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William White: Why we need to debate exchange rates

A currency war or a war on currency?

William White, formerly head of monetary and economic affairs at the Bank for International Settlements and now chair of a key OECD committee,  is one of the few mainstream economists willing and eager to keep the debate about exchange rates systems alive. Most of them want to bury it. In a paper published by the Dallas Fed, How False Beliefs About Exchange Rate Systems Threaten Global Growth and the Existence of the Eurozone, he insists on the need for a debate for good reason; false beliefs about exchange rates have done and continue to do enormous damage. They were one of the most important causes of the financial crisis and are now threatening global growth.

They include notably the beliefs

1. that floating exchange rates would promote smooth adjustment to international imbalances

2. that floating would enable a country to avoid unwanted spillovers  from US monetary policy

3. that a floating exchange rate plus price stability eliminate the possibility of crises.

With these policies in place, there is no need for governments to prepare to manage crises.

In the real world, these beliefs make crises inevitable. Policies based on them are even now laying the ground for another crash, while also holding back recovery from the last (e.g. high debt levels are restraining consumer spending). White:

“Had there been an alternative international monetary system in place that imposed some international discipline on the behaviour of countries (particularly the US but also China, Germany and Japan) the global economy would not have become so seriously unbalanced and exposed to future shocks.”

Likewise, had the spillover effects of US domestic monetary policies been given greater attention, more would have spotted the flaw in the belief system.

His conclusion: “Reforming the international monetary system should be given a much higher priority than it has been”.

He thus joins the select group of senior financial wizards  like Paul Volcker, Jacques de Larosiere and Bob Mundell in urging the need for reform.

A lost cause?

Is this a lost cause? Maybe. If so, it will be because of the grip that such false beliefs have on the minds of economists and policy-makers.

But, he says, the battle is not necessarily lost. History records many transitions from floating to fixed rate regimes. There was the return to gold after World War l and the introduction of Bretton Woods after World War ll. There was the formation of a currency union in Europe. Many other countries have given up entirely on their own currency and chosen to adopt the dollar or the euro as an alternative.

“The Money Trap” cited

In Bill’s view it is no longer inconceivable that the current dollar based system might be replaced with a truly international currency. Indeed he goes so far as to say the currency might be “perhaps linked in some way to the price of something real” (my italics). Here Bill refers to The Money Trap, which, he kindly says, outlines “some very practical suggestions”. Thank you, Bill.

RP comments: Beliefs have functions

The following are some comments on Bill White’s profound and wide-ranging paper (the above is only a brief summary of one section).

First, false beliefs like these do not come out of the blue, nor pure ratiocination; they serve a purpose; they are, often, the outcome of political calculation and institutional interest.

Take the case of the central banks. The false propositions made it possible for central bankers to persuade governments, markets and the public that the doctrine of inflation targeting was harmless.  If they had admitted, back in the 1990s, that there was no evidence that “price stability”, even if attained, would promote a sustainable pattern of international payments, then it would have been much harder  to “sell” the inflation targeting doctrine to policy makers.

Likewise, if they had admitted that inflation targeting/price stability would afford no protection from periodic monetary surges from the US, this admission also would have weakened their case. Then it would have been clear that all countries outside the US would feel the full backlash of swings in Fed policies.

Everybody outside the US knew full well the potential that such swings had to cause such global effects, because of the size of the US economy as well as the global role of the dollar. Without the mantra that floating would provide effective insulation, it would have been obvious that such swings would face policy-makers in other countries with uncomfortable policy dilemmas. Would any central banker have been able to convince their governments and public that inflation targeting with floating rates was nothing more than a highly risky experiment?

Surely,  people would have hesitated to adopt it. That is why reassuring if false beliefs about exchange rates had to be assiduously promulgated. How was this done? The huge patronage of the Fed over economic research in the US played an important role. Doubtless a mistaken concept of patriotism played a part too. It became “unpatriotic” for an American to favour any international system that would impose discipline on the US, even as part of an international order.

Then there is the little matter of the definition of price stability forced on the world by the United States – which in fact, if realised, would guarantee inflation without end.

Despite its manifest weaknesses as a standard, central banks stood to gain from the public and political status that such an idea gave them. Acceptance of the inflation targeting dogma offered them enormous political leverage. They have managed their ascendancy astutely. The Great Recession has merely served to consolidate their grip. The more damage it does, the more the dogma is idolised by the central banking community (with the honourable exception of their club, the BIS).

In short, central bankers’ belief systems illustrate Daniel Kahneman’s observation that,  since we have to believe something,  we might as well believe something convenient.


Secondly, such doctrines also suit the short-term interests of governments – above all the US, but also those of other big countries such as Germany and Japan. They are off the hook.  There is nothing to ensure consistency of the various national policies in terms of the common interest in a stable international order.

In practice, the inflation targeting dogma gives central banks enormous discretion, which is what they like. It is not a true monetary standard, one that disciplines policy. Thus political economy fills the vacuum. In practice, they pursue a dual mandate of full employment and inflation targeting. Thus any possibility, however remote,  of deflation is a pretext for unrestrained monetary expansion and undeclared currency wars.

In this way the value of money in each country comes to depend on what some group of economists in the relevant official committees feels it should be from time to time.

Can anybody sensibly blame markets for being short term when central banks set such a bad example?

Blame somebody else

Meanwhile, the central banks are already carefully preparing public opinion so that the blame falls on governments and the private sector the next time things go pear-shaped.

It is significant that central banks are quietly letting the banking reforms be eroded by lobbying.

More than a debt trap

Thirdly, central banks have become unwittingly the scourges of money.  The remedy for getting out of the last crisis is always more of the same policies as produced the last one: more money, more debt. That is the money trap.

This is more than a debt trap because it involves the very nature and functions of money. Central bankers, once the guardians of money,  are being reduced to fighting to destroy money and driving us back to barter. That is what the logic of negative interest rates leads to.

They want to punish you for holding money. They know what you should be doing with your money better than you do. It is the logic of planning, of physical controls, penalties and prisons.

The perversion of monetary guardians

It is often said that policies of QE are tantamount to starting an undeclared currency war. That is true enough. But far more insidiously and profoundly, they amount to a war on currency, on money.