Floating Exchange Rates: The Only Viable Solution
Stentor Smith

For some, the collapse of Mexico's economy proves that floating exchange rates and markets
without capital controls are deadly. Others find the crash of the European exchange-rate mechanism
(ERM) in 1993 to be proof that targeted rates will always be overturned by the free market. Many
see the breakup of Bretton Woods as the failure of fixed rates. Yet others believe monetary
unification in Europe is the only way to achieve economic and political stability. Many others hold still
different beliefs. There are, however, four main proposals for the management of international
currency exchange rates: monetary unification, fixed rates, floating rates maintained within certain
"reasonable" limits of variability and freely floating rates. Both fixed exchange rates and rates based
on either explicit or unwritten targeting are impossible to maintain, especially in an era of free trade.
Complete monetary unification would be impossible to bring about without extensive integration and
unification of international governments and economies, a task so vast that it is unlikely ever to be
accomplished. Thus, the only option central banks have is to allow exchange rates to float freely.

The European Monetary System, which virtually collapsed in 1993, was an attempt to fix exchange
rates within certain tight bands, to coordinate monetary policy between member nations and to have
central banks intervene to keep exchange rates within the bands when necessary. The reasons for the
collapse were myriad, but, simply put, it happened because Germany, dealing with financial problems
in part arising from its reunification, refused to lower its high interest rates. This meant other European
countries either had to keep their rates equally high and allow themselves to fall into recession as a
result, or devalue their currency against the mark, a move viewed by many as a political
embarrassment. The possibility of a devaluation caused speculators to bolt from the lira, the pound,
the franc and other currencies, sending the markets into chaos and destroying all semblance of
stability. In the end, the ERM was adjusted to allow currencies to fluctuate within 15 percent on
either side of their assigned level, up from (in most cases) a limitation of 2.25 percent. The bands
became too wide to be meaningful or stabilizing, and the system remained alive "in name only"
(Whitney 19).

Many saw this collapse as inevitable and say all attempts at government-imposed stability will fail:
Governments both will not and cannot stick to pegged or fixed rates. First, maintaining targeted or
fixed rates requires a consistent and fairly uniform monetary policy among nations. There are many
reasons that national governments will not consent to this, the foremost being that different countries
want different things, different economies have different needs and different governments have
different policies. For example, it is thought that Europe and Japan are more willing to tolerate
recession than inflation, while the United States prefers to keep interest rates low and the economy
growing, even if prices do increase (Whitt 11). In addition, many nations are in different stages of
their overall economic cycles ("Gold Standard" 79). Many countries thus cannot afford to subscribe
to uniform monetary policy. For a country that would otherwise have had low interest rates, for
example, raising them could be both economically counterproductive (what good is exchange rate
stability if recession is its cost?) and politically disastrous (more people notice high interest rates and
unemployment than care about currency stability). Even if the government were willing to bow to
international standards, nationalism is strong in the world today and most people do not look fondly
upon consolidated global power--witness the problems of the United Nations. People would not
widely support what would effectively be international control of their country's economic policies
and money supply.

Speculators, unfortunately, know that governments today are likely to put their self-interest ahead of
the nebulous common good and to eventually choose the monetary policy that is best for their
individual economy (as it could be argued happened in the collapse of the ERM). Speculators will act
on this suspicion, dumping uncertain currencies and running to the strongest (in the case of the 1993
debacle, the Deutsche mark).

So, that is why governments will not stick to targeted rates and what happens as a result. There are
also reasons they cannot. First, there is the decline of capital controls and the resulting ease with
which speculation occurs. With the growing popularity and reality of free markets and with the
advent of the "Information Age," control over the international money supply is both unwanted and
impossible. The