CURRENCY WARS: YESTERDAY, TODAY – AND TOMORROW?

1. CURRENCY WARS: YESTERDAY, TODAY – AND TOMORROW? Benjamin J. Cohen University of California, Santa Barbara Remarks prepared for the Conference on “The Political Economy of International Money” Federal Reserve Bank of Dallas, 4 April 2014

2. THE POLITICS OF EXCHANGE RATES • What are the lessons from the Great Depression about the management of currency values? • Conventional wisdom at the time: “the proved disadvantages of freely fluctuating exchanges” (International Currency Experience, 1944). Exchange rates would have to be managed, subject to rules

3. TWO QUESTIONS • 1. Was the conventional wisdom right? (That is, was the correct lesson drawn?) • Answer: a qualified Yes • 2. Has successfully has the lesson been implemented? (That is have exchange rates been managed well?) • Answer: not very well, in part because another important lesson was forgotten

4. 1. WAS THE CONVENTIONAL WISDOM RIGHT? • There is no doubt that “freely fluctuating exchanges” invited competitive depreciations – in effect, currency war • From 1930 to 1938, 20 countries devalued by more than 10 %, some several times • Some evidence that depreciations may have been to some extent beneficial, by allowing less restrictive monetary policy (Eichengreen and Sachs, 1985) • But also no doubt that they were disorderly and disruptive • Legitimate conclusion: need some kind of rules to prevent currency wars

5. 2. HOW SUCCESSFULLY HAS THE LESSON BEEM IMPLEMENTED? • Short answer: not very well. Hence much talk of currency wars today • Longer answer: a series of attempts to implement effective rules, but with little success. Most notable: • Bretton Woods (1944) • Committee of Twenty (1972-74) • Second Amendment (1976)

6. BRETTON WOODS • Floating was to be discouraged; but there was also a fear of too much rigidity • Hence a compromise: the par value system, meant to provide stability but also allow for adjustments in specific circumstances (“fundamental disequilibrium”) • Ultimately proved unworkable (What is a “fundamental disequilibrium?”)

7. COMMITTEE OF TWENTY • Called for a new “exchange rate regime based on stable but adjustable par values” • Proved unacceptable – overtaken by events

8. SECOND AMENDMENT • New Article IV • Free choice of exchange rate policies, subject only to: • admonition to “avoid manipulating exchange rates… to gain an unfair competitive advantage” • “firm surveillance” by the IMF • These are the prevailing rules today

9. HOW WELL HAVE THE RULES WORKED? • The IMF has tried hard • As early as 1977, the Fund specified principles for the exercise of surveillance • Article IV consultations were instituted • Principles for surveillance were updated in 2007 • But governments have resisted oversight; dirty floats have become increasingly prevalent; talk of currency wars is not exaggerated

10. WHY HAVE THE RULES NOT WORKED? • General issue: state sovereignty (resistance to supranational authority) • More specific issue: Geopolitics • A forgotten lesson of the Great Depression: the Tripartite Agreement of 1936 highlighted the importance of consensus among the major powers of the day; acknowledgement of mutual responsibility for systemic management. • Is a modern version of the Tripartite Agreement possible today? • Unlikely

11. CONCLUSION • Lessons have been learned, but selectively and imperfectly. • George Santayana said: “Those who cannot remember the past are condemned to repeat it.” • Are we condemned to repeat the currency wars of the 1930s? • Not impossible…