Exchange Rate Protectionism: A Harmful Diversion for Trade and Development Policy
Malpass, David, The Cato Journal
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 value. 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 Asia. …