at the Chicago Mercantile Exchange International Finance Symposium,
Le Meridian Piccadilly Hotel,
November 11, 1986.
the virtues of free markets—particularly the advantages of
floating exchange rates versus a system of fixed exchange rates—is
a non-ending process. While the theme is always the same and
our words repetitive, it is imperative that they be reiterated.
One cannot become complacent or look the other way lest the
proponents of central planning gain a foothold in the unending
war between economic good and evil. Beware, it is a slippery
slope—the road to central planning is paved with good intentions.
the fall of 1986, the United Kingdom staged its well publicized
Big Bang in which age-old traditions and regulations based
on fixed modes of operation in the securities markets were
abandoned in favor of competitive applications. It was a signal
change for the British and an irresistible opportunity to again
beat the drum for free markets.
British cannot ever be accused of being rash. Indeed, the civilized
world has come to expect the United Kingdom to act as the final
filter for revolutionary ideas—where the probity of every untested
concept will be settled with certainty; where every nuance is
thoroughly analyzed; where every issue— pro and con—is exhaustively
debated; and where every shred of evidence is convincingly scrutinized.
Only then will the subject in question receive the British stamp
of approval. Sometimes this process may be a bit slow.
October 27, 1986, some 15 billion years after the original Big
Bang, the British Isles staged their own version of this event.
In doing so, the British government, at long last, accepted two
fairly controversial ideas. It acceded that the original cosmic
phenomenon had merit (pity Albert Einstein isn't around to agree);
and it embraced the radical concept of competition (the tenets
of Adam Smith take time to understand).
contrast to British reverence for tradition, the United States
is wedded to the spirit of pioneerism. As a rule, we encourage
new ideas, give radical thoughts an even chance, and are famous
for our innovations and inventions. Some detractors may even
say we shoot from the hip. Alas, while we are not burdened by
a fear of change, we have a problem staying with our winners.
All too often, just when we are about to be reap the rewards
of our risks, we snatch defeat from the jaws of victory. In other
words we have a tendency to get cold feet.
when U.S. long-standing efforts to convince the world that capitalism
is the only economic system capable of lifting the world from
its mediocre fate are about to bear fruit, just when U.S. precepts
of free enterprise are about to change the way the world works,
just when U.S. theories about competition are about to become
universally embraced, suddenly, some Americans have second thoughts.
In China after centuries of economic dead-ends and endless false
starts, the last decade witnessed a clear movement toward our
side of the street. Perhaps the Peoples' Republic of China may
have at last seen the light and concluded that the way to lift
its masses from economic misery to something better is through
principles that look suspiciously close to capitalism.
Europe, after years of socialistic flirtations and dictates,
there is a resurgence of capitalistic ideals, and a strong movement
toward privatization and away from nationalization. All over
South America, the Far East, and even Africa, the concepts of
free enterprise have taken root and proved far more successful
in raising economic standards and hopes than their counterparts
of socialism or communism. And in England, one need not look
further than Big Bang, embracing as it does virtually every standard
of open competition including the concept of dual trading to
understand which way the wind is blowing.
short, American preaching about the virtues of capitalism, free
trade, deregulation, competition, and free enterprise are finally
paying off the world over. They may even win us the cold war.
Yet, at this propitious moment of near-victory, some American
business representatives have begun to have doubts about the
sanctity of competition. Some of their elected officials have
introduced 818 bills in Congress that, to one degree or another,
will stifle or inhibit free trade. Some of their news media have
begun to shout about the dangers of innovation to financial markets
and lament the effects of the technological revolution. And some
of their leaders openly begin to dream about a return to a system
of fixed exchange rates—an issue close to my heart.
defeat from the jaws of victory is the single most effective
deterrent to success. To be perfectly honest, the malady is not
unique to Americans. Its symptoms can be found throughout human
history. It stems from mankind's recurring problem with its memory.
As Santayana put it, "Those who cannot remember the past are
condemned to repeat it."
1971 was not so long ago that we have forgotten the economic
setting of that day and the desperate measures it demanded? Remember
the U.S financial confidence crisis? Remember the run against
the dollar? Remember how President Nixon closed the gold window
and ended dollar convertibility? What followed was an era of
financial upheavals unequaled in the annals of man, such that
tested the very foundations of western society. Surely we haven't
forgotten the dollar's plunge to its lowest historical levels?
U.S. unemployment in excess of 10%? Oil prices skyrocketing to
$39 a barrel? The Dow Jones Industrial Average falling to 570?
Gold at $800, inflation at 20% and interest rates even higher?
These financial shocks and upheavals represented the crises of
the 1970s and early 1980s. We dare not forget how all of that
came to pass, nor ignore the lesson implicit in this history,
lest we are prepared to repeat it.
1945, the western world instituted the Bretton Woods system of
fixed exchange rates. It did so because it was the only sensible
thing to do in a world completely ravaged by World War II. It
did so with the express understanding that desperate measures
were in order. The system was a resounding success. It was one
of the essential ingredients that combined to stabilize the world
monetary order and achieve the post-war era of prosperity. It
worked because the United States represented the only remaining
industrial nation with its financial system intact; it worked
because the U.S. dollar was the only remaining currency of value;
it worked because the U.S. could dictate its economic resolve;
and it worked because the U.S. was capable and willing to use
its own financial resources to the benefit of everyone else.
the finance ministers of that day forgot the reasons for their
success. They forgot Bretton Woods was a short-term solution
and began to believe that a system born of necessity and uniquely
suited for reconstruction could continue to serve under normal
conditions. The basic and fundamental flaw of a fixed rate system—its
rigidity—was destined to become its undoing. The very system
that served so well during conditions of post-war reconstruction
was highly inadequate once the process was completed. By definition,
a fixed system could not effectively cope with the constant demands
of value change resulting from the daily flows of political and
economic stresses between the member participants of Bretton
Woods. Moreover, the system's cumulative effects were bound to
result in disastrous imbalances that ultimately would produce
one of the western world's partners achieved a different level
of economic competence, each at a different rate of growth, each
with widely divergent expectations and limitations. Each of the
participating members of Bretton Woods was directed by significantly
different fiscal and monetary philosophies and beholden to substantially
different forms of governments.
proper currency value cannot remain static in a world where countries
are subjected to differing degrees of trade union bargaining
power, have differing elasticities of both supply and demand
for their exports and imports, are at different stages of their
trade cycles, and suffer from different election timetables and
differing kinds of political risks. External differences and
internal self-interests of and between member nations must ultimately
be the ruination of a system dependent upon a unified opinion
about respective currency values.
the very U.S. resources that saved the western world could not
forever be expected to be drawn upon without themselves becoming
weakened. Indeed, the cumulative effect of fixed exchange rates
so disadvantaged the United States, that, by the time they were
discarded, our nation's financial structure was in shambles.
There were a few who saw the signs and read the handwriting on
from the time Bretton Woods became effective, it was inevitable
it would break down... It tried to achieve incompatible objectives:
freedom of countries to pursue an independent internal monetary
policy; fixed exchange rates; and relatively free international
movement of goods and capital...As one of the architects of
Bretton Woods, Keynes tried to resolve these incompatibilities
by providing for flexibility of exchange rates through what
he intended to be frequent and fairly easily achieved changes
in official parities. In practice, this hope was doomed because
maintaining the announced parity became a matter of prestige
and political controversy. Countries therefore held on to a
parity as long as they could, in the process letting minor
problems grow into major crises and then making large changes...(1)
by the time these warnings were heeded, it was too late. The
pressures and imbalances created during reconstruction and exacerbated
by virtue of fixed exchange rates were destined to take their
toll. When that happened, it would threaten the very foundation
of the industrial world.
all of the protective measures instituted by the United States
in 1971, none was more telling than the abandonment of Bretton
Woods and the defacto acceptance of floating exchange
rates. Indeed, floating rates proved to be the single most effective
tool enabling the western world to survive the dramatic shocks
of the next decade and a half. Here is the International Monetary
Fund's assessment of floating exchange rates as published in
its Occasional Paper, July, 1984:
the events of the past decade, it is easy to be impressed by
the resiliency of the present system...Indeed, in such an environment,
managed floating might well have been the only system that could
have functioned continuously.
similar sentiment was expressed by the Group of Ten, as published
June 21, 1985, "....it is questionable whether any less flexible
system would have survived the strains of the past decade..."
is but fifteen years ago, yet already some have forgotten this
history and urge a return to those utopian days of fixed exchange.
The free market causes too much volatility, they tell us. The
free market causes a misalignment of values they argue. Not only
have these folks forgotten their economic history, they have
failed to recognize economic reality.
western industrial world—West Germany, Japan, Great Britain,
France, and the other EEC nations—are not even remotely the same
pitiful entities that forty years ago looked to the U.S. for
salvation. Today, they are strong and independent sovereignties
who are financially as sound—or sounder—than the U.S. Today,
it is exceedingly unrealistic to believe we can dictate to them
our monetary or fiscal philosophy. Today, it is exceedingly unrealistic
to assume that the U.S. opinion about relative values of foreign
exchange will for very long be everyone's accepted view.
important, the last forty years have achieved a technological
revolution of monumental proportions. In today's world, the telecommunications
capabilities of every financial participant—from the lowliest
individual investor to the largest cartel—allow up-to-the-second
recognition of every event worldwide, and the means by which
to translate this knowledge into immediate action. This action
is transformed into daily capital movements equal to many hundreds
of billions of dollars that can completely overwhelm traditional
fundamentals such as inflation differences, or the trend of the
current account balance. These capital movements are the principle
causes of today's volatility in foreign exchange as well as the
reasons for recent long-lasting misalignments. The money flows
resulting from the technological revolution cannot, for very
long, be diverted from their course or channeled in a direction
they do not want to go.
overwhelming influence of capital movements and the huge amount
of liquid dollar holdings in the world explain another unique
feature of the dollar. It is the only currency for which it can
be said with certainty that, under conditions of capital mobility,
it can function only as a fully floating currency. Any fixed
dollar rate, or even a mere target zone for the dollar, would
sooner or later be toppled by irresistible capital flows and
the enormous amount of volatile dollar holdings.(2)
those among us who still nurture the belief that an international
committee or system can indefinitely dictate the relative values
of foreign exchange have failed to understand the effect of the
marriage of the computer chip to the telephone.
fundamental truths governing the value of money are no different
than those for all commodities. The market forces that make
it difficult for OPEC to artificially ordain the value of oil
or for the International Tin Council to unrealistically fix the
price of tin are the same market forces which will similarly
undo the manipulations of the G-5, G-10, or any artificial system
created to dictate currency values. In today's world, a fixed
rate or targeted range for currency in international capital
markets will last for only so long as the free forces of supply
and demand are in agreement.
September 1985 efforts of the Group of 5 seemed successful more
because their timing was excellent and the market agreed with
the result than for any other reason. To assume otherwise is
to forget history, ignore reality, and perpetuate a false belief.
In today's world, the free market is the only umpire that can
command everyone's respect.
there are those who will tell you differently. There are those
who are blind to the clear evidence about us. There are those
who would have us, once again, snatch defeat from the jaws of
victory. There are those who distrust the free market process
and denigrate the forces of supply and demand. They dream of
something better. Do not be fooled by such a dream. It denies
us the advantage of our memory and condemns us to repeat our
No Such Thing as a Free Lunch, International Economic
Policy, Milton Friedman.
International Role of the Dollar, 1985, Otmar Emminger.
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