Since the financial panic began in 2008, global leaders have been at pains to stress their "cooperation" on numerous issues—stimulus spending, new bank rules, trade. Yet they still insist on going their own parochial, self-interested way on monetary policy and exchange rates. It's as if world leaders had consciously decided to deal with every economic issue except the most important one—the price of the global medium of economic exchange.
The result has been a world of monetary disruption and growing commercial and political disputes. Brazil has had to cope with surging capital inflows and a rising real, with government bond yields hitting double-digits. The rising yen has roiled Japanese politics and led its central bank to intervene. Other Asian nations—part of what is, or was, the dollar bloc—have taken to devaluation or interest rate adjustments to stop their currency shifts against the dollar.
Meanwhile, what Nobel economist Robert Mundell calls the world's single most important price—the euro-dollar rate—continues to fluctuate wildly. The nearby chart shows that the swings have become more frequent and severe since 2005, from 1.2 euros to the dollar to 1.6, then down to 1.25, back to 1.5 in a matter of months, down again to 1.2 and now back above
1.36.
Mr. Mundell—the father of the euro and the world's foremost expert on currency systems—recently said on Bloomberg TV that this "is a terrible thing for the world economy" and that "We've never been in this unstable position in the entire currency history of 3,000 years."
Such sharp currency moves lead to huge swings in prices, especially for commodities like oil. They disrupt business planning, as companies find it difficult to know what their real costs and return on investment will be. And they lead to the misallocation of resources, with investment decisions pegged as much to exchange-rate movements as to long-run productivity gains or potential breakthroughs in technology. Some $4 trillion now turns over daily in global currency markets.
The growing danger today is currency protectionism—what students of the 1930s will remember as competitive devaluation or "beggar-thy-neighbor" policies. As economic historian Charles Kindleberger describes in his classic "The World in Depression," nations under domestic political pressure sought economic advantage by devaluing their national currency to improve their terms of trade.
But that advantage came at the expense of everyone else. "As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all," Kindleberger writes. "With tariff retaliation and competitive depreciation, mutual losses were certain."
We can see signs of similar behavior today, especially in the global economy's main potential flash point of U.S.-China relations. This week, the U.S. House of Representatives voted 348 to 79 to impose tariffs on Chinese goods if Beijing does not revalue its currency. Ominously, the vote was bipartisan. While the Senate has so far restrained itself, a similar rout in that body can't be ruled out after the elections—especially in the absence of Presidential leadership.
