Princeton
Economics
International Ltd
The Following correspondence was the reply to our objections in
the establishment of the G5 in 1985 to "manage" the global
economy through intervention on a coordinated basis. Given the
fact that the floating exchange rate system affords governments
the freedom to now spend as they like pursuing their domestic
policies objectives separate and apart from the international fiscal
responsibility behind the value of the currency in global capital
flows, it is simply unlikely that the current system will be
sustainable long-term. Volatility will rise and will spread among
the markets driven by swings in currency values. Eventually, in the
course of events that will now follow, the global economy will
become increasingly more unstable and reflect much high degrees
of volatility as historically has always taken place under floating
exchange rate systems. In the end game, the global economy will
be attracked to the next major sovereign debt crisis that should
appear going into 26 years from the 1985 birth of the G5 (2011),
and perhaps culminate in new global monetary system by 2016.
Copyright 1986 for the PEI Annual Economic ConferenceNovenber 8, 1985
Dear Mr. Armstrong:
The pr ed me to respond to your letter of
October 25. It is important that concerned citizens such as
yourself expresy their views and we appreciate your efforte.
fe whare your concern aboot intervention into foreign
exchange markets. Numerous studies have failed to alow that
Sterilirea intervention has a long-run impact on the exchange
Fate, and unsterilired intervention affects the exchange rete
Walle ae the sane tine increasing the risk of reneved
Anflation. we agree thet foreign exchange rate intervention
is not the appropriate means by which to influance the
exchange rate, We do not share, however, your coacern over
exchange rate volatiiity.
Both the igh value of the dollar and the volatility of
Aes value Under the flexible exchange rate period have been
sources ef concern for many. “the flrat iswie which needs. to
be eddrersed fo the reason behing the dollar's appreciacion
andthe inptteations for our econonie perfemence. The
Simultaneous existence of s current sceount deficit ant a
high foreign exchenge value of the dollar are often cited me
tvidence that our interneeional economic eyaten de dn
Glserray. hodern exchange rave theory har Senoomerated that
the exchange rate we obearw nead not be the one wiien
Delancen the cureent account n'a world of capital mobs}ity.
The exchange Fate ie instead influenced by Doth current and
pected erade and capival flue,” Intervention which
attempts Co force the exchange rate to a level thought to
Schieve a current sccouit belance of tera Lv therefore
Mioguided and nay not be desirable.
In addition, one mast remenber that the exchange rate,
jane time, both reflects and affects econanie
s The exchange rate, for example, is affected by
the sane variables which have led ts the riee in the current
account deficit. One important factor driving the present.
Gurrent account deficit is the difference in economic growth
Fates between the U-S- and the reat of the world. This
fcononic groweh vbich we now enjoy de therefore an important
factor driving the value of the dolac.
The volatility of the exchange rate is also cited ex
evidence of disarray in international financial marketa. We
Go not believe thir to be the cace. The exchange rate ie the
price of an ssaet vhich, 1ike all esi is determined by
the values of future economic vertables a well ae by their
current velues. As ds the case with many asset prices, day~
to-day fluctuations which reflect = reaction to news can be
large: however, the apperent volatility does not indicate“2
market imperfections or irrationality on the part of market
participants. In addition, the enpitical evidence doa not
Fuppore the hypothesis that exchange rate voimediity sa an
Inpedimant to trade. Op the contrary, intarnational erage
has flourished in the floating-rate period, axpanding much
mora rapidly then ie id during the fixed-rate period.
The eyeten you proposed to eliminate exchange rate
volatility ensentiolly smplias a return co's fixed-exchange
Fate regime. Wa beljave thae such a system would suffer fron
any of the #ace problans encountered under the Bretton Woods
System, ‘since there i¢ no central international monocary,
authority, an SDR-based uyatan would Fequire that the
Ronetary suthorities of various nations antarvene either
Girectly or indirectly to maintain the por value of thelr
currency vith respect to other currencter included in the 6DR
currency basket. This would mean that rations relinquish the
ability to dee monetary policy to poraue domestic policy
Objectives, e very unpopular alternative. ‘Te Broposed.
SDR-beved bysten adao suffers fron the reality of portfolio
preferences. Countries have failed £5 axnsbie a Genand for
BDR's and have prefarsed to eseher Let their currencies float
oF to Fin their currency tos beeket of their om choosing.
Te Would be undecirabie to force @ country to accepe a eyecem
which fixed thelr currency to other currencles which they do
not desire to hold.
In conclusion, we bellave that the attriouter of =
floating rate ayaten have bean misinterpreted a deficien-
cies. exchange rate volatility hee not been linked to &
Sealine in economic growth and merely reflects a rational
Kesponse to current Or expected changes in economic
Eonditions: ‘The hich value of the dollar does not imply an
sconomy da turmo.ly
Father, the dollar reflects s healthy
‘ensure nonintletionary
Feduction in
‘coward euch goa)
Binge! Jp
Fy We Sprinkel
Hr, Martin Armstrong
Chairman
Princeton Economics International
101 Carnegie Center, Suite 314
Princeton, New Jersey 08540sncx near Congress of the nited States
me ‘house of Represenrantes
—— Washingt, B.C, 293 :
oat December 14, 191
Nr. Martin A, Armstrong
Princeton Economic Consultants Inc.
161 Carnegie Center
Suite 314
Princeton, NJ. 98540
Dear Mr, Armmtrong?
Thank you #0 much for your kind comments on cur Mo
conference, and especially for your ideas on monetary rafor
I share your skepticien about temporery, stopgap sol
which will not work for long, I atrongly agree with you
peed for establishing single international unit of scco
facilitate trade. I em not convinced, however, that the par
will do the job.
I am enclosing my remarks from the conference, and
you will see that we agree on e nunber of points. Agein
thanks for sharing your thoughts with me,
cerely yours,
is