Is It Time To Sink Floating Rates?


By Judy Shelton

Free Press x 399pp x $24.95

Some authors have an uncanny knack for spotting news before it hits the front page. Judy Shelton, a senior research fellow at Stanford University's Hoover Institution, made her mark with her 1989 book, The Coming Soviet Crash, which predicted the economic and political calamities that befell the Soviet Union a year later. In another display of prescience, Shelton recently delivered Money Meltdown: Restoring Order to the Global Currency System--just as the U.S. dollar was plummeting to a historic low against the Japanese yen and stumbling badly against the German mark. The greenback's collapse made headlines worldwide, breathing new life into the old debate about whether the current system of floating exchange rates can provide the lubrication needed for an increasingly complex global economy.

The first three chapters of Money Meltdown provide an accessible and comprehensive study (albeit through a conservative lens) of the global currency markets, back to the creation of the Bretton Woods monetary system in 1944. Along the way, Shelton provides plenty of fodder for critics of the present system. The dollar's steady decline, she argues, is just the latest evidence of a flawed system that creates a drag on the world economy. The floating-rate structure exerts little discipline on governments that engage in reckless deficit spending, she contends, and the resulting volatility creates disincentives for corporations to invest abroad. Meanwhile, central bankers play "high-stakes poker" with speculators, frittering away billions of dollars in mostly vain efforts to influence the value of their currencies. "The real producers and consumers of the world can only be discouraged and disgusted by a game that is biased toward the shrewd practitioners of monetary artifice," she writes.

A subsequent valuable chapter explores various reforms experts have proposed, such as private currencies and "trading bands" supported by multigovernment intervention. Unfortunately, Shelton's own prescription is one of the least attractive: the re-imposition of an international gold standard. Her reasoning: A return to gold-backed currencies would force governments to display more fiscal responsibility or face the prospect of investors demanding gold for their paper currency. This would stabilize currency-exchange rates and presumably lower the cost of capital, stimulate corporate investment overseas, and launch a new era of global growth.

Unfortunately, by the end of the book, the reader is left with the suspicion that Shelton isn't driven simply to reduce rate volatility but to rein in "self-serving governments." When Shelton argues that the issuance of paper notes by a "redistributionist government" can lead to "class warfare," readers must believe she is most worried about the plight of the creditor class.

Shelton's call for a new gold standard today seems outdated. She produces little empirical evidence that the current system truly impedes global growth. She simply issues apocalyptic warnings that floating exchange rates will spark future catastrophes such as the hyperinflation that sparked fascism and World War II. Can we, she asks, "in this nuclear age...accept the inevitability of a scenario that has led to such misery and destruction in the past?" Could spats over exchange rates, she adds, result "in the possibility of military conflict?"

There are practical problems with trying to impose a new gold standard, which Shelton dismisses too quickly: The world gold supply isn't growing fast enough to support a vibrant global economy, and reliance on a gold standard subjects nations to the vagaries of a miners' strike in Russia or South Africa. New production adds only about 2% annually to the existing supply of gold. Since that's below the projected growth rate of the global economy in coming decades, a gold standard could have a deflationary impact--although, truth be told, that might be fine with creditors. And what happens if domestic economic troubles prompt a nation to dump its gold reserves on the world market? Shelton finds such potentially destabilizing scenarios preferable "to the fiscal offenses that are carried out by profligate politicians in the absence of the discipline inherent in a gold standard."

While it is difficult to defend the deficit spending of many nations in recent years, the imposition of a gold standard would impede the ability of governments to act in the best interests of their

citizens by, for example, providing fiscal stimulus during recessions. As economist Milton Friedman has noted, governments forced to constrain their domestic policies to meet international obligations are akin to the circus clown who breaks his back lugging a piano over to his stool.

In truth, Shelton and other critics may overstate the consequences of recent exchange-rate volatility. The dollar's tumble against the yen is largely the result of the shortsighted trade policies of Japan, which refuses to shrink its huge world surplus. Actually, when calculated on a trade-weighted basis, the greenback is up for the year against other currencies. Despite similar gyrations in the stock and bond markets, corporations somehow manage to raise capital through the sale of debt and equity. Would Shelton, the free marketeer, advocate tight restraints on those markets as well?

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