Floating exchange rates may have to be tied up somewhat
WHEN the finance ministers of the most powerful industrial democracies met in Washington late last month, they reaffirmed solemnly that current exchange rates are ``within ranges broadly consistent with underlying economic fundamentals.'' Not so, says C. Fred Bergsten, director of the Institute for International Economics. It would be true only if the United States could ``sustain indefinitely'' international payments deficits of $100 billion a year and Japan surpluses of about $75 billion.
The Group of Seven nations also recommitted themselves to cooperating closely ``to foster the stability of exchange rates around current levels.'' During the first five months of this year, foreign central banks reportedly did spend some $70 billion to maintain the dollar, with some success.
Nonetheless, Dr. Bergsten regards a ``free fall'' of the dollar as ``quite possible.'' Should foreign private investors believe it likely the dollar will fall further - say 20 percent - they could go on ``strike,'' he says. They would both take some of their money out of the US and refuse to buy buy more American Treasury paper, corporate bonds, stock, or other US investments.
Indeed, there may already be some signs of a ``strike.'' Since Bergsten spoke to the Wallenberg Bankers Forum at Georgetown University after the Group of Seven met, Tokyo has published statistics showing net capital outflows from Japan amounted to only $1.38 billion in August, compared with a monthly average of $13.6 billion in the first seven months of the year.
That ``strike'' - if it has continued - may explain to some degree the fall in US stock and bond prices of recent days. Japanese money has possibly not been available to help support these markets.
Bergsten actually favors the efforts of the US, Japan, West Germany, France, the United Kingdom, Italy, and Canada to control the value of their currencies. He just disapproves of the timing. He believes the dollar should have been allowed to fall further to help reduce the US trade deficit, especially since Japan and West Europe have not stepped up economic growth adequately to boost even faster import growth.
Bergsten proposes a managed but flexible international monetary system. It would be a synthesis of the fixed exchange-rate system that existed under the Bretton Woods system until its collapse in the years 1971-73, and the free floating system that prevailed until more recently.
Unmanaged floating, where private demand and supply in the markets determine exchange rates, has failed, says Bergsten. It resulted in the dollar's being overvalued about 40 percent in early 1985, prompting massive US trade deficits and a burst of American protectionism.
So, he maintains, the US and its key allies must devise a system of ``reference ranges'' for their currency relationships and ``indicators'' to guide the coordination of national economic positions.
The US and other national governments may decry the loss of absolute nominal sovereignty implied in such currency management. But ``real economic sovereignty has long since eroded substantially,'' says Bergsten. ``They cannot escape from reality.''
British Chancellor of the Exchequer Nigel Lawson did propose a more formal system of managed floating to the world's finance ministers Sept. 30. So it may be that the theories of such economists as Bergsten will become practice.