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. Before the devaluation: 1 Gold OZ = $35 £1 = $2 Therefore 1 Gold OZ = £17.5 After the Devaluation: 1 Gold OZ = $40 £1 = $2 Therefore 1 Gold OZ = £20 From that we can see that as a result of the devaluation of the dollar against gold, the pound has depreciated against gold as well. This is because the pound is pegged to the dollar, when the dollar appreciates against gold, the pound would also appreciate against gold, if the dollar depreciates against gold, the pound will also depreciate against gold. The exchange rate of the pound against the dollar remains unchanged, it is the exchange rate of pounds against gold that depreciates.
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