foreign exchange & related...

[bishop]

since we have a couple economic related threads here, all making similar baseless allegations - i just wanted to show the historical progression that our currency, and international foreign-exchange rates have seen over the past 50 years or so...

following ww2, our monetary policy was governed by a system of fixed-rates, using gold as the standard for the dollar's value. it was focused on providing domestic policy autonomy and international monetary stability. since we were the victor of ww2, and our economy became the most powerful in the world, countries began to peg their currencies to our dollar. they gradually began to fill their central bank reserves with dollars. at the same time, we pegged the value of the dollar at $35 an ounce in gold. over time, the dollar became the de facto standard currency because so many countries had filled their reserves with dollars. despite occassional instances of competitive devaluation, particularly in the 30's, this system provided stability to the international monetary system.

between the end of ww2 up until 1971, our foreign policy was becomming increasingly involved in foreign pursuits. there was a huge outflow of dollars to pay for reconstruction in western europe and japan. then we had the korean war, and later, vietnam. what this meant was that one day, we would no longer be able to redeem our dollars in gold. inflation began to creep into the market
as confidence in the dollar was increasingly questioned. however, countries that built up dollar-denominated reserves agreed to retain their dollars - mostly for fear that we would withdraw our investments and return to isolationism. also, exporting countries (japan in particular) chose to retain their dollars in order to maintain access to our market.

and then we had lbj's presidency... the increasing costs of the vietnam was, combined with his "great society" project caused global inflation to accelerate and further threatened the dollar. in a political attempt to hide the costs of vietnam, lbj chose to pursue inflationary macroeconomic policies rather than raising taxes. instead, lbj cut taxes even though our country's expenditures were constantly increasing. the acceptance of keynesian economics began with jfk, greatly worsened under lbj and continued under nixon.

in 1971, nixon abandoned the gold standard and imposed a temporary 10% tariff on all imports in order to sufficiently devalue the dollar (it needed to be devalued because of rampant inflation). there was also the smithsonian agreement where other countries agreed to let their currencies appreciate until a sufficient balance was restored. later, in 1976, the days of fixed rates officially came to an end with the jamaica conference - when flexible exchange rates were established..

at this point, we had two options. we could either return to fiscal responsibility, or we could abuse our newfound priviledges - we were priviledged because all major foreign economies held dollars as their reserve currency (not gold). it must be human nature or something, but we went the greedy route - exploiting their adherence to the dollar, we began to view balanced budgets are not being very important. the possession of large foreign reserves of dollars has financed both our budget deficit, as well as our account deficit.

and this is where we are today - continuing to exploit foreign "dependency" on dollar denominated assets.

[bishop]

the basic problem with the current foreign exchange system is that there are no rules whatsoever. since the dollar is the top dog, we are able to spend into oblivion without any noticeable domestic impact, and, we can endlessly print new dollars.

right now, we're exploiting the pre-eminence of our currency to benefit our standard of living. that's fine, but this is not a policy that can last indefinitely. eventually, we will have to deal with our national debt and general account deficit.


suggested solutions by two experst....

nobel laureate robert mundell - close cooperation among the three major currencies (dollar, euro, yen). but cooperation would entail restraints on our economic policy autonomy, and therefore, would not happen due to political reasons.

barry eichengreen - economic and political changes have made a return to fixed rates impossible. his two suggestions are to continue with a system of freely floating exchange rates, or, to unify under a single currency whose value is managed by regional/central banks. but, people have been talking about monetary integration for quite some time now, and the only ones to have done it are the europeans (and whether the euro can last still remains to be seen).


slowly but surely, other countries are making moves to move away from the dollar - but this movement is not uniform. the chinese and iranians, and to a lesser extent the russians, are making movements whereby they will gradually start filling their reserves with a mix of dollars and euros. but then the japanese and much of south-east asia have acquired record levels of dollars (enabling bush to run record high deficits). the biggest no-no in my mind was the fed's refusal to raise rates despite our ever increasing budget deficit.


the only long-term solution that can truly do some good would be if we began a concerted effort to balance our budget and pay down the debt.

[Leopard]

Originally posted by bishop, the basic problem with the current foreign exchange system is that there are no rules whatsoever. since the dollar is the top dog, we are able to spend into oblivion without any noticeable domestic impact, and, we can endlessly print new dollars.

I agree with most of what you say except here. No matter what, there ARE rules. We all must live in the world as it exists and within the world of human action there are some pretty well-defined axioms of economics. We cannot endlessly print new money without consequence, other countries will not continue to support our debt forever, we will not be able to use force as we have in the past indefinitely on into the future withoud dire consequences...


michael

[bishop]

i suppose it depends on how you frame your argument.. i completely agree with what you said.

by virtue of the fact that we are the only country with currency seigniorage, we can print as many new dollars as we want. that statement is true. but, as you point out, it is also rational that we cannot continue such behavior indefinitely.

as far as how the float-rate system actually works.. that's one incredibly complicated system based on a variety of different economic models/formulas. one need only look at the forex and see substantial currency volatility occur every single day to realize that the current exchange-rate system isn't a rule-based process. instead, it functions much like the stock market, based on ever-increasing speculation.

some have suggested that we institute the tobin tax in order to promote currency stability. essentially, the tax would work against speculation, and limit the volume of forex trading - and it's thought that that will introduce some rational behavior into the market.


i'm curious if anyone here has any workable ideas on how we can achieve currency stability.

[Leopard]

I see no reason to have stability in the first place - the world is not stable and we change everyday with the economic decisions we make... stability is a farce and if we try to 'force' stability, it will undoubtably lead to harm...
I prefer relating a currency to a commodity, or a basket of commodities...

michael

[bishop]

currency became a commodity when they moved to floating exachange rates.

in reality, governments and central banks will always intervene in the economy for political reasons. that is an inescapable fact of life. they'll act in order to push towards price stabililty (ex. when the fed raises rates to curb inflation), or they'll act to spur the economy (ex. when the fed cut rates to increase money supplies). all that we have seen since we instituted a system devoid of rules has been currency volatility. much of the cause for japan's decade long recession has to due with the affects of currency volatility.

there are good arguments in having flexible rates. primarily, they help economies deal with external economic shocks. however, the country with seigniorage (america) must not exploit its situation.. but that clearly isn't the case.. today our account deficit hit an all time high, and our national debt breaks its own record every single day. some 35% of our debt is held by foreign countries, and their share of our debt grows each passing day.


my suggested solution is that we devise a rule based regime governing exchange rates, although that will not happen since our government will not relinquish its priviledged position.. the only solution remaining is for us to actively work to balance the budget and pay down the debt. unfortunately, chances are that our elected representatives will not do that until foreign countries begin to fill their reserves with non-dollar denominated assets. moreover, that process is likely to be extremely slow in reality (as they assume more of our debt).