Forex: National Money in Foreign Exchange
We leave aside the issue of what constitutes the appropriate international money, who should issue it, in what amounts, and to whom in order to explore the opposite solution--- reliance on national moneys alone, with each country adopting an independent monetary policy and flexible exchange rates between national moneys.
The dispute for this system rests on substantial benefits or the avoidance of other costs, and low costs as well. In particular it is contended that a flexible exchange rate system obviates the need for countries to adjust monetary policies to the balance of payments, thus enabling them to gain an extra degree of freedom for domestic policies. It is also claimed that the costs in foreign trade and investment are minimal, since they can be maintained through the foreign exchange market; buttressed if need be by an expansion of forward dealings.
The second law of thermodynamics makes one doubt than an extra degree of freedom for domestic policies is available by adopting a technical solution to a problem. Economists know that perpetual motion is unlikely, and that there is no free lunch. And so, upon examining this proves to be with flexible exchange rates, although their more dogmatic adherents will agree with reluctance. Any country can gain an extra degree of freedom for monetary policy by adopting a floating exchange rate.
Either the authorities get involved in the exchange market, or they do not. If they intervene, they can prevent destabilizing speculation from moving the rate to levels which add to the problems of domestic monetary management rather than ease them--- a depreciated rate in a period of inflation or an appreciated rate during deflation. Control of the rate adds exchange policy to monetary and fiscal policy. With three policies, one can hit three targets: balance of payments, price stability, and full employment.
However, the weapon of exchange policy is not obtained out of thin air, but granted by the other countries with which the one country has trade and financial relations. If they intervene, they may want to do so at cross-purposes. Just as in international money, it is necessary to coordinate monetary policies, so in flexible exchange rates and intervening, to coordinate exchange policies.
The purists among flexible exchange rate advocates thrust flexible rates freely without intervention. If speculation is stabilizing, this will work very well; but if it is destabilizing, in the sense of moving the rate away from stability rather than heading to it, and threatening to produce irreversibility in levels of costs, wages, prices, and such--- it seems inevitable that intervention will be resumed.
|