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Floating Exchange Rates: The Only Viable Solution
Floating Exchange Rates: The Only Viable Solution Floating Exchange Rates: The Only Viable Solution Stentor Smith For some, the collapse of Mexico's economy proves that floating exchange rates and markets without capital controls are deadly. Others find the crash of the European exchange-rate mechanism (ERM) in 1993 to be proof that targeted rates will always be overturned by the free market. Many see the breakup of Bretton Woods as the failure of fixed rates. Yet others believe monetary unification in Europe is the only way to achieve economic and political stability. Many others hold still different beliefs. There are, however, four main proposals for the management of international currency exchange rates: monetary unification, fixed rates, floating rates maintained within certain "reasonable" limits of variability and freely floating rates. Both fixed exchange rates and rates based on either explicit or unwritten targeting are impossible to maintain, especially in an era of free trade. Complete monetary unification would be impossible to bring about without extensive integration and unification of international governments and economies, a task so vast that it is unlikely ever to be accomplished. Thus, the only option central banks have is to allow exchange rates to float freely. The European Monetary System, which virtually collapsed in 1993, was an attempt to fix exchange rates within certain tight bands, to coordinate monetary policy between member nations and to have central banks intervene to keep exchange rates within the bands when necessary. The reasons for the collapse were myriad, but, simply put, it happened because Germany, dealing with financial problems in part arising from its reunification, refused to lower its high interest rates. This meant other European countries either had to keep their rates equally high and allow themselves to fall into recession as a result, or devalue their currency against the mark, a move viewed by many as a political embarrassment. The possibility of a devaluation caused speculators to bolt from the lira, the pound, the franc and other currencies, sending the markets into chaos and destroying all semblance of stability. In the end, the ERM was adjusted to allow currencies to fluctuate within 15 percent on either side of their assigned level, up from (in most cases) a limitation of 2.25 percent. The bands became too wide to be meaningful or stabilizing, and the system remained alive "in name only" (Whitney 19). Many saw this collapse as inevitable and say all attempts at government-imposed stability will fail: Governments both will not and cannot stick to pegged or fixed rates. First, maintaining targeted or fixed rates requires a consistent and fairly uniform monetary policy among nations. There are many reasons that national governments will not consent to this, the foremost being that different countries want different things, different economies have different needs and different governments have different policies. For example, it is thought that Europe and Japan are more willing to tolerate recession than inflation, while the United States prefers to keep interest rates low and the economy growing, even if prices do increase (Whitt 11). In addition, many nations are in different stages of their overall economic cycles ("Gold Standard" 79). Many countries thus cannot afford to subscribe to uniform monetary policy. For a country that would otherwise have had low interest rates, for example, raising them could be both economically counterproductive (what good is exchange rate stability if recession is its cost?) and politically disastrous (more people notice high interest rates and unemployment than care about currency stability). Even if the government were willing to bow to international standards, nationalism is strong in the world today and most people do not look fondly upon consolidated global power--witness the problems of the United Nations. People would not widely support what would effectively be international control of their country's economic polici... This is ONLY a preview of the article. If you would like to view the entire document, you must subscribe to Academic Library. Please register below now!
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