The cost of floating exchange rates

The IMF working paper found that the effect of the introduction of a common currency in Europe was equivalent to a 4 per cent reduction in tariffs. Rose found that exchange rate variability has a large depressing effect on international trade.

It is for these reasons that we must abandon the dogma of floating exchange rates relying on instrumental monetary stabilisation policies (interest rate movements and central banks buying and selling currency).

We need to restore a Bretton Woods currency peg system at the very minimum, or adopt Keynes’s Bancor concept.

Critics argue that the Bretton Woods arrangements became unstable in the 1970s and we had a decade of stagflation across the world as a consequence.

With the global financial crisis the policy analysis has been about treating the symptoms, similarly the analysis of the stagflation period dealt with the symptoms. The move to floating exchange rates allowed quick fixes in major economies without understanding the problem that required addressing and has sowed the seeds for the first ripple (GFC) that will eventually turn into a tsunami unless action is taken.

The Bretton Woods system came out of World War II, there was no other nation strong enough to provide the reserve currency and this task fell to the United States. By the 1960s this had changed but there was not the will to enable the Bretton Woods system to evolve with the changing world circumstances.

Hence at the start of the 1970s the combined events of the Vietnam War and the OPEC oil embargo effectively were external price shocks to the United States economy that spread world wide. If a Bancor had been established or a currency basket used as the world’s reserve the impact of the Vietnam War could have been mitigated, instead the drain it provided on the United State’s economy had worldwide impact.

Just imagine the effect on economic welfare if a worldwide reduction in tariffs of 4 per cent could be delivered. Imagine the impact on world growth and social welfare if the trillions of dollars locked up in currency hedging could be dispersed to productive investment.

Just imagine the impact on full employment policies across the globe if those trillions of dollars could be put to use.

Just imagine the fight against poverty that we could launch with even a small fraction of those trillions of dollars.