NOBODY LIKES the way the currency exchange rates are working. Currencies swing wildly up and down against each other, distorting the prices of goods and skewing the patterns of world trade. The French government has a particularly strong grievance, for ever since the Socialists came to power two years ago, the exchange rate of the franc has been sinking steadily. But it's not only French politicians who complain. Traders and manufacturers in every country want urgently to know what their foreign earnings--and their foreign competitors' prices--are going to be.
Unfortunately there is no technical fix that can produce stable rates. Governments, after all, did not abandon the old system voluntarily. They used to keep their currencies at par values against each other, with relatively infrequent changes. That was the Bretton Woods regime, so attractive in retrospect. But the rise in international trade and investment in the 1960s created flows of money that could easily knock over the dikes that the par value system tried to maintain. When a surge of money began to run out of one currency into another, governments tried to neutralize it by making offsetting sales and purchases of those currencies. By the early 1970s, those attempts at stabilization were failing regularly.
In those years, foreign exchange bought and sold in New York probably amounted to several billion dollars a day. By 1980, when the New York Federal Reserve Bank last measured it, the flow was over $15 billion a day. By last year it was apparently around $30 billion. Currently, with declining inflation, it seems to have dropped to around $25 billion a day. Simply for comparison, we might note that $25 billion every business day is roughly twice the GNP of the United States. To be sure, that figure counts money moving both in and out of the dollar; much of it is money constantly on the move, washing restlessly back and forth in search of speculative advantage. Against those amounts of money, no government has the resources to defend artificial rates.
But that drop in the flow over the past year is a clue to the formula for stability. Exchange rates will hold firm between two countries only as long as their economies are run in close coordination. The French franc will continue to fall as long as the French inflation rate is twice as high as its neighbors'. The American dollar will continue abnormally high, damaging American exports, as long as American interest rates remain abnormally high. In practice, as experience even in the highly integrated European Common Market has shown, it is very difficult for countries with differing political traditions to coordinate economic policy. But the principle is clear. Stable economies produce stabl exchange rates, not the other way around.