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Are Fixed Exchange Rates Coming Back?

Fixed exchange rates are quite likely America's best bet to avoid being victimized by exchange-rate manipulation on the part of other nations.
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The International Monetary Fund or IMF, long a citadel of free-market thinking, conceded in a little-noticed official report in February that controls on the international movement of capital may be appropriate in some circumstances. This report deserved more attention, because this is big.

Before socialists break out their long-dormant bottles of Swedish champagne and capitalists make plans to emigrate to some planet with freer markets, it's important to understand what capital controls really are. They are restrictions on the ability of (primarily) financial institutions and multinational corporations to move large blocks of capital around the world.

Such restrictions were in force in most major capitalist economies during the Bretton Woods era of fixed exchange rates (1945-71)--otherwise known as the Golden Age of the American economy, or what the French to this day call les trente glorieuses, the Thirty Glorious Years. The American and world economies performed better in this period than ever before or since. And therein lies the tale.

Consider the problem of currency manipulation.

China currently manipulates its currency to make its goods artificially cheap in the U.S., which is a big reason it's running a huge trade surplus against us. As the United States is thus painfully learning, floating exchange rates and a free market in currencies are not a real option. The profits to be made from manipulating one's currency are so great that key governments cannot resist the temptation. (Japan and the Europeans do it, too, in different ways.) As a result, our only real choices are fixed rates or manipulated rates.

What's the place of capital controls in this? Without free movement of capital, there's no manipulating currencies. That's one big reason why, pre-1971, America was a net creditor nation and ran either small trade surpluses or deficits tiny by present standards. So if you bring back capital controls, you necessarily force the world back towards much more balanced trade.

And if you have fixed exchange rates, you can't keep them fixed if huge amounts of capital are allowed to slosh around the world economy without restraint. You have to have capital controls if you want fixed exchange rates This is something nations like Thailand, which tried to maintain fixed exchange rates without firm global capital controls, learned the hard way a few years ago.

As a result, fixed exchange rates are quite likely America's best bet to avoid being victimized by exchange-rate manipulation on the part of other nations. This is one big reason why America supported fixed exchange rates for so long--even under such notorious communists as Richard Nixon, who tried desperately to save the Bretton Woods system with the Smithsonian Agreement of 1971 but failed when domestic economic conditions forced the Fed to cut interest rates, sinking the dollar.

Fixed exchange rates are definitely not some scheme of socialistic central planning. They are a stabilizing mechanism for a capitalist global economy that is not, laissez-faire mythology notwithstanding, self-stabilizing. (Presumably, Americans realize that much by now.)

America's current titanic trade deficits must eventually come to an end. Their end may be a gradual and gentle winding down, but there's absolutely no guarantee of that, especially as the only way this will happen is either if nations like China voluntarily agree to stop manipulating their exchange rates, or if the U.S. grows some [unsuited for mixed company] and stops this manipulation on its own.

Why doesn't the U.S. just unilaterally stop currency manipulation? Because the way currency manipulation works is that, for example, the Chinese government forbids China's exporters from using the dollars they earn from overseas exports as they please. Instead, they are required to swap these dollars for Chinese currency at China's central bank, which then "sterilizes" these dollars by sending them back to the U.S. to buy not American goods, but American debt and assets, largely Treasury securities. So if we ever did stop selling foreigners our T-bills and other assets (the Swiss did something similar in 1972), the problem would be solved pronto.

Unfortunately, the U.S. has grown so addicted to this cheap international credit that we can't forswear it right now, or we'd starve our economy for capital to lend and borrow, and interest rates would go sky high, quite likely knocking us into recession. This is true even though we know perfectly well that the party must end sometime, as no nation's indebtedness can expand forever. (Ask Greece.)

If we ever do forswear cheap foreign capital, we'll need to raise our domestic savings rate, which has dropped abysmally low due to the consumption splurge of the last two decades. But as the consumption splurge that killed our savings rate was itself enabled by cheap foreign capital resulting from our import binge coming back to us in the form of international debt, all these issues are linked. And as we certainly ought to raise our own decadent savings rate, for a whole host of reasons, this may be exactly the kick in the behind we need anyway. (We're probably going to get it.)

The possibility that the world may return (granted, a fairly speculative "may" at this point, but the underlying logic is remorseless and will grind away) to capital controls and fixed exchange rates is just another part of the emerging trend of a repudiation of the excessively laissez-faire thinking that has dominated the world since about 1980. But all eras in economics eventually come to an end, so this should be no surprise.

This doesn't mean the end of international capitalism any more than it did in 1970, when multinational corporations were doing just fine, thank you, albeit under somewhat different rules. They'll adapt just fine this time, too. And the U.S. may even stop hemorrhaging jobs, running down its industrial base, and piling up foreign debt due to trade deficits.

Ian Fletcher is the author of Free Trade Doesn't Work: What Should Replace It and Why (USBIC, $24.95) He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933. He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He maintains a website at and may be contacted at