BEFORE THE UNITED STATES HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING AND FINANCIAL SERVICES
HEARING ON EXCHANGE RATE STABILITY IN
MAY 21, 1999
Chairman Leach and Members of the Committee:
I consider it a great privilege to have this opportunity to express my views on the subject of international monetary relations. So I will try to be brief and focus on just those key points I would hope to convey this morning.
Let me say at the outset that the Committee showed great foresight in scheduling this hearing on exchange rate stability just a day after your hearing on the architecture of international finance. Currency chaos has been a major factor in recent global financial turmoil. Establishing an orderly international monetary system would be a tremendous boon to global financial stability and would contribute significantly to productive economic growth around the world.
There are three main observations I wish to emphasize today:
This last observation has a crucial bearing on the likely direction of exchange rate relations in the future. Regional currency unions seem to be the next step in the evolution toward some kind of global monetary order. Europe has already adopted a single currency. Asia may organize into a regional currency bloc to offer protection against speculative assaults on the individual currencies of weaker nations. Numerous countries in Latin America are considering various monetary arrangements to insulate them from financial contagion and avoid the economic consequences of devaluation. An important question is whether this process of monetary evolution will be intelligently directed or whether it will simply be driven by events. In my opinion, political leadership can play a decisive role in helping to build a more orderly, rational monetary system than the current free-for-all approach to exchange rate relations. So I would urge Congress to help ensure that the United States take the initiative on this crucial economic issue.
The evolution of monetary relations may proceed largely on its own--- propelled by the desire of some nations to replace their national money with the local dominant currency or by technological innovations offering new forms of private electronic money that could potentially outperform government-issued currencies. In any event, it is imperative that the United States begin to develop and put forward its own global monetary vision for the future.
Toward a Stable World Monetary System
What exchange rate regime or currency order would best facilitate international trade and the most productive use of global financial capital? What kind of international monetary system is most in keeping with U.S. economic principles to support entrepreneurial endeavor and free markets?
My own view is that a fixed-exchange rate system or common currency provides the optimal monetary platform to maximize the benefits from free trade and improve global living standards. Floating rates, while appealing in theory, have proved damaging in practice---governments too often seek to manipulate the value of their currencies and the resulting "dirty float" serves to distorts price signals across borders.
But in recommending a fixed-exchange rate approach or common currency, let me be clear in saying that only a strict mechanism based on a universal reserve asset and guaranteed convertibility for individuals would be desirable and prove sustainable. An exchange rate regime predicated on the oxymoronic notion of "controlled flexibility" that would attempt to maintain pegged rates or target zones through central bank intervention in currency markets is highly undesirable and unworkable.
Our overall objective should be to facilitate free market capitalism, which works best when the monetary unit of account conveys the same information to both buyers and sellers. The doctrine of comparative advantage is the rationale for free trade; all participants are better off when they produce those goods and services most appropriate for their economy and then have the opportunity to offer those products or investment opportunities in the international marketplace.
As Prof. Robert Mundell of Columbia University has observed: "The only closed economy is the world economy." The world economy today is rapidly becoming a global common market. As we have seen in Europe, the sequence of development is (1) you build a common market, and (2) you establish a common currency. Indeed, until you have a common currency, you dont truly have an efficient common market. Instead you have a fragmented market with participants relying on different units of account to provide a monetary frame of reference for assessing value. Moreover, those units are constantly fluctuating.
Remember that the ultimate purpose of floating rates was to stabilize exchange rates. The goal of any monetary system is to provide a stable frame of reference for evaluating the relative appeal of goods and services, or investment opportunities, wherever they may be available. When a premium must be paid to compensate investors for the risk of foreign exchange loss, or where competitive depreciation permits some sellers to underprice their goods at the expense of others, markets are compromised. Financial instability results when market participants recognize that currencies do not accurately reflect the true value of competing products and investments in the global marketplace.
The United States should seek to guide the process toward a stable global monetary system. What we can already glean from Europes bold experiment is that, while a common currency helps to realize the economic gains to consumers and producers from transparency and competitive pricing, the integrity of the currency itself cannot be merely vouchsafed by officials from the European Central Bank. Meanwhile, the United States offers the worlds best brand of money---in terms of its performance as a unit of account, store of value, and medium of exchange---but the perceived integrity of our money is highly dependent on one very competent chief central banker.
Ideally, every nation should stand willing to convert its currency at a fixed rate into a universal reserve asset. That would automatically create a global monetary union based on a common unit of account. The alternative path to a stable monetary order is to forge a common currency anchored to an asset of intrinsic value. While the current momentum for dollarization should be encouraged, especially for Mexico and Canada, in the end the stability of the global monetary order should not rest on any single nation.
Thank you. I would be happy to respond to any questions.