Exchange rate protectionism: a harmful diversion for trade and development policy.

• Author: Malpass, David

Exchange rate protectionism usually refers to the idea that a country's exchange rate might be undervalued, causing the country to import less and export more than it would with a stronger exchange rate. I would like to discuss exchange rate protectionism in a different context.

The Primary Meaning of Exchange Rate Protectionism

I think most of the trade impact of an exchange rate policy is overwhelmed by the policy's impact on economic development. In practice, therefore, the primary meaning of exchange rate protectionism is that an unstable currency tends to cause underdevelopment, limiting a country's imports and exports. The converse also holds: countries with stable exchange rates have seen imports and exports grow rapidly, with China a clear example.

Needed: A Stable Dollar Policy

In my address at Cato's 1999 monetary conference, entitled "Replacing the Vacuum in International Economic Policy," I presented the view that exchange rates, rather than reflecting economic fundamentals, cause them. An extract follows:

In recent years [as of October 1999], the United States has seemed to build its entire exchange rate view on the sound bite that "a strong dollar is in the national interest." Yet it has declined to explain how a currency's strength should be measured or whether unlimited strength is good. Clearly, a "stable" currency, not strong or weak, is appropriate during most of a country's economic life. A "strong dollar" policy made good sense after a period of currency weakness and inflation as the United States experienced in 1993 and 1994. President Clinton and Secretaries Rubin and Summers deserve credit for this constructive 1994 shift in U.S. policy. By continuing the policy into 1997 and 1998, however, the administration has created a giant momentum play into the U.S. dollar, adding to our asset values and our growth rate, but subtracting from those abroad and increasing the difficulty of the transition to currency stability. Meanwhile, the jingoistic "strong dollar" policy of the United States confused foreign countries. Since 1997, the world has suffered from a global competition to see who could have the strongest currency. The Japanese played the game, deepening their deflation spiral and prolonging their economic stagnation. Germany let the mark get too strong in 1998, setting the stage for a "euro crisis" earlier this year as the euro moved back to an appropriate value. The confusion sown by the United States in...