Friday, April 30, 2010

The Folly of Currency Pegs

John H. Makin has an excellent post with that title in the May issue of the American Entreprise Institute Outlook Series. He draws an apt parallel between the current crisis of the Euro, and the demise of the Bretton Woods system, and finds that it gives the European economies good reason for hope, if only their governments accept to recognize the facts.


“The current flap over the sustainability of Greece's membership in the European Economic and Monetary Union (EMU) is reminiscent, in many ways, of the events leading up to the collapse of the Bretton Woods system--another ultimately untenable currency regime--which was put into place after World War II and terminated by the break of the dollar's link to gold after August 1971. The period of increased exchange-rate flexibility that followed the demise of the Bretton Woods system turned out to be beneficial. The same possibility exists with respect to the aftermath of the current currency crisis in Europe.”

Makin further notes:

“The abandonment of fixed exchange rates--although it was not realized at the time--was fortunate. The oil-price shocks of 1973-74 would have blown apart any system of fixed exchange rates in the midst of a highly disruptive crisis environment that required substantial exchange-rate adjustments. Today, substantial exchange-rate adjustments are required in the EMU in the aftermath of the 2008 financial and economic turbulence caused by the bursting of the housing bubble.
Since the 1970s, among the most ill-founded currency pegs are those involving Argentina, Greece, and China. Argentina's peg to the U.S. dollar lasted from 1991 through 2001 and ended with a debt default by Argentina and, of course, a break in the exchange-rate peg of the Argentine peso to the dollar.”

His conclusion:

“The obvious fact is that the eurozone, with its single central bank and sixteen separate national treasuries, will not survive the aftermath of the 2008 bursting of the financial bubble. The corollary to this is that, given the persistent recurrence of such bubbles, currency pegs are inadvisable ex ante and even more damaging ex post while governments are wasting resources and delaying necessary adjustments by lending to accommodate fixed exchange-rate regimes that will ultimately break own.
… Let us hope that the Europeans see the light before even heavier costs and distortions are visited on Europe to support the fantasy that it constitutes an optimum currency area. As Greece, Ireland, Spain, and Portugal are discovering the hard way, it does not.”

The complete paper is first rate and well worth reading. It is the best one I have seen recently.

Paul Krugman also reaffirms in the New York Times his former euro-skeptical analysis – he writes that it is vindicated, and I agree -, and honestly recognizes that he was wrong to follow Barry Eichengreen’s assertion that exit was impossible.

My comment: I really can’t understand this kind of ultra conservative argument that since some (international) arrangement has been created, it can’t be changed afterwards. Don’t these people read history, including ancient and contemporary monetary history?

No comments: