IMAGINE WHAT IT would be like if each of our 50 states had its own currency, with no fixed relationship among them. Aside from the sheer confusion and inefficiency, we would risk windfall losses every time we traded across state lines. New York might be tempted to devalue its currency against Ohio's to gain a temporary trade advantage. Soon other states would retaliate with self- defeating protectionist measures, ranging from tariffs on Kansas wheat, to import quotas for Florida grapefruit to "Buy Arkansas" policies. Everyone would lose.
Ridiculous? But that's exactly what's been happening to the world economy over the past dozen years.
We see a popular airline that has offered cheap fares to Europe go bankrupt; few people realize that the airline, earning income in British pounds but paying costs in dollars, was a victim of the pound's fall against the dollar.
We see Detroit automakers pummeled by Japanese imports, losing jobs; what we don't see is that the price of a Japanese auto has been cut from $10,000 to $7,500 by a rise in the dollar against the yen.
It's a crime when steel and auto workers in my district have to worry about the state of the U.S. dollar. Sure, steel and auto manufacturers are responsible for the competitiveness of their products. But when they are priced out of the market, and jobs are destroyed, merely because the relative value of the dollar is hurtling around like a loose cannon, then I say there's something fundamentally wrong with the monetary system.
The job of money is to permit us to exchange other goods. Money bridges the gap between a sale and a purchase. Since that gap may be only a few minutes or several decades, money must hold its value if it is to be a sturdy bridge from the present to the future. Reliable money inspires confidence, becomes widely accepted and vastly expands our economic horizons. When money is doing its job, nothing is so easy to take for granted; when money is not doing its job, few things can do as much economic damage.
From 1945 to 1971 the world largely had the luxury of taking its money for granted. This is a tribute to the systems formalized at Bretton Woods, N.H., which restored the benefits of a common international money after the currency and trade wars of the 1930s. Other nations agreed to redeem their currencies in dollars, and the United States agreed to redeem dollars in gold.
The system had its flaws, but its record was enviable compared with the floating-rate system which replaced it. From 1945 to 1973, world trade expanded by 7 percent a year in real terms, inflation was low and long-term interest rates never exceeded 5 or 6 percent.
In 1971, the United States abrogated its responsibilities under the Bretton Woods agreement by closing its gold window to other countries. Early in 1973, Europe and Japan cut loose from the dollar. World inflation quickly exploded, leading to record levels of interest rates and unemployment. World trade slowed sharply from 1973 to 1979, then contracted.
Why did we abandon stable exchange rates? The postwar system had its technical problems, but it was really the victim of an idea -- the idea that the economists can manipulate money in order to regulate domestic spending or "aggregate demand." By doing so, they could supposedly trade a little more inflation for a little less unemployment, or vice versa. Each country could "do its own thing," isolated from the rest of the world by floating rates. But the notion that we could reduce unemployment or boost exports merely by devaluing our money ignored the fact that the only permanent result of sinking the dollar abroad is to sink its value at home.
Some economists have argued that sharing the same international measure of value by establishing fixed exchange rates is objectionable "price fixing" or "interventionism." By this logic we ought to abolish standard yards or meters as an interference in the free market. And what's the difference between central bank "intervention" in the foreign exchange markets and "intervention" in the domestic bond market as a tool of monetary policy?
The pervasive assumption seems to have been that the United States can be treated as a closed economy, separable from the rest of the world. Yet we simply cannot escape the fact that the dollar has a special role as an international reserve, and that 70 percent of world trade is conducted in dollars. Nor can we ignore the fact that one in six American jobs depends on trade. The only closed economy is the world economy.
When the dollar was allowed or encouraged to sink, as in 1973-74 or 1977-79, it led directly to price increases of goods quoted in dollars, such as oil and gold. Other industrial countries could acquire dollars cheaply, or borrow against the inflated dollar value of their gold reserves, to bid up commodity prices. Commodity-exporting countries, in turn, overborrowed against the inflated value of their exports.
Reversal of American monetary policy in 1974-75 and 1980-82 slammed the global economy into reverse. Other countries followed American interest rates upward to keep their currencies from sinking too rapidly against the dollar, which would have further swelled the costs of critical dollar-priced imports, such as oil and grain. The developing countries, in turn, were caught between the rising cost of servicing debt and the falling demand for their exports.
The key role of the dollar, in turn, has also dramatically affected Federal Reserve efforts to conduct a purely domestic monetary policy -- targeting either domestic interest rates or the domestic money supply. When the dollar was falling, a historically "normal" interest rate became wildly inflationary; when the dollar was rising, a "moderate" slowing of the money supply became drastically contractionary. Thus in the last two years our own farms and factories were devastated by the high interest rates, the rise of the dollar and the worldwide slump.
The obvious alternative to the painful experience of either a rising or a falling dollar is a stable dollar, with the low long-term interest rates it brings. There is a growing consensus that the experiment with floating exchange rates has been a failure. One of the chief architects of the floating system, former Chancellor Helmut Schmidt of Germany, offered this candid appraisal: "Valery Giscard d'Estaing, George Shultz and I, with others, were the authors of the decisions of 1973. If any of us entertained longer-term hopes with these decisions, these hopes have definitely been disappointed. The present 'world monetary system' does not deserve the name." Schmidt's French counterpart, Giscard, agrees: "There is need for people to have some knowledge and security about the future value of their currency," he says. Giscard proposes "a movement toward a fixed exchange rate systyem, which would "link domestic monetary policy to objective values and aims." Giscard's successor, Francois Mitterand, recently made a strong appeal for fixed exchange rates.
Here in the United States a growing consensus favoring greater stability of exchange rates includes economists from many different schools, and public figures ranging from Lewis Lehrman to Henry Kissinger to Felix Rohatyn.
Last December, Treasury Secretary Donald Regan met with an enthusiastic reception abroad when he proposed a new international monetary conference. Unfortunately, the administration has not yet followed through on this critical initiative.
While much more preparation would be needed before convoking a "new Bretton Woods" conference, the Williamsburg economic summit could start laying the groundwork, by frankly reviewing the performance of the floating rate system and mapping out the problems which must be addressed in moving toward fixed exchange rates.
Whether we recognize it or not, the United States still carries a special responsibility in the world economy. Only the United States can lead the way toward a reform of the international monetary system which can lay the foundation for lasting, world- wide price stability, low long-term interest rates and strong, job-creating economic growth.