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.(This generally means cutting back on domestic demandand attempting to switch resources to promote export produc-tion.It generally implies consuming less  a policy that bankersand politicians like to recommend for others.)The gold standard, when it operated for all trading counties atthe beginning of the twentieth century, imposed just this disci-pline on world economic affairs and some observers with longmemories still hark back to these days and the certainties thatthis system embodied.© 2004 Tony Cleaverholiday the last thing you want is continually changing foreignprices  which is exactly what would happen if the exchange rate isfloating, not fixed.Whether it is trying to arrange a holiday or tosecure a vital business contract, varying prices impose a cost  andthus a disincentive  on trade.Such an argument is particularlyrelevant if you are in a small country that deals regularly with a bigneighbour.With so much business at stake, it is better to fix theexchange rate so everyone knows the costs involved.FINANCIAL CRISESThe trouble is, trying to maintain fixed exchange rates at timeswhen global markets question the value of the currency concerned,has been a contributing factor in most modern financial crashes.The East Asian currency crisis in 1997, Russia 1998 and Argentina2001 are only the most recent at the time of going to press.Theyare hardly likely to be the last.At first, international financiers are reassured by fixed exchangerates.The risk in buying foreign securities is reduced if you knowthat the overseas earnings you later receive will not be devalued bysome future fall in price of the currency.A developing country which perhaps has a change of govern-ment and pegs its currency to the dollar, removes restrictions on theinternational movement of money and pursues prudent financialpolicies familiar to Western bankers may become very attractive tooverseas investors.Especially if it is resource rich, needful of capitaland with fledgling industry and commerce welcoming to interestedoutsiders.Local bankers quick on their feet can now call on fargreater supplies of finance if foreign creditors are confident aboutexchange rates.And it is easy to make money when everyone else isgetting in on the act  entrepreneurs find that in setting up a newcompany in boom times, everybody wants a share and prices on thebonds and securities they issue keep rising.Does it matter thatprojected future profits are based on scarce or over-optimistic data?If confidence holds, not really.Those people rushing in to get richquick will not worry if the paper they hold is over-priced  so longas they are confident that they can sell it later for even higherprices.The market succumbs to feverish buying.until sometime,somehow, somebody blows the whistle.© 2004 Tony CleaverAll crashes occur when assets become overvalued in a speculativebubble.The readjustment that is inevitable and which everyoneknows is coming sooner or later, typically occurs in one traumaticcollapse rather than in a gentle and less painful slowdown overtime.Why? Because no one wants to hold on to their stocks ifprices are falling.Once started, fear of loss terrifies everyone intopanic selling.To just blame the herd instinct, collective myopia or capitalistgreed getting the better of wisdom is to describe the problemwithout explaining it.The reality is that the prices of speculativeassets repeatedly diverge from their underlying values, financialintermediaries can provoke rather than contain binge buying, unre-stricted international money flows add to the pressure and, whensentiments change, sudden price readjustment can be catastrophic.Piling in and out of foreign currencies can quickly force exchangerates apart.Immature financial sectors in developing countries canperhaps be forgiven, but when international markets get in on theact it is not just a few local businesses that go under  no exchangerate can hold out against vast and rapid speculative money flowsacross borders as everyone rushes to sell one currency and buyanother.Then whole countries can suffer.The history of any one financial crisis will always illustratespecial factors that lead people to think that this time, this place, inthis case, things will be different.In the case of Japan and other EastAsian economies like Thailand, South Korea, and Indonesia theyhad been amongst the fastest growing economies in the world forthe last half of the twentieth century and international bankseverywhere were happy to lend them money.The fact that this wasfuelling rapid property price rises was nothing special  owning realestate in such a dynamic quarter of the globe seemed a good invest-ment.But, if the backing or collateral on too many bad loans isunproductive property and banks all try at the same time to cash inthat property to get their money back, then these prices collapse.Confidence is shaken.Many local intermediaries thought at first tobe rock solid can be exposed as issuing too many risky loans toundeserving cronies.Then there is panic and wild selling.Forei-gners want to get their money out.Dollar-denominated loans,incurred from overseas to fund local Asian investment, have then tobe paid back when the domestic currency is skydiving.It can t be© 2004 Tony Cleaverdone.Foreign debt holders won t accept your paper anymore.Sobusinesspeople go bankrupt.Companies fold.Governments whichhave similarly borrowed internationally now have to default onloans since their interest payments in dollars have soared whilsttheir domestic tax revenues have collapsed.Economies as a wholeslump into recession.Argentina is different.Surely fixed exchange rates were justifi-able here? Rampant inflation at the end of the 1980s was eventuallycured in 1991 when the old currency was reformed by the govern-ment s Convertibility Plan  which instituted a fixed, one-for-onepeso to the dollar exchange rate.Control of the money supply wasthus secured.The domestic currency could now only be created ifthe country possessed equal reserves of US dollars.In one fellswoop, this prevented financial intermediaries from over-issuingcredit and stoking up more and more spending [ Pobierz caÅ‚ość w formacie PDF ]