Smoothing exchange rate waves
IT'S not a bad rule: If it ain't broke, don't fix it. Calls for reform of the floating currency exchange rate system in place since March 1973 have been rising from the halls of Congress and the think tanks lately. They are likely to become more strident in the months ahead.
But for all their troublesome volatility, floating rates may be the best system possible.
To talk of exchange rate systems is to talk of lesser evils. Given the major economic upheavals since fixed exchange rates were abandoned -- oil shocks, inflation, stagflation, recession, changes in world patterns of industrialization and trade -- it can be argued that floating rates have done better as economic shock absorbers than fixed rates would have done.
And returning to fixed rates is out of the question, if only because of the sheer volume ($150 billion worth) of money changed around the globe on a given day.
Exchange rates were originally allowed to float because the world's major trading partners were pursuing domestic economic policies that didn't mesh smoothly with one another. Central banks were forced to intervene continually to preserve the fixed rates. Ultimately the nations involved decided they would prefer to use monetary policy to control domestic inflation rather than to control exchange rates, and so currencies were allowed to float.
And they have indeed floated -- like corks on the swells of the ocean.
But the global net of economic interdependence has drawn tighter over the years.
Exports and imports have grown in relation to gross national product. Trade flows are more often swamped by the movements of capital, and these are no longer gentle ebbs and flows; they are more like the thundering tides in the Bay of Fundy.
Domestic tax policies and financial deregulation are also factors. Accelerated depreciation, part of US tax law since 1981, has driven up returns on real assets, thus affecting returns on financial assets as well and ultimately sucking in billions of dollars from foreign investors. Changes in tax law -- such as those to be debated in the Senate after the new year -- could send some of those funds rushing right back out again, with consequent effects on the exchange rate.
No wonder we hear calls for, if not fixed rates, then maybe the halfway house of ``target zones'' or ``bands,'' modeled on the European monetary system and its ``snake.'' More active management of exchange rates is also an option; New Jersey Sen. Bill Bradley's ``strategic capital reserve'' concept bears study.
But the bottom line is that we can't expect the currencies of different countries to work together any more smoothly than the respective fiscal, monetary, and tax policies of those countries.
Readers are perhaps weary of being harangued about the $200 billion federal budget deficit in the US. But that deficit is still largely responsible for the strong dollar that has lost markets for US products ranging from wheat to bedsheets. M-1 (the basic money supply, cash and checking-account deposits) has been roaring ahead like a tandem trailer truck whose brakes are subject to question: M-1's November growth, annualized, was 13 percent, well above the Federal Reserve's target.
Meanwhile, in West Germany and Japan, the countries that matter most in all this, both fiscal and monetary policy are relatively tight.
The record of nations on coordinating such policies is not good. And economic forecasting, an essential tool in setting these policies, often seems more art than science. Witness the current disagreement as to whether the US has a rosy or a gloomy 1986 outlook.
Still, international coordination is the high road to steadier exchange rates. Efforts along this path could help steady exchange rates within just a few years.