Floating Exchange Rates: The Only Viable Solution

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Term Paper Title	Floating Exchange Rates: The Only Viable Solution
# of Words	2569
# of Pages (250 words per page double spaced)	10.28

Floating Exchange Rates: The Only Viable Solution

Floating Exchange Rates: The Only Viable Solution

Stentor Smith

For some, the collapse of Mexico's economy proves that floating exchange rates
and markets without capital controls are deadly. Others find the crash of the
European exchange-rate mechanism (ERM) in 1993 to be proof that targeted rates
will always be overturned by the free market. Many see the breakup of Bretton
Woods as the failure of fixed rates. Yet others believe monetary unification in
Europe is the only way to achieve economic and political stability. Many others
hold still different beliefs. There are, however, four main proposals for the
management of international currency exchange rates: monetary unification, fixed
rates, floating rates maintained within certain "reasonable" limits of
variability and freely floating rates. Both fixed exchange rates and rates based
on either explicit or unwritten targeting are impossible to maintain, especially
in an era of free trade. Complete monetary unification would be impossible to
bring about without extensive integration and unification of international
governments and economies, a task so vast that it is unlikely ever to be
accomplished. Thus, the only option central banks have is to allow exchange
rates to float freely.

The European Monetary System, which virtually collapsed in 1993, was an attempt
to fix exchange rates within certain tight bands, to coordinate monetary policy
between member nations and to have central banks intervene to keep exchange
rates within the bands when necessary. The reasons for the collapse were myriad,
but, simply put, it happened because Germany, dealing with financial problems in
part arising from its reunification, refused to lower its high interest rates.
This meant other European countries either had to keep their rates equally high
and allow themselves to fall into recession as a result, or devalue their
currency against the mark, a move viewed by many as a political embarrassment.
The possibility of a devaluation caused speculators to bolt from the lira, the
pound, the franc and other currencies, sending the markets into chaos and
destroying all semblance of stability. In the end, the ERM was adjusted to allow
currencies to fluctuate within 15 percent on either side of their assigned level,
up from (in most cases) a limitation of 2.25 percent. The bands became too wide
to be meaningful or stabilizing, and the system remained alive "in name only"
(Whitne...

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