Home > Uncategorized > Perils of exchange rate miss-alignment

Perils of exchange rate miss-alignment

from Asad Zaman

As I have only recently come to realize, stabilizing the exchange rate at the wrong level can have massively harmful effects. One can trace major economic tragedies to such attempts. The British attempt to go back to the gold standard after post WW1 failed because they set the level too high (as Keynes pointed out). This attempt set of a sequence of events which had far reaching consequences. A similar story is told about Pakistan in “The Rupee is falling; let it crash”. Linked article shows that overvaluation of Pak Rupee de-linked the Pakistan and Indian Economies, which may the economic root of current political hostilities. Current problems of the European Union are a more advanced version of the same problem, where the rate of exchange between European countries cannot be re-aligned according to the gaps between their imports and exports. This is a subject worth exploring further, and if readers have more pointers/articles, I would appreciate learning more about it. The article below deals with the Dutch Disease in Pakistan.  read more

  1. January 27, 2019 at 4:11 pm

    Here:
    https://eprints.soton.ac.uk/36569/1/KK_97_Disaggregated_Credit.pdf
    Is a nice paper by Richard Werner noting that a disaggregated measure of credit has the highest success in predicting economic crisis. Exchange rates are not very useful predictors of same.

  2. Calgacus
    January 27, 2019 at 5:03 pm

    Basically the answer is simple. Don’t set exchange rates. Let them float. Tend your own garden. Problems solved. To quote FDR’s message to the 1933 London Conference: “The sound internal economic system of a Nation is a greater factor in its well-being than the price of its currency in changing terms of the currencies of other Nations.” And Keynes on this message: “Magnificently right” .

    This is a subject worth exploring further, and if readers have more pointers/articles, I would appreciate learning more about it.

    This article is basically right, but this is a major point of Abba Lerner’s Functional Finance and today’s MMT. For most countries, for developed countries, there is basically never any reason to peg exchange rates. The discussion in Lerner’s Economics of Employment is a personal favorite, an unsurpassed must-read.

    Conceivably, under some circumstances, with adroit leadership, developing countries might want to peg their currency – often low, to become “monetary mercantilists”, but sometimes high. But this is playing with fire! Again, it is extremely dangerous.

    Examples of this adroitness are few and far between. Examples where rigid exchange rates led to developmental destruction and welfare for the rich and ultimately, chaos, poverty and indebtedness are legion. So not floating, at best will give a nation a small gain, at risk of great destruction. Look at Venezuela now.

    For developed countries, if Churchill’s England was too long ago – look at Mitterand’s France – successful socialist policies wrecked by (a very European) deranged dick-size obsession with exchange rates. And of course the Euro is the best current example of exchange rate mania destroying economies. Eurozone delenda est!

    • Econoclast
      January 29, 2019 at 8:14 am

      The reference to Abba Lerner, one of my teachers, is a good one. Lerner’s 15 lessons on functional finance are available in a useful Levy Economics Institute paper (www.levyinstitute.org/pubs/wp272.pdf). Lerner published the core of his ideas 80 years ago and they are quite relevant today.

  3. Martin Noble
    January 27, 2019 at 7:32 pm

    Recognise that an economy cannot be managed by polititians and an honest economist would tell them that and forgo the fee. Furthermore acting as though currency is a commodity is to misunderstand that money represents units of economic time. I know that I am letting the cat out of the bag but unless serious thought is given to this concept national economies will continue to spiral.

  4. Craig
    January 27, 2019 at 10:02 pm

    The way to take the sting out of exchange rates and develop more robust economies is to guarantee a stable decent economic and monetary lifestyle with universal dividend and discount/rebate policies….which will enable the rapid industrialization/re-industrialization of their economies without having to worry about domestic inflation or the present need to import. Globalization is so titanically stupid and obviously financially tyrannical that its surprising there is any real discussion of change…before it is remedied.

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