Bretton Woods System. The main problem was that one national currency which is the U.S. dollar had to be an international reserve currency at the same time. This made the national monetary and fiscal policy of the United States free from external economic pressures, while seriously affecting those external economies. The U.S. was forced to run deficits in their balance of payments in order to ensure international liquidity which had been caused world inflation. In the 1960s, there was a run of very inflationary policy which limited the convertibility of the U.S. dollar since the reserves were insufficient to meet the demand for their currency. Yet, the other member countries were not willing to accept the high inflation rates that the par value system would have caused and “the dollar ended up being weak and unwanted, just as predicted by Gresham’s law: Bad money drives out good money.” The Bretton Woods System had collapsed. Another fundamental problem was the delayed adjustment of the parities to changes in the economic environment of the countries. It was always a great political risk for a government to adjust the parity and “eac