Suppose that under the Bretton Woods system, the dollar is pegged to gold at a rate of $35 per ounce and the pound sterling is pegged to the dollar at a rate of $2 = £1. If the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, what does this imply for the exchange value of the pound? Explain your answer.
To understand the implications for the exchange value of the pound in this scenario, we need to analyze the relationship between the US dollar, gold, and the pound sterling.
Under the Bretton Woods system, the dollar was initially pegged to gold at a rate of $35 per ounce. This means that the US government agreed to exchange one ounce of gold for $35.
Additionally, the pound sterling was pegged to the dollar at a rate of $2 = £1. This means that one pound could be exchanged for two US dollars.
Now, if the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, it implies that the US government is now willing to exchange one ounce of gold for $40. This means that the value of the dollar has reduced in terms of gold.
However, the pegged rate between the dollar and the pound remains unchanged at $2 = £1. This means that the exchange value of the pound is still determined by the fixed rate with the dollar, rather than gold.
Therefore, the devaluation of the dollar against gold does not directly impact the exchange value of the pound. The exchange value of the pound will only change if the fixed rate between the dollar and the pound is adjusted.
It's important to note that this explanation assumes a simplified scenario and does not account for other factors such as market forces and free-floating exchange rates, which may influence currency values in practice.
To understand the implications for the exchange value of the pound in this scenario, we need to consider the relationship between the dollar, gold, and the pound under the Bretton Woods system.
In the Bretton Woods system, the value of the dollar was originally pegged to gold at a rate of $35 per ounce. This means that the US government guaranteed to exchange one ounce of gold for $35.
Additionally, the pound sterling was pegged to the dollar at a rate of $2 = £1. This means that the British government guaranteed to exchange one pound for $2.
Now, if the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, it means that the US government is now guaranteeing to exchange one ounce of gold for $40.
So, how does this devaluation of the dollar against gold affect the exchange value of the pound?
To answer this, we need to consider the new relationship between the dollar and gold. Since one ounce of gold is now worth $40, it means that the purchasing power of the dollar has decreased in terms of gold.
If the dollar has lost value against gold, it implies that the pound sterling, which is pegged to the dollar, has also lost value relative to gold. This means that the exchange value of the pound has decreased.
To understand the extent of the devaluation, we can calculate the new exchange rate between the pound and gold using the new value of the dollar pegged to gold. Since £1 is equivalent to $2, and $40 is the new value of an ounce of gold, we can calculate:
£1 * ($40 / $2) = £20
This implies that after the devaluation of the dollar against gold, the exchange value of the pound has decreased to £20 per ounce of gold.
In summary, if the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, the exchange value of the pound would decrease to £20 per ounce of gold.