Supply Side Economics
Yesterday at the Hotel Vancouver, 1999 Nobel Laureate in economics and acclaimed "Godfather" of the European Monetary Union, Dr. Robert Mundell rattled off his proposal for a common currency in North America (specifically for NAFTA), and his vision for the future of currency arrangements in the rest of the world.
He is currently an economics professor at Columbia University in New York, since 1974. His ideas on international exchange rate arrangements have been gaining momentum since the apparent success of the Euro. In fact, the lecture had a slight promotional feel to it. The event was put on by the Vancouver Board of Trade, and was sponsored by the Business Development Bank of Canada, The Vancouver Sun, and Placer Dome Canada Ltd. At our table sat a representative from the Bank of Canada, along with what looked like two of his apprentices. Dr. Mundell is a politically influential man, with impressive credentials and a 45-year international record of academic excellence and professional achievements that I have rarely seen. Suffice it to say that the man is well connected.
The event is important because it comes just as the United States is grappling with an enormous payments deficit on its current account, which correction will catapult the Euro, and likely Dr. Mundell's vision, into high esteem. Underlying his thesis is the premise that the volatility in exchange rates has been counterproductive to optimal economic performance over the past twenty-five years. He cited, as example, the 75% decline in the Dollar/Yen over a relatively short period during the eighties, followed by a near 100% appreciation between 1995 and 1997 (just two years), which he believed was at the root of the Asian economic crisis in 1997. He cited the volatility in Dollar/Mark over the years, which showed equal volatilities. Even the Euro has declined by about 25% in only 18 months against the Dollar, and more against the Yen. As anyone in the business of international trade knows, currency movements of even 10% can wipe out entire profit margins, or create windfall gains. The choice is to either focus your business inward and concentrate on the domestic markets, hire some financial magician to hedge your problems away, or just day trade your company's treasury from the comfort of your own home, where you might have an equal shot at making or losing money. In fact, Dr. Mundell confidently asserted that the derivatives industry has grown to enormously destabilizing levels, coincident with an increasingly large mass of hot money that likes to tamper with equilibrium levels, as a direct result of the proliferation of floating exchange rates. What's more, the industry is entirely unnecessary.
Interestingly, his overall premise echoes a report by one of his peers, Eugene Birnbaum, entitled "Dollar Instability and World Economic Growth," prepared for the Vice Chairman of the United States Joint Economic Committee in 1996. In that report, Eugene Birnbaum compares the vitality of economic trends between two periods. The first period covered the twenty-three year period between 1945 and 1968, where exchange rates were fixed under an ultimately abused Bretton Woods system of money. The second period started after the collapse of Bretton Woods, in 1973, upon the accidental arrival of our current free floating exchange rate arrangement to the present day. Mr. Birnbaum showed, quite diligently, how the economic performance in the United States for much of the past quarter century clearly deteriorated under a floating exchange rate regime. He then made the case that monetary stability is a crucial element in economic performance. He argues that the value of a currency is not merely a price, but a commitment to its people that the currency will retain its purchasing power.
One of my questions directed at Dr. Mundell, but which didn't make it to him before the end of the session was, "is there a difference between the value of a currency and its price, and if so, how would you make it more transparent?" I was hoping to underhandedly reveal his bias for a gold standard, and thus establish a connection to Mr. Birnbaum's vocal support for a gold standard. Oh well, can't win them all.
In any case, both economists, Dr. Mundell and Mr. Birnbaum, believe in stabilizing the "coin of the realm," rather than "the realm of the coin." There are growing debates about fixed exchange rate regimes, outside of the United States of America, as the monetary experiment with floating exchange rates has extended over a long enough period of time to lend itself to scientific observation and analysis. It should also be duly noted that the USA has shown a remarkably shrewd ability to recognize exchange rate problems before they arrive, and "imperialistically" (a word used by Dr. Mundell without inhibition) move toward supporting fixed exchange rate mechanisms, conveniently at such time that the Dollar is in trouble. That is why I felt that the event was slightly promotional, or at least fit a "plant the seed in Canada" format. Anyhow, here is the backbone of the lecture. There are five different options that he lists for a North American Monetary Union:
- The status quo; a dysfunctional floating exchange rate "arrangement," which has created an enormously unnecessary hedge fund industry, at the expense of traditional business activity/trade, and which has shown few of the advantages many once thought it had.
- A single currency union, called the "Amero," modeled after the Euro. He suggests that Canada might gain, while the US might lose the esteem accorded the "Dollar," by name. Therefore, it would not even get past congress.
- Dollarization; an effective way to eliminate unstable monetary policies and poorly run central banks in underdeveloped countries, but might strike nationalistic chords in Canada and Mexico.
- A Currency Board; a sophisticated system of fixed exchange rates, which would have to be managed by buying or selling Dollars in order to maintain their price targets. This was his favorite option, as it proved to be the least politically incorrect and the most economically effective system for North America's particular circumstances.
- Currency Bands (the snake); the system that was practiced in Europe before the adoption of the Euro, but it was obviously not optimum with so many different monetary policies involved in the system.
At the end of the day, Dr. Robert Mundell is telling us that a NAFTA currency board is in our future. Of course, if the US Dollar is indeed heading for trouble, the United States will count on its partners in the currency board to support the Dollar and maintain the exchange rate arrangement. That means that Canada's money supply will have to go through the roof to accommodate its obligations under such an arrangement. In the midst of all this change, can you see a light at the end of the tunnel for Gold prices? I can. In fact, a move towards fixed global exchange rate systems cannot occur without something to fix them against. Why? Because there is a difference between the value of a currency and its price. How do you measure such a difference if you fix the prices of a basket of currencies against no standard measure of value?
Another question one might ask Dr. Mundell, would be, "why is it that you are implying that the Dollar has been so successful, by your objections against the Amero or Dollarization, while at the same time advocating a fixed exchange rate system? If it ain't broke, why fix it?" I guess that might reveal his true analysis of the current circumstances of the Dollar, if not assert that the prestige accorded the world's dominant currency is outright misplaced. In fact, he says as much while trumpeting the future course of the Euro. In this contradiction he trips over himself as he tries to hide his true agenda, as an agent of the US Treasury.