CURRENCY WARS: YESTERDAY, TODAY – AND TOMORROW? Benjamin J. Cohen University of California, Santa Barbara Remarks prepared for the Conference on “The Political Economy of International Money” Federal Reserve Bank of Dallas, 4 April 2014

THE POLITICS OF EXCHANGE RATES What are the lessons from the Great Depression about the management of currency values? Conventional wisdom at the time: “the proved disadvantages of freely fluctuating exchanges” (International Currency Experience, 1944). Exchange rates would have to be managed, subject to rules

TWO QUESTIONS 1. Was the conventional wisdom right? (That is, was the correct lesson drawn?) ▫Answer: a qualified Yes 2. Has successfully has the lesson been implemented? (That is have exchange rates been managed well?) ▫Answer: not very well, in part because another important lesson was forgotten

WAS THE CONVENTIONAL WISDOM RIGHT? 1. WAS THE CONVENTIONAL WISDOM RIGHT? There is no doubt that “freely fluctuating exchanges” invited competitive depreciations – in effect, currency war ▫From 1930 to 1938, 20 countries devalued by more than 10 %, some several times Some evidence that depreciations may have been to some extent beneficial, by allowing less restrictive monetary policy (Eichengreen and Sachs, 1985) But also no doubt that they were disorderly and disruptive Legitimate conclusion: need some kind of rules to prevent currency wars

2. HOW SUCCESSFULLY HAS THE LESSON BEEM IMPLEMENTED? Short answer: not very well. Hence much talk of currency wars today Longer answer: a series of attempts to implement effective rules, but with little success. Most notable: ▫Bretton Woods (1944) ▫Committee of Twenty ( ) ▫Second Amendment (1976)

BRETTON WOODS Floating was to be discouraged; but there was also a fear of too much rigidity Hence a compromise: the par value system, meant to provide stability but also allow for adjustments in specific circumstances (“fundamental disequilibrium”) Ultimately proved unworkable (What is a “fundamental disequilibrium?”)

COMMITTEE OF TWENTY Called for a new “exchange rate regime based on stable but adjustable par values” Proved unacceptable – overtaken by events

SECOND AMENDMENT New Article IV ▫Free choice of exchange rate policies, subject only to:  admonition to “avoid manipulating exchange rates… to gain an unfair competitive advantage”  “firm surveillance” by the IMF These are the prevailing rules today

HOW WELL HAVE THE RULES WORKED? The IMF has tried hard ▫As early as 1977, the Fund specified principles for the exercise of surveillance ▫Article IV consultations were instituted ▫Principles for surveillance were updated in 2007 But governments have resisted oversight; dirty floats have become increasingly prevalent; talk of currency wars is not exaggerated

WHY HAVE THE RULES NOT WORKED? General issue: state sovereignty (resistance to supranational authority) More specific issue: Geopolitics ▫A forgotten lesson of the Great Depression: the Tripartite Agreement of 1936 highlighted the importance of consensus among the major powers of the day; acknowledgement of mutual responsibility for systemic management. Is a modern version of the Tripartite Agreement possible today? ▫Unlikely

CONCLUSION Lessons have been learned, but selectively and imperfectly. George Santayana said: “Those who cannot remember the past are condemned to repeat it.” Are we condemned to repeat the currency wars of the 1930s? Not impossible…