Exchange rate protectionism usually refers to the idea that a country's exchange rate might be undervalued, causing the country to import less and export more than it would with a stronger exchange rate. I would like to discuss exchange rate protectionism in a different context.
The Primary Meaning of Exchange Rate Protectionism
I think most of the trade impact of an exchange rate policy is overwhelmed by the policy's impact on economic development. In practice, therefore, the primary meaning of exchange rate protectionism is that an unstable currency tends to cause underdevelopment, limiting a country's imports and exports. The converse also holds: countries with stable exchange rates have seen imports and exports grow rapidly, with China a clear example.
Needed: A Stable Dollar Policy
In my address at Cato's 1999 monetary conference, entitled "Replacing the Vacuum in International Economic Policy," I presented the view that exchange rates, rather than reflecting economic fundamentals, cause them. An extract follows:
In recent years [as of October 1999], the United States has seemed
to build its entire exchange rate view on the sound bite that "a
strong dollar is in the national interest." Yet it has declined to
explain how a currency's strength should be measured or whether
unlimited strength is good.
Clearly, a "stable" currency, not strong or weak, is appropriate
during most of a country's economic life. A "strong dollar" policy
made good sense after a period of currency weakness and inflation
as the United States experienced in 1993 and 1994. President
Clinton and Secretaries Rubin and Summers deserve credit for this
constructive 1994 shift in U.S. policy. By continuing the policy
into 1997 and 1998, however, the administration has created a giant
momentum play into the U.S. dollar, adding to our asset values and
our growth rate, but subtracting from those abroad and increasing
the difficulty of the transition to currency stability.
Meanwhile, the jingoistic "strong dollar" policy of the United
States confused foreign countries. Since 1997, the world has
suffered from a global competition to see who could have the
strongest currency. The Japanese played the game, deepening their
deflation spiral and prolonging their economic stagnation. Germany
let the mark get too strong in 1998, setting the stage for a "euro
crisis" earlier this year as the euro moved back to an appropriate
The confusion sown by the United States in international economic
policy has resulted in a world of momentum-based volatility
in which exchange rates drastically overshoot a stable norm. At the
core of the economic confusion is the prevailing, and harmful, view
that the value of a currency should change with the business cycle
to reflect economic fundamentals. When an economy slumps, the
argument is that the currency should weaken, and vice versa. This
was the market logic that pushed the euro to extreme weakness in
early July when there was talk of it breaking par with the dollar.
The same logic pushed the yen to 147 yen per dollar in May 1998 and
has now strengthened it to 106 yen per dollar, so strong that it
will choke off Japan's recovery. These wild swings in exchange rates
are anti-growth and are the responsibility of government.
Businesses don't devalue their accounting unit when they lose
money. Nor do they increase their unit of account when their profits
rise. Suppose auditors advised companies to report earnings in
frequent flyer miles if profit growth slowed. Not only would
investors have to analyze the earnings slowdown, they would also
have to analyze the uncertainty caused by a new unit of account. The
United States and the IMF actively promote this illogic, causing
economic decline across Latin America, Africa, Russia, and parts of