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©2003 Copley News Service, 10/21/2003
Countries that anchor the value of their currencies to a larger, relatively stable currency, such as the dollar and the euro, are wrongly accused by many world leaders of "manipulating" their currencies. Leaders who pressure countries with fixed exchange rates to allow their currencies to float freely on foreign exchange (Forex) markets aren't considering the inherent limitations of currency markets, and they fail to appreciate the economic havoc floating exchange rates create.
Two fundamental freedoms are necessary for markets to work properly - one relating to prices and the other to production. First, producers must be free to establish the price of their products without outside interference by governments or private syndicates, and consumers must be free to choose whether or not to purchase products for the posted prices, i.e., no price controls. Second, producers must be free to produce as much or as little of their products as they wish without outside interference by governments or private syndicates, and consumers must be free to purchase as much or as little of goods and services as producers are willing to sell them, i.e., no forced rationing.
Many ersatz markets exhibit only one of these fundamental market freedoms. In the electricity market, producers and consumers are free to produce and consume as much electricity as they desire, but government sets prices directly. The world oil market and Forex markets illustrate the obverse form of quasi-free, ersatz markets where OPEC and governments do not fix prices directly by fiat order but rather control production and ration output.
The auction market in which buyers and sellers bid the price of oil daily, ironically, is the oil syndicate's tool for efficiently rigging the market to their advantage. If OPEC desires the price of oil to rise, it restricts output, and the cartel opens the production spigot if it wants prices to fall.
Very few people delude themselves that the auction market in oil results in an efficient level of oil production. However, many government and business leaders delude themselves that the efficient "value" of the dollar can and should be determined by freely floating exchange rates. The value of a nation's money is determined by its monetary policy (i.e., how much money it prints) and is reflected in changes in the prices of commodities, most especially gold. The correct value of the dollar is one that keeps these prices stable.
Like OPEC, the producers of money - governments - are monopolists that control the output of money. The government monopolies that run the monetary printing presses indirectly determine the foreign exchange price of their currency by the monetary policy choices they make. Consequently, as long as governments maintain a monopoly on the production of money, floating exchange rates no more establish the correct (i.e., efficient) level of money production than floating oil prices determine the correct (i.e., efficient) level of oil production.
In both the cases of oil and money, the problem is easily rectified in theory: Break up the producers' cartel and government monopolies, dismantle state-owned oil enterprises and central banks, and allow private oil companies and private financial institutions to maximize profits by determining for themselves the proper level of production of oil and money respectively. The international oil and Forex auction markets, in which prices are freely set, will do the rest. In both cases, the appropriate role for government is the same: Define and maintain the unit by which both oil and money are measured - the definition of a "barrel" (159 liters) where oil is concerned and the definition of a "dollar" (a fixed gold weight) where money is concerned.
In practice, alas, neither theoretical solution is politically viable. In the case of money, however, there is a readily available second-best solution. If the U.S. government is going to retain the monopoly power to print money, it should enact into law objective criteria to control the printing press. The law should restrain government officials from devaluing the dollar when election and business cycles come into phase. It should also protect against the temptation to devalue the dollar indirectly by using diplomatic and economic leverage on other countries to coerce them into restricting the production of their own money, thereby deflating their currencies and increasing the foreign-exchange value of their currencies relative to the dollar.
In order to ensure a stable dollar of constant value (neither a "strong" nor a "weak" dollar), it has long been my view that the Fed should announce that it intends to maintain a fixed dollar-price of gold, or if gold is politically verboten, then announce that it will maintain a fixed dollar price of an index of price-sensitive commodities. Then the Fed can conduct monetary policy, i.e., buy and sell bonds, as required to hit that price target, and Forex markets will measure the relative stability and instability of other currencies through the price mechanism.
If the dollar is stable and other nations choose to maintain a stable currency of their own by calibrating their money-production activities to maintain a fixed foreign-exchange ratio of their currencies to the dollar, all the better for a thriving international economy. That is not currency manipulation; it is the ultimate in sound monetary policy