Currencies in Crisis: Proposals Draw Fire
By Paul Blustein
Imagine: Asia creates a single currency, rivaling the euro. That idea came from Joseph Yam, chief of the Hong Kong Monetary Authority, who proposed early last month that the region should consider creating an "Asian currency unit."
Imagine: Latin America adopts the U.S. dollar as its currency. That notion was sparked by Pedro Pou, president of Argentina's central bank, who announced last month that his country was discussing a plan with Washington to scrap the Argentine peso and make the dollar legal tender.
Imagine: The dollar, euro and yen attain stability relative to each other. That proposal came from the finance ministers of Japan, Germany and France, who in recent weeks have touted a pact among the Group of Seven industrial nations to eliminate "excessive volatility" among the world's major currencies.
These ideas have already drawn criticism – in some cases, derision – from many experts, and opposition from powerful policymakers. Yet they manifest a growing unease about the impact of currency swings on the world's economic health, and they pique oft-asked questions: Why doesn't somebody do something about the wild oscillations in foreign exchange markets? Can't we Euro-ize? Dollarize? Or at least stabilize?
Over the past year and a half, vast swaths of the developing world have sunk into recession, dealing a crushing blow to the living standards of millions, as investors dumped the Thai baht, South Korean won, Indonesian rupiah, Russian ruble and Brazilian real. Meanwhile, some major currencies have undergone strange, violent movements – notably the exchange rate between the dollar and the yen, which went from 80 yen per dollar in the spring of 1995 to 147 last June and then back to 108 a month ago.
All this can spell havoc even for ordinary American companies and workers, a prominent example being the U.S. steel in
dustry, which has laid off thousands of workers following a mid-summer flood of imports cheapened by the declines in the yen and the ruble.
What makes the turmoil all the more incomprehensible is that it comes when 11 European nations have adopted a common currency, the euro, creating a zone of currency calm dubbed "Euroland."
"For a lot of people, including myself, there's a frustration level associated with this extraordinary level of volatility," said E. Gerald Corrigan, the former president of the Federal Reserve Bank of New York. "Inevitably, it brings you face to face with the idea that there's got to be a better mousetrap."
But alas, there aren't many practical ways of building that better mousetrap – at least not according to the vast bulk of opinion in the economics profession. That viewpoint is shared in the top echelons of the Clinton administration.
Speaking at the World Economic Forum in Davos, Switzerland, last weekend, Treasury Secretary Robert E. Rubin made clear that the U.S. government sees little alternative to the present system in which major currencies lurch up and down according to supply and demand, as determined by the thousands of traders hunched over computer screens in banks and brokerage firms around the world. His words poured ice water on the German-French-Japanese initiative for stabilizing the dollar, euro and yen.
"To paraphrase Winston Churchill's famous statement about democracy," Rubin said, "the floating exchange rate system is the worst possible system, except for all others."
Academic economists, too, are "pretty heavily committed to the idea that floating exchange rates are the least bad arrangement," said Richard Cooper, a Harvard professor, who adds: "I am in the minority in being very uncomfortable with that conclusion. There is something wrong with a system that produces the results we've had."
The majority view on carefully calibrated exchange rates is that they aren't worth the cost for most countries – because they can require painful actions in the domestic economy, such as raising interest rates when recession looms, to attract investors and keep the currency within bounds.
Moreover, "the amount of money that can be mobilized against you is so enormous," said Peter Kenen, a Princeton economist, referring to the $1.5 trillion that courses each day on average through the world's currency markets. "It's not just the foreign investors or the George Soroses of the world. It's when your own citizens take their capital and run away. A lot of the Brazilian story is Brazilians moving their money overseas – not just foreigners."
As for currency unions such as Europe's, skepticism abounds that they would work in Asia or the Western Hemisphere.
Creating a currency union means that a super-national central bank decides when to print money, when to lower interest rates to combat recessions, and when to raise them to curb inflation. The "Euroland" countries have agreed to such an arrangement as the crowning step in their effort to bind themselves together and avert the strife that has afflicted their continent for centuries.
But to reach that point, they have spent the better part of 50 years making their economic structures and policies as similar as possible; the deal won't hold together if, say, recession-bound Spaniards are screaming for easy money while inflation-wary Germans want to keep money tight. The economies of Asia and the Western Hemisphere are far more disparate and less integrated.
"Think of a currency union just in North America for a moment," said Kenen. "Would the U.S. Congress agree that Alan Greenspan's successor could be a Canadian or a Mexican? Would the Canadians let an American run their central bank? Or think of an Asian monetary union: Would a Japanese be permitted to become the central bank governor? The point is, you need habits of trust before you can have a substantial sacrifice of monetary sovereignty."
It's not that governments are helpless to prevent or treat the kinds of crises that have recently swamped many currencies and economies. Work is underway in the world's capitals on a "new global financial architecture" setting the rules of international investment, which is expected to include measures such as taxes to discourage rapidly moving, "hot," foreign money from flitting in and out of emerging markets for short periods.
But this effort is aimed chiefly at addressing the underlying causes of crises – for example, poor banking regulation in developing countries – rather than the symptom of zig-zagging currencies.
Indeed, the recent spate of crises has solidified the convictions of many economists that governments are usually foolish to resist floating currency rates. After all, one country after another has crashed and burned in futile attempts to maintain "pegs" linking the value of their currencies to the dollar within narrow bands. In the end, the pegs helped turn market jitters into full-blown panics, because once investors became fearful that the pegs wouldn't hold, the rush to get out ahead of the collapse became overwhelming.
Even the Treasury and the International Monetary Fund, famous for demanding that crisis-stricken countries adopt economically painful measures to keep their currencies from going into free fall, are now letting it be known that they were never enthusiastic about the currency pegs they backed in nations such as Brazil, whose president, Fernando Henrique Cardoso, had staked his credibility on stability for the real.
Still, calls for radical and semi-radical changes in the world's currency system persist – and understandably so, because it has plenty of drawbacks, quite apart from the recent crises.
"What clearly has costs is when the flexible-rate system allows currencies to get way out of whack for a prolonged period," said C. Fred Bergsten, director of the Institute for International Economics.
That's what happened in the early 1980s, when exuberant foreign exchange markets bid up the dollar to astronomical levels against the yen and other currencies, driving up the price of U.S. products compared with foreign goods. Nobody can say for sure why markets "overshoot" like this, but "it decimated a lot of American manufacturing companies and American agriculture, and even some of our most competitive firms became very uncompetitive," Bergsten said. "There were big layoffs, and big losses of production – a lot of which was never recovered."
In addition, volatile currencies may cause some good jobs to go uncreated.
"We know there are a lot of mid-level American firms, very competitive, that don't export," said Harvard's Cooper. "Now, why they don't export is a bit of a puzzle. But I think a part – I don't want to say it's the whole explanation – is that currency fluctuations are positively scary if you haven't learned how to deal with them."
For all its flaws, however, the system does not lend itself easily to being overhauled.
The world is a far different place than it was when currency rates were fixed during the first quarter century after World War II. At that time, governments maintained strict controls over the flow of capital across their borders. Today, money sloshes around the world with few fetters because of the widely accepted view that growth will be maximized if capital is free to seek the highest returns. And whatever action is taken to limit "hot" money flows, few if any experts believe the broad trend can or should be reversed.
Thus virtually the only countries still able to maintain truly stable currencies in this era of free-flowing capital are the handful operating under the ironclad rules of a "currency board," including Argentina, Hong Kong, Bulgaria and Estonia. These arrangements typically require the government to maintain a fixed exchange rate with enough dollars in reserve to back every unit of local currency.
Currency boards have worked to help countries recover from severe financial crises. But their use entails a steep price – namely, that the government is prohibited from expanding the money supply and lowering credit costs to fight slumps. The upshot is a neat illustration of the "no-free-lunch" maxim so beloved by economists.
"One has to be very careful in talking about exchange rate stability to recognize that goals trade off," Lawrence H. Summers, the deputy treasury secretary, told a Senate panel last month, "and that to pursue exchange rate stability as a goal, one inevitably gives something else up."
The same lesson applies, he continued, to proposals favored by Bergsten and others for establishing "target zones" aimed at keeping the dollar within broad ranges against other major currencies. Imagine what would have happened in early 1995 if Washington had been obliged under a target zone system to reverse the dollar's slide before it hit the 80 yen level: "It would [have been] incumbent on us to have a very substantial increase in interest rates even though the economy was falling," Summers said.
The message from the economics mainstream about floating currencies thus boils down to this: Make the best of it, because the system is going to be around a long time.
Yes, the number of currencies in the world may shrink in coming years, and the number of currency boards may grow, as some countries conclude that they are willing to surrender their monetary sovereignty to quell the tempests besetting foreign exchange markets.
But economists predict most countries will conclude that their best course is to make floating rates more tolerable – for example, by increasing opportunities for companies and banks to hedge themselves against currency swings.
"There's no perfect arrangement, but the way in which the tide is moving is clear," said Barry Eichengreen, a professor at the University of California at Berkeley. "The task is for countries to build institutions and markets so they can live with greater exchange rate variability, rather than to deny that variable exchange rates are the wave of the future."
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