Greetings all,
Re recent discussion of currency speculation & volatility, this illustrates
my statement that there are alternatives to floating (freely tradable with
variable rates) exchange rates.
Hi Ho, Euro
Steve
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January 2, 1999
Era May End for Floating Currencies
By JOSEPH KAHN
Last year's dominant economic story might be summed up this
way:
When currencies float, economies sink.
From Thailand to Russia, many nations' currencies floated when
their
exchange rates against the U.S. dollar collapsed, often under
pressure
from speculators. Then, without exception, those nations'
economies
sank. The failure of links, or pegs, to the dollar, the world's
benchmark
currency, made it harder for Russia and many Asian countries to
repay
foreign loans and contributed to severe recessions.
The currency-induced turmoil has shaken some core assumptions of
modern economics. For decades, the prevailing orthodoxy in
monetary
policy has favored floating exchange rates. Financial markets,
not
governments, should dictate the value of a currency, the thinking
goes.
Central banks should achieve policy objectives by raising or
lowering
interest rates to influence the market. Most major Western
economies
manage their currencies this way.
But one outcome of the global financial turmoil is that some
economists
are challenging that way of thinking, at least as it applies to
smaller and
less-developed countries. The debate seems likely to heat up this
year
and could well lead to the most radical shifts in the way
economies
interact with one another since the system of fixed exchange
rates broke
down in the early 1970s.
In Latin America, Eastern Europe and parts of Asia, leading
economists,
businessmen and government officials are pondering the idea of
effectively
abandoning their independent currencies, strictly curtailing the
powers of
central banks and linking themselves to one or another of the
world's
major currencies, especially the dollar or the euro, as the
modern
equivalent of gold.
"I sense a growing feeling in Asia and Latin America,
particularly, that
floating rates are fine for the United States but not so good for
small
countries," said Merton Miller, a Nobel prize-winning economist
at the
University of Chicago. "For many years, everybody in America
thought
floating exchange rates were the answer, but now there's a sense
that this
exacerbates the problem."
Miller has recently won converts to his long-held view that
smaller
countries should replace the central bank with a currency board,
which in
its pure form has none of the market-intervening powers of
today's central
banks. In this system, the country still issues currency, but the
central
bank by law agrees to exchange the currency at a preset rate for
dollars
or some other strong foreign currency. Money supply is dictated
by the
central bank's reserve of hard currency, meaning that the
quantity of local
currency fluctuates depending on how much foreign currency the
country
gathers through trade or investment.
A leading benefit of currency boards, proponents say, is to
remove the
power of central bankers who use money supply to manipulate their
economies, often for political purposes.
"Currency sovereignty is the right to have stagnant growth
because the
central banks screw up all the time," said Rudiger Dornbusch, an
economist at the Massachusetts Institute of Technology. "In this
environment it is increasingly ridiculous to argue that every
country must
have its own central bank."
Today, only a handful of governments, including those of Hong
Kong,
Argentina and Bulgaria, have currency boards, which were a common
management tool for colonies in the British empire. Hong Kong and
Argentina back their local currencies with U.S. dollars, while
Bulgaria
guarantees convertibility with the German mark at a fixed rate.
Though countries with currency boards have been affected by the
same
global turmoil that struck their neighbors -- Hong Kong's economy
is in a
deep recession -- the currency boards have so far survived. They
have
given the developing world a rare example of monetary stability.
Hong
Kong, Argentina and Bulgaria are widely seen as better positioned
than
their neighbors to rebound quickly, in part because outside
investors have
faith that if they invest in those nations they won't face the
risk of
devaluation before they get their money back.
Making money stable has been the greatest monetary challenge of
the
ages. Stable currencies promote trade and investment, which have
become increasingly important drivers of economic growth in
recent
years. Historically, countries sought to make their currencies
solid by
stocking treasuries with gold, which prevailed as the monetary
standard in
the United States from the late 19th century until the Great
Depression.
With the decline of classical economics in the 1930s and '40s,
economists
turned against the gold standard and promoted the creation of
bigger and
much more powerful central banks. Now the tide appears to be
shifting
again, in favor of smaller central banks and more rigid currency
regimes.
One of the biggest contributors to that shift, of course, is
European
monetary union, which took effect Friday. The 11 participating
nations are
replacing their currencies with a single currency, the euro, and
a single
central bank, a once unthinkable sacrifice of national monetary
sovereignty in favor of a high-minded economic ideal.
"The euro is a great example of how the world is going to look,"
said
Sebastian Edwards, a professor of international economics at the
University of California at Los Angeles. "The euro itself will
float against
the dollar and other currencies, but member countries will have
rigid
exchange rates among themselves."
Indeed, many economists see the world eventually dividing into
two or
three currency zones, one ruled by the euro, one by the dollar
and
perhaps a third, farther in the future, that uses the Japanese
yen or
Chinese yuan as an anchor. Each smaller country in a region would
either
simply accept the benchmark currency as legal tender at home or
adopt a
currency board.
No one expects the transition, if it happens at all, to come
overnight. The
International Monetary Fund has favored the use of currency
boards in
some cases but discouraged them in others. Some leading
economists
argue strongly that free-floating currencies are still the best
system. And
many analysts agree that the leading enemy of monetary stability
is not a
genuine free float but currency alchemy, the kind of monetary
distortion
that may occur, for example, when a country tries to have the
fixed
exchange rates of a currency board but still gives its central
bank power
to manipulate exchange rates and money supply.
Alan Greenspan, the Federal Reserve chairman, has warned against
quick-fix solutions to fundamental problems in emerging markets,
arguing
that tinkering with currency regimes is no substitute for sound
macroeconomic management.
"Many emerging-market economies have tried a number of technical
devices: the fixed rate peg, varieties of crawling peg, currency
boards and
even dollarization," Greenspan said in a recent speech. "The
success has
been mixed. Where successful, they have been backed by sound
policies."
Still, some economists say they would not be surprised if the
move
toward currency boards gathers momentum in coming months or
years.
Among the countries most likely to adopt them are Brazil, Mexico,
Russia
and Indonesia. The issue is being debated in all those countries.
Brazilian economists and politicians are considering whether to
follow
Argentina's lead by linking the real to the dollar, creating the
core of a
currency alliance that would tie those two countries together
with Uruguay
and Paraguay. A vocal group of Mexican economists and businessmen
are pushing for the dollarization of the economy -- abandonment
of the
national currency altogether in favor of reliance on the American
dollar --
though few see that outcome as imminent.
Indonesia explored setting up a currency board last year, before
the
Suharto government collapsed, and the idea may be revived as the
nation
struggles to restore order to its economy. Russia is under
pressure to take
radical steps, including establishment of a currency board, to
restore some
credibility to the battered ruble.
Those nations would have to sacrifice sovereignty over areas of
monetary
management that were once considered purely national. But the
lesson of
the recent world turmoil may be that currency management is
fundamentally international anyway.
"Remember that Germany and France had deep enmity extending back
many years," Miller said. "They came together to form the core of
the
euro countries. Who's to say that Brazil and Argentina, or China
and
Japan, cannot resolve their grievances? I think that sooner or
later they
will realize that this is the way to go."
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