The real sterling problem
Harold Lever
riomment on sterling's recent precipi- tous decline continues to focus on superficial factors. The fall in oil prices, and prospects of further falls, are certainly relevant matters affecting market opinion about the pound: so too are judgments on Britain's future competitiveness. Govern- ment statements that they have no ex- change rate policy and have no intention of intervening have also encouraged specula- tive pressure. All these could justify and explain some adjustment in the pound's parity, but they by no means explain the extent of its descent: from its peak in 1981, sterling has fallen 54 per cent against the dollar and 32 per cent against all major currencies.
What has been ignored or hardly men- tioned in press comment is the structure of the floating exchange rate market itself. This is the decisive factor which has pro- duced the anomalies in parities we have witnessed in recent years.
In 1971 and 1972 Britain was in the forefront when the leading powers opted to abandon the Bretton Woods system of fixed exchange rates. The Heath govern- ment's move to floating rates was explicitly based on the argument that Britain was adding to its ability to take autonomous economic decisions, unrestrained by the necessity to maintain a declared parity. The arguments of the protagonists of float- ing rates had been swallowed hook, line and sinker. In vain, their opponents pointed out the dangers. We were told that unreasonable volatility of parities relating to short-term pressures would be coun- tered by market speculators who would take a long-term view. The danger of serious and perverse effects upon parities of capital movements was belittled. These, too, would be neutralised by notional speculators acting on a long-term view. Suggestions that sudden and unreasonable exchange rate changes would bring press- ure to bear upon governments' economic policies, far more severe than the pressures on reserves and credit involved in defend- ing a declared parity, were completely discounted. In short, the mechanics of the market under floating rates would ensure a rational parity on the basis of which we could organise freely to pay our way in the world — we would enjoy a parity which continuously reflected the economic fun- damentals freed from distorting govern- ment interventions. A free market would give the right answers. When John Boyd- Carpenter said, 'A free and floating rate is the perfect instrument for maintaining the balance of the national economy,' he un- doubtedly reflected the euphoria in ex- pectations. The position of the proponents of float- ing was based on a particular view of how markets operate. This has proved, at almost every point, to be fallacious. In- sufficient distinction was drawn between money markets and, say, commodity mar- kets. In these, unreasonable fluctuations are usually self-correcting, at least in the medium-term, because corrective specula- tion is based on tangible and calculable supply factors. Money markets have no corresponding equilibriating factor. To read now, in the light of our experience of recent years, the arguments in favour of floating rates which appeared so convinc- ing to the government at that time would make a cat laugh and a currency bear smile.
The arguments about the consequences of the floating rate system are no longer theoretical. The experience of the last 12 years demonstrates beyond any doubt that floating rates produce distorted parities which nobody could possibly relate to economic fundamentals. No currency has been exempt from movements which no government would have expected, planned for or sought in advance to justify. The resulting volatility of parities has demon- strated that floating rates diminish rather than increase the ability of governments to control their economies. It has raised serious problems for the management of inflation, has strengthened protectionist tendencies and has added greatly to world uncertainties.
No country has been more vulnerable than Britain and no parity has been such a vulnerable cockshy of disruptive and spe- culative pressures upwards and down- wards. Floating rates, where there is no stabilising government intervention, create a market of chronic uncertainty in which money holders jostle from currency to currency seeking an unobtainable security. The activities of the exchange markets have multiplied explosively. The over- whelming bulk of these vast money- changing operations has nothing to do with trade or long-term investment but is direct- ly related to money holders seeking to protect or enhance their money assets. Parities have become not a reflection but a caricature of economic fundamentals — a projection of the political and economic anxieties and expectations of tens of thousands of operators.
Of course, the changing scene of the last decade would have inevitably required adjustments in parity to reflect changing economic fundamentals, just as they have done among the EMS currencies. But they would not have brought about yoyo par- ities which make the leading currencies resemble gambling counters. Floating rates were sold as an automatic pilot which would react appropriately to relevant signals. In fact, the rates react to quite different signals, sent out by the chronic feverishness of a leaderless world market which has developed mechanisms resulting in a destructive travesty of market economics. The automatic pilot has be- come a whimsical disruptive force in the world economy. We have exchanged the pragmatism of the Bretton Woods system, which gave time for flexible responses to market pressures, for the inflexible urgen- cies of parity threats which have injured every government in turn.
When it became clear that we had brought about a system manifestly di- vorced from the purposes we intended to serve, a new line of argument made its appearance. The floating rate market was to be valued as a thing in itself. It was no longer a tool to be used. Its pronounce- ments were true, fateful and inescapable. Those who so recently defended the mar- ket's pronouncement of $2.40 as the right value for the pound are now obliged with equal conviction to defend the oracle's edict of $1.12 or, for that matter, any other rate to which speculative anarchy drives it. Faulty analysis has ended as ideological dogma. Only in a bewildered society, capable of worshipping industrial debris as high art, could so deformed a system continue to be accepted, still worse, to be admired and respected.
What is the alternative? There has to be an understanding among a few leading nations about what extremes of parities are mutually tolerable and those which are so badly out of line that they must be firmly resisted by concerted intervention. In- tervention would not be directed to achieve optimum rates, still less to support rates which could not be justified having regard to domestic policies and other circumstances. They would only be directed to prevent extremes of fluctuation which, by common consent, were wholly unreasonable.
Would intervention of this kind be effec- tive or would it be overborne by the weight of the market money? Past interventions were often fruitless because they were not related to any agreed and systematic co- operative purpose. On those occasions when there was sufficient co-operation and agreement, they were successful, as with Roy Jenkins in 1968.
Again, in 1978, the dollar received the greatest battering of its post-war experi- ence. All corrective efforts were unavailing until the US government, contrary to its previous practice and declared principles, mounted and declared a $60 billion in- tervention package. That package, by far the greatest ever recorded, could not have been mounted without the willing co- operation of other leading countries. It was completely successful without using more than a small fraction of the package.
Far from seeking to overthrow the pur- poses of governments resolute to prevent
further deformity of currencies, the market would be a powerful ally in support. Indeed, this concerted action by the lead- ing governments would itself become a major market factor. The Good Book says that the race is not always to the swift, nor the battle to the strong. But as Damon Runyon added, 'That's the way to bet,' and all experience shows that is the way the market would bet. In Paul Volcker's words 'a sense that extreme fluctuations will be resisted and reversed could help stabilise market expectations, and thus reduce the risk of those extreme fluctuations develop- ing in the first place.'
At some point the world will have to choose between living with the chronic instability of floating rate markets or mov- ing to more stable markets in which the leading countries, in the common interest, bring their co-ordinated forces to bear.
The Finance Ministers and Central Bank Governors at the Group of Five meeting in Washington last week declared that 'the US, West Germany, Japan, the UK and France stand ready to join in concerted intervention in the exchange markets, whenever they think fit.' The significance of this statement is the advance it repre- sents in the prospects for that world co- ordination which alone can stabilise pari- ties and, more immediately, curb any further rise in the dollar or further decline in the pound.
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