Scott Lincicome reports on recent remarks of Nobel Prize-winning economist Prof. Robert Mundell (who is described by the Heritage Foundation as "the academic founder of supply side economics"). Here's a summary of the key point for my purposes, from Sean Rushton of NRO:
[Mundell] says the U.S. should fix the dollar’s value against the yuan and the euro, thus creating an enormous common-currency area free of exchange-rate turbulence, which will prevent future debacles. It should be clear that Mundell sees a low and unstable dollar as culprit Number One in the crisis, and as the Bush administration’s biggest mistake.
So for this conservative, fixed exchange rates are a good thing.
On the other side, here is an article by John Makin of AEI, called "The Folly of Currency Pegs," in which he says:
... It is ironic that the instability of pegged-currency systems--usually established in the name of fostering more stability--results from a basic fact. Countries that peg their currencies lose control over monetary policy. If Greece uses the same currency as Germany, it must adopt ECB monetary policy. If the United States pegs its currency to gold, it must adopt monetary policies that imply a fixed dollar price of gold by keeping prices stable. That might or might not be desirable, but simply saying that "the dollar is as good as gold" or that Greece has a hard-euro currency does not make it so.
When policies diverge, pressure increases for currency pegs to break. A crisis ensues--like the current Greek crisis--and calls are issued to effect a quick reduction of spending in countries where evidence of excess spending has emerged. If the excess spending has gone on too long and debt accumulation is on an unstable, unsustainable path, the currency peg breaks. With substantial hard-currency debts having been accumulated (as they were in the case of Argentina and have been in the case of Greece), a default accompanies the collapse of the currency peg. The United States did not officially need to default at the end of the Bretton Woods system because it simply devalued the dollar against gold and other currencies--in effect, lowering the real value of its external debts in terms of hard currencies and gold.
The eagerness of governments to enjoy the overrated benefits of fixed exchange rates without paying the price of such arrangements leads to financial exchange-rate crises. Beyond the cases of Greece in the EMU and the United States under the Bretton Woods system is a long list of disruptive "crises" tied to stubborn and, ultimately, unsuccessful efforts to maintain nonviable currency pegs.
I definitely lean towards the second view. My question is this: If you're a free market type (as I am happy to call myself, if that was not already obvious), why is "exchange rate turbulence" such a big concern? No doubt there are many benefits to stable exchange rates. But there are also benefits to stable prices for gas, milk, apples, etc., and I don't hear free market supporters calling for those prices to be fixed. Is there an exception for exchange rates? Are currency values a fundamentally different part of the economy than ordinary products, and therefore subjecting them to what are, in effect, "price controls" is acceptable?
I admit that I am a little torn on this one. I do like the efficiency of a common currency. However, I'm skeptical that we can set an exchange rate that can be sustained for any significant period of time. It's possible that certain regions could be characterized as "optimal currency areas," where this sort of thing would work, but aside from that I think I'd rather see floating rates.
