On 1 March 1973, there was a showdown at the meeting of the Bundesbank’s Central Bank Council. A day later, the Bretton Woods system of fixed exchange rates, which had determined the exchange rate landscape for decades, had, in effect, been abolished. What had happened?

The Bretton Woods system is born

Towards the end of World War II, the world’s most important trading nations agreed on a new cur-rency regime. The aim was to avoid a repeat of the nationally motivated competitive devaluation seen in the 1930s. In 1944, a system of fixed exchange rates was agreed in Bretton Woods, in the US state of New Hampshire. The US dollar was the anchor currency, and the other currencies had to remain within narrow exchange rate bands against it. Germany joined the fixed exchange rate system in 1952. Under the agreement, the US central bank, the Federal Reserve (Fed), agreed to exchange any member state’s dollar reserves into gold. In 1945, the United States held more than 70% of global gold reserves.

Mutual dependence

For reasons of security policy, West Germany, unlike France or Switzerland, refrained from ex-changing its liabilities against the Fed for gold. During the Cold War, West Germany was reliant on the United States for protection. “That was one reason why the United States believed that it could obtain funding for any deficit. The United States “benignly neglected” the consequences this had for other countries, former Bundesbank President Helmut Schlesinger said in an interview (see article on the right). With the Vietnam War in the 1960s, the US deficit grew and grew, as did the problems for Germany and Japan.

The US dollar comes under pressure

The Bretton Woods system was, however, based on a strong anchor currency, and the US dollar was no longer strong. In 1971, the greenback came under pressure and frequently landed at the lower intervention limit against the D-Mark. That was the point at which the Bundesbank had to intervene to support the dollar. In April and early May 1971, the Bundesbank had to buy USD 6 billion, for which it paid DEM 22 billion. The higher money supply stoked inflation. On 6 May 1971, Germany’s minister for economic affairs, Karl Schiller, therefore ordered that the D-mark should float temporarily. Only two months later, the “Nixon Shock” occurred: the United States cancelled the direct convertibility of the US dollar to gold and imposed a 10% surtax on all imports. As a consequence, almost all major global trading nations adopted a floating exchange rate policy against the dollar. This phase ended in December 1971 with what is known as the Smithsonian Agreement, in which the participating states resolved to renegotiate their exchange rates. The US dollar was devalued, and the zones of fluctuation were increased. However, the Smithsonian Agreement survived less than 15 months. At the beginning of 1973, the wave of speculation on the foreign exchange markets initially hit Switzerland, which ceased interventions at the end of January.

Showdown on the Central Bank Council

After that, speculation shifted to the D-Mark. At the beginning of February 1973 alone, the Bun-desbank had to buy just under USD 6 billion for DEM 18.5 billion. The situation continued to escalate. On 2 February, the Directorate of the Bundesbank asked the government to relieve it of its duty to intervene; Finance Minister Helmut Schmidt, in particular, roundly rejected this request. After the Bundesbank had to buy USD 1.7 billion on the morning of 1 March 1973, because the US currency had again fallen below the intervention limit, there was a showdown at the Central Bank Council meeting of 1 March 1973. Vice-President Otmar Emminger left the meeting to attend a hastily arranged meeting of the West German government under Willy Brandt in Bonn. Shortly beforehand, Emminger had called on the government to release the bank from its obligation to buy US dollars. A day later, on 2 March 1973, the government finally conceded. The Bundesbank was permitted to stop buying US dollars. Germany’s exit from the system of fixed exchange rates sealed the fate of Bretton Woods. It was officially abandoned shortly afterwards.

Source: Bundesbank Magazine 4/2013