Page 4 of
5 The US as leading
currency manipulator By Henry C
K Liu
trade in competition with the
US, creating a so-called United States of Europe
and as a stepping stone to a single-currency
regime in Europe.
Britain joined the ERM
in October 1990 at a fixed parity of 2.95
deutschmarks to the pound, an overvalued rate
intended to put pressure on the British economy to
reduce inflation rather than institutionalizing
international competitiveness. British pride might
have
played a role in insisting on a strong pound. This
chosen rate, or any fixed rate required by ERM
membership, proved misguided, because it tried to
benefit from the effect of a single currency for
separate economies without the reality of a single
currency within an integrated economy.
During its 23 months of ERM membership,
from October 1990 to September 1992, Britain
suffered its worst recession in six decades, with
GDP shrinking by 3.86%. Unemployment rose more
than a third, by 1.2 million, to 2.85 million. The
total price of the ERM fixed exchange rate for the
United Kingdom was estimated to be as high as
13.3% of 1992 GDP. The number of residential
mortgages with negative equity tripled, reaching a
peak of 1.25 million, and company insolvency rose
above 25,000 a year.
The British
government of prime minister John Major sought to
balance political and macroeconomic
considerations, only to fail in its effort to
support the unsupportable to prevent a devaluation
of a freely traded pound by market forces. If the
UK had not lost some 8.2 billion pounds defending
the currency's unsustainable exchange rate, it
could have avoided budget deficits, tax hikes,
cuts in public spending, and the unpopular
value-added tax on fuel. Spending on the National
Health Service could have been more than doubled
for 12 months.
Withdrawing from the ERM
released the UK economy from persistent deflation
and provided the foundation for the
non-inflationary growth subsequently experienced.
It enabled monetary policy to be freed from the
sole task of maintaining the exchange rate, thus
contributing to economic expansion by a
combination of rational monetary measures. While
ERM countries were compelled to maintain
relatively high real interest rates to prevent
their currencies from falling outside the
permitted bands, Britain enjoyed the freedom to
benefit from lower rates.
Hong Kong, with
its freely convertible currency pegged to the US
dollar, faced the same problems for a whole decade
after the 1997 Asian financial crisis. After a
decade-long recession, Hong Kong's economy finally
recovered with direct subsidy from Beijing. Its
economy is now again booming from the runaway
liquidity effects of the dollar debt bubble
created under then-chairman Alan Greenspan by the
US Federal Reserve's permissive monetary policy of
low interest rates, but Hong Kong will face
another crisis when the US economy faces the
inevitable consequence. Waiting for an improved
economy before de-pegging is like waiting for
death to cure an infection, or one more high
before cold turkey, a sure path to death by
overdose.
The appropriate exchange rate of
currencies at any particular time is that which
enables their economies to combine full employment
of productive resources, including labor, with a
simultaneous balance-of-payment equilibrium. An
excessively high exchange rate causes trade
deficits and domestic unemployment, while a low
one generates an excessive buildup of
foreign-currency reserves and stimulates domestic
inflationary pressures that lead to a bubble
economy. Thus every nation with a freely
convertible currency must retain the ability to
adjust the external values of its currency in this
unregulated global financial market and an
international financial architecture based on US
dollar hegemony. To be fixated on a fixed exchange
rate within rigid limits is to court economic
disaster in the current international finance
architecture of freely convertible currencies.
This is why China resists full convertibility of
the yuan.
The ERM was a transitional
regime whose problems were finally removed once
the EU moved toward a single currency in the form
of the euro. Still, the anti-inflation bias of the
European Central Bank continues to create conflict
with monetary-policy needs of national economies
within Euroland. The current dispute surrounding
the exchange rate of the yen to the euro is the
result of interest-rate disparity between the two
currencies.
In a fast-changing economic
environment of unregulated global markets, the
value of the exchange rate that facilitates full
employment and a foreign-trade balance will
frequently fluctuate. Speculative volatility must
be countered and the exchange rate managed by the
national bank to prevent disruption in the
domestic economy and in external trade. However,
this does not imply fixed, unchangeable bands as
under the ERM. The optimum strategy for
cooperation between national central banks on
exchange rates requires a combination of maximum
short-term stability with maximum long-term
flexibility, the opposite of the effects of fixed
exchange rates.
Since, under ERM,
Britain's interest rate was pegged to that of
Germany through the fixed exchange rate, reduction
in interest rates was not available to deal with
increasing unemployment and declining growth in
the UK. The fact that Britain had no control over
interest rates, coupled with the questionable
independence of the Bundesbank, Germany's central
bank, was an important factor in the final
decision to withdraw the pound from the ERM
fixed-exchange-rate regime.
The
reunification of Germany cracked open the
structural flaw in the Exchange Rate Mechanism
because massive capital injection from West to
East Germany had produced inflationary pressure in
the newly unified German economy, leading to
preemptive increases of interest rates by the
Bundesbank. At the same time other economies in
Europe, especially that of Britain, were in
recession and not prepared for interest-rate hikes
dictated by Germany. This interest-rate disparity
magnified the overvaluation of the pound in the
early 1990s.
Along with the European
Currency Unit (ECU, the forerunner of the euro),
the ERM was one of the foundation stones of
economic and monetary union in Europe. It gave
currencies a central exchange rate against the
ECU, which in turn gave them central cross-rates
against one another. It was hoped that the
mechanism would help stabilize exchange rates,
encourage trade within Europe and control
inflation. The ERM gave national currencies an
upper and lower limit on either side of this
central rate within which they could fluctuate.
In 1992, the ERM was torn apart when a
number of currencies could not keep within these
limits without collapsing their economies. On
Wednesday, September 16, a culmination of factors
led Britain to pull out of the ERM and to let the
pound float according to market forces. Black
Wednesday became the day on which George Soros,
hedge-fund titan, broke the Bank of England,
pocketing $1 billion profit in one day and more
than $2 billion eventually. The British pound was
forced to leave the ERM after the Bank of England
spent $40 billion in an unsuccessful effort to
defend the currency's fixed value against
speculative attack. The Italian lira also left and
the Spanish peseta was devalued.
To curb
German inflation, an increase in German interest
rates was necessary, but if the Bundesbank had
been completely independent of German
political-economic interests as a dominant
regional central bank, it would not have adopted
this policy, as there were cries from all over
Europe for a decrease in interest rates. By
adopting tight monetary policies in response to
domestic inflationary pressures that followed
German reunification in 1990, German short-term
interest rates, which had been rising since 1988,
continued to rise, reaching nearly 10% by the
summer of 1992. So at a time when Britain needed a
counter-cyclical reduction in interest rates, the
Bundesbank sent the interest rate upward, plunging
Britain deeper into recession through the ERM.
This kind of cyclical conflict is likely to
surface regularly among China, the US, Japan and
the EU once the Chinese yuan is freely
convertible.
This was the fundamental
problem with the ERM - fixed exchange rates
conflicted with the interest-rate levels needed by
different economic conditions in separate member
economies. The British
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