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Volatile Money Hurts Growth and Trade

The dollar-euro exchange rate has moved 20% eight times in a decade, causing crisis and stagnation.


By James Kemp and Sean Rushton

May 8, 2017 6:43 p.m. ET

It’s the most important price in the world: How many U.S. dollars does it take to buy one euro? The exchange rate between the two largest world currencies affects profits and financial conditions around the globe—and it has been dangerously unstable for more than a decade. Since 2007, the dollar-euro rate has swung up or down by about 20% no fewer than eight times. Exchange rates that gyrate this much produce crisis and weak economic growth, while undermining the case for free trade.

Yet virtually no one in Washington—not the big think tanks or the business lobby or the tea party or the International Monetary Fund—is talking about it. That’s crazy. The seesawing dollar-euro rate disrupts trade, reduces investment, and damages the bread-and-butter interests of working people on both sides of the Atlantic.

Created in 1999, the euro today covers 19 countries and an economic area roughly on par with that of the U.S. Its arrival meant the American dollar was no longer the sole global super currency, defining the mainstream of world prices and monetary conditions. Instead, the global financial system was cleaved in two. The first major bloc, the dollar area, included the U.S. plus nations pegged to the dollar, including China and Hong Kong, the Persian Gulf states and parts of Latin America and Africa. The second bloc, the euro area, represented the countries using the European common currency, plus Eastern Europe and much of Africa. Together, these blocs make up about two-thirds of world economic output.

Is it any wonder that the fluctuating dollar-euro rate has left the world economy prone to bubbles, crises and slow growth? Last month, a forum on exchange rates sponsored by the Jack Kemp Foundation addressed the issue head-on by presenting ideas from leading economists and policy thinkers such as former Federal Reserve Chairman Paul Volcker, former Treasury Secretary James Baker and House Speaker Paul Ryan.

The model was a series of conferences that then-Rep. Jack Kemp and the Nobel-winning economist Robert Mundell started in 1983. At the time, many observers scoffed at the idea of increasing stability among the largest currencies. Yet the effort paved the way for the Plaza Accord in 1985 and the Louvre Accord in 1987. Those agreements to realign and stabilize the dollar were the last serious attempts to coordinate international monetary policy. Why? The conventional wisdom would dismiss a new attempt as too hard, too pie-in-the-sky, with too many vested interests lined up against it.

Yet today’s status quo is destructive and unsustainable. As Mr. Mundell warned in a letter to last month’s conference: “There is no valid economic argument in favor of global monetary disarray. The multiple and major currency shifts that take place every year serve to exacerbate trade tensions and spawn protectionism. Exchange-rate instability does not provide any kind of positive adjustment in the world. It is just turbulence and waste. It condemns the world to sluggish economic growth, which contributes to rising political stresses.”

A stable dollar-euro rate would provide the world with a strong economic anchor. The end goal should be a unified international currency system that is consistent with the principles of free trade and would facilitate optimal capital flows.

For supporters of limited government, this is essential. Exchange rate swings are an enormous source of financial volatility, which leads to calls for greater regulation, bailouts and bigger government. Steve Hanke, a professor at Johns Hopkins University and co-chairman of the forum, put it well when he called financial volatility “the Achilles’ heel of capitalism.” Mr. Hanke’s research shows that all of the 100 largest American corporations cited volatility in exchange rates as a challenge in their 2016 annual reports.

Is there much hope for an agreement soon to stabilize the major currencies? No, Mr. Volcker told the forum, because governments aren’t willing to coordinate domestic monetary policy to achieve it. But he said that greater stability in exchange rates among the top players—the U.S., Europe, China and Japan—would help the world economy. Perhaps the U.S. and Europe could agree to a band of 10% between which their currencies could fluctuate.

Whatever the solution, the necessary coordination will not happen without leadership from Washington, Mr. Baker said. “If we want to maximize long-term growth, minimize the risk of protectionism, and create greater stability in foreign-exchange rates,” he told the forum, “then we should learn from our experience with the Plaza Accord and work consistently, vigorously and in a regular, sustained way to coordinate macroeconomic policies.”

The lesson of the Kemp forum is that robust economic growth and renewed support for trade will require a new international monetary order, and the first step should be a dollar-euro stability pact. As the Trump administration begins to fill empty offices in the Treasury Department, the Senate should ask its nominees for their views on this crucial subject.

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