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 ConferenceNovenber 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 08540sncx 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