Floating Exchange Rates

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Floating Exchange Rates: The Only Viable Solution

Stentor Smith

For some, the collapse of Mexico's economy proves that floating exchange rates and markets

without capital controls are deadly. Others find the crash of the European exchange-rate mechanism

(ERM) in 1993 to be proof that targeted rates will always be overturned by the free market. Many

see the breakup of Bretton Woods as the failure of fixed rates. Yet others believe monetary

unification in Europe is the only way to achieve economic and political stability. Many others hold still

different beliefs. There are, however, four main proposals for the management of international

currency exchange rates: monetary unification, fixed rates, floating rates maintained within certain

'reasonable' limits of variability and freely floating rates. Both fixed exchange rates and rates based

on either explicit or unwritten targeting are impossible to maintain, especially in an era of free trade.

Complete monetary unification would be impossible to bring about without extensive integration and

unification of international governments and economies, a task so vast that it is unlikely ever to be

accomplished. Thus, the only option central banks have is to allow exchange rates to float freely.

The European Monetary System, which virtually collapsed in 1993, was an attempt to fix exchange

rates within certain tight bands, to coordinate monetary policy between member nations and to have

central banks intervene to keep exchange rates within the bands when necessary. The reasons for the

collapse were myriad, but, simply put, it happened because Germany, dealing with financial problems

in part arising from its reunification, refused to lower its high interest rates. This meant other European

countries either had to keep their rates equally high and allow themselves to fall into recession as a

result, or devalue their currency against...