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The case against floating exchanges
362
Book reviews
Paul Einzig. The Case Against Floating Exchanges. New York: St. Martin’s Press, 1970, xi, 211 pp.)
(London:
Macmillan;
With over fifty books to his credit, Dr. Einzig has written still another “to discredit the case for ‘gnomocracy’ - a system under which the determination of exchange rates would be left to the mercy of speculators as a result of the adoption of floating exchanges”. Recently agitation for such a system has become alarmingly influential. “It is a strange spectacle to behold dignified and formerly orthodox theoretical economists and Central Bankers playing a role very similar to that formerly played by comic currency cranks.” Einzig accuses free-exchange advocates of moral lapses ranging from intellectual dishonesty to politically motivated cynicism. In his book, he admits. he has “antagonised and insulted practically every one of its potential reviewers.” Yet he felt his colorful language necessary to convey his strong feelings: “1 could not hope to die in peace if I had not said what I feel impelled to say, or if I had not said it in exactly the way I did.” Einzig restates the man-in-the-street arguments about speculation and all that. Going beyond them, he emphasizes what he considers a key practical or technical difficulty: “... the volume of forward exchange facilities available for importers and exporters would tend to contract sharply under floating exchanges, while the need for such facilities for covering the increased exchange risk would increase. Should importers and exporters be unable to obtain covering facilities, except at prohibitive costs, many of them would prefer to abandon the transactions rather than expose themselves to ruinous losses. The resulting contraction of world trade might trigger off a world-wide slump with incalculable consequences.” Forward “facilities” would shrink, SUPposedly, because banks limit the amounts to which they are prepared to accept forward commitments from each other. With floating spot rates heightening uncertainties and increasing the risks of default on forward commitments, banks would narrow their limits. Einzig does not recognize that This argument begs the question. “facilities” as, rather, specific traders demand and supply not SO mu& currencies for forward delivery against other specific currencies. Forward demands and supplies would tend to grow in step as forward cover against exchange risk became increasingly routine and as world production and trade continued to grow. Einzig overlooks how the forward market would operate more smoothly if its use became a routine matter, rather than a practice plagued, as nowadays, by lopsided
Book reviews
363
variation when speculation mounts about prospective adjustment in fixed exchange rates. “Quite independently of [his] unanswerable practical argument against it”, Einzig has discovered “a fundamental fallacy in the theoretical case for floating exchanges.” That case allegedly rests on the concept of a free-market equilibrium rate at which import and exports would balance. Einzig calls attention to the separate rates that would equilibrate capital movements, speculation, and arbitrage. Only by the most fantastic coincidence would these three other equilibrium rates all coincide with the trade-balancing rate, or would the non-trade factors separately tending to make the actual rate deviate from the trade-equilibrium rate happen to cancel each other out. Not only does Einzig repeatedly stress this supposedly crucial point; he even hints that the required degree of coincidence is still more fantastic, since distinctions must be made between the rate that would balance foreign trade and the rate that would achieve full employment and between forward and spot rates of exchange. Free-rate advocates wouId counter that Einzig had quite misunderstood their case. Einzig hints at further arguments against flexible exchanges, such as that the problem of leads and lags in foreign-exchange transactions, familiar under the current system of fixed-but-adjustable rates, would worsen under free rates. Warning against “leapfrogging competitive currency depreciations”, he fears “aggressive economic nationalism, a revival of the ‘beggar-my-neighbour’ policy pursued in the thirties.” Einzig lays stress on the anti-inflationary discipline of fixed exchange rates and on the scope that free exchange rates would allow to demagogic inflationary laxness. Insofar as exchange depreciation cures a previously existing balance-of-payments deficit, it tends to have an inflationary impact on the depreciating country. (The fact that an inflation-absorbing payments deficit could hardly have been financed indefinitely under fixed exchange rates, however, deprives this argument of a good deal of its relevance). Furthermore, depreciation tends to crank up prices and wages somewhat mechanically. True, depreciations and appreciations may alternate; and anyway, depreciation by some countries implies relative appreciation by other countries. This, however, is no consolation. An asymmetry, Triffin’s “ratchet effect”, is at work: appreciations do not tend to lower prices and wages in domestic currency to anywhere near the extent that depreciations tend to raise them. “Leapfrogging depreciations” can push up, lastingly, the
364
Book reviews
domestic price and wage levels of the countries successively involved. Furthermore - although Einzig’s analysis is not explicit at this point domestic monetary policies, aiming at full employment, will tend to ratify the depreciation-bred cost-push inflations. Even speculative exchange-rate movements can tend to consolidate themselves by their domestic inflationary impacts. Transcending the mere static theory of an equilibrium rate, Einzig argues “that exchange rates, by deviating from their equilibrium levels for no matter what reason, tend to change the equilibrium levels themselves. As a result of this basic tendency, deviations from equilibrium level [sic] do not result in mere temporary discrepancies but tend to create new equilibrium levels. The reciprocal character of the relationship between exchange rates and their trade equilibrium levels is overlooked by advocates of floating exchanges.” Einzig denounces compromise exchange-rate systems - managed flexibility, a wider band, and so forth. The “crawling peg” is “puerile”, “silly”, “absurd”, and “idiotic”. He recommends, instead, improving the existing Bretton Woods system - but not, apparently, by further development of “re-phasing”, “re-cycling”, and “paper gold”; we have already had an “overdose” of such inflationary international cooperation. Among other things, however, “There is a strong case for major changes of parities, and there is indeed a particularly strong case for a substantial increase [sic; an obvious slip] in the gold value of the dollar.” Einzig’s brand of economic theory is quite casual. So are his citations and his apparent acquaintance with the literature (he seems to think, for example, that the purchasing-power-parity doctrine has gone out of fashion, without being adequately replaced). Though he trumpets the lessons of history, his history too is sweeping and casual and totally non-quantitative. Crucial distinctions between free rates on the one hand and adjustable or manipulated rates on the other hand get lost. French and Italian experience during the 1940’s and 1950’s, for example, supposedly provides a grim warning against free exchange rates. Still, Einzig has done a service in writing his book. It makes available, in convenient format and entertaining style, the standard worries about free exchange rates. It provides interesting twists on some of them and introduces a couple of quite novel arguments, particularly concerning the supposed problem of a plurality of noncoinciding equilibrium rates and a feared scarcity of forward-exchange “facilities”. It stresses what is probably the most serious argument against free rates: loss of financial
Book reviews
365
discipline and the danger of asymmetrical inflationary dislocation of equilibrium levels themselves. (This is not to say that the argument is decisive, but appraising it would exceed the scope of a book review. One would have to compare, as Einzig does not, the inflationary tendencies of the free-rate system and those, demonstrated in both theory and experience, of the Bretton Woods system.) The book provides a fair sample of the level of argument commonly used against free exchange rates and reminds supporters of that system of the kinds of misunderstandings they must cope with. It will figure prominently for years on reading lists in international finance. Leland B. Yeager University of Virginia
Charles E. Staley, International Economics: Analysis and Issues. (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1970, pp. x + 285.) This book consists of two parts, the first, entitled International Trade, contains Chapters 1 to 14 (17 1 pp.) and the second, entitled The Balance of Payments, contains Chapters 15 to 22 (111 pp.). The book is written as a text or a supplement to a text, and makes no claims for originality, and I shall therefore evaluate in on those terms. Although the book is plainly meant as a text, it is not clear at what level the book is meant to be used, for there is a great deal of unevenness with respect to difficulty. The discussion ranges from very elementary treatments of the transformation curve and the construction of the factor box diagram, and descriptions of what indifference curves, isoquants, and IS and LM curves are, to the mathematical derivations of such things as the Metzler condition for a tariff to leave domestic prices unchanged (pp. 45-6, p. 11 1), the formula for the optimum tariff (p. 12 l), and the condition for a transfer to improve the terms of trade under both classical and Keynesian assumptions (p. 263 the author does not formally define and pp. 266-7). Furthermore, either the production function or the utility function, returns to scale are never formally defined, and none of the basic trade theorems are derived mathematically. In fact, the standard geometric demonstration of the Heckscher-Ohlin Theorem is not even included.
Book reviews
Paul Einzig. The Case Against Floating Exchanges. New York: St. Martin’s Press, 1970, xi, 211 pp.)
(London:
Macmillan;
With over fifty books to his credit, Dr. Einzig has written still another “to discredit the case for ‘gnomocracy’ - a system under which the determination of exchange rates would be left to the mercy of speculators as a result of the adoption of floating exchanges”. Recently agitation for such a system has become alarmingly influential. “It is a strange spectacle to behold dignified and formerly orthodox theoretical economists and Central Bankers playing a role very similar to that formerly played by comic currency cranks.” Einzig accuses free-exchange advocates of moral lapses ranging from intellectual dishonesty to politically motivated cynicism. In his book, he admits. he has “antagonised and insulted practically every one of its potential reviewers.” Yet he felt his colorful language necessary to convey his strong feelings: “1 could not hope to die in peace if I had not said what I feel impelled to say, or if I had not said it in exactly the way I did.” Einzig restates the man-in-the-street arguments about speculation and all that. Going beyond them, he emphasizes what he considers a key practical or technical difficulty: “... the volume of forward exchange facilities available for importers and exporters would tend to contract sharply under floating exchanges, while the need for such facilities for covering the increased exchange risk would increase. Should importers and exporters be unable to obtain covering facilities, except at prohibitive costs, many of them would prefer to abandon the transactions rather than expose themselves to ruinous losses. The resulting contraction of world trade might trigger off a world-wide slump with incalculable consequences.” Forward “facilities” would shrink, SUPposedly, because banks limit the amounts to which they are prepared to accept forward commitments from each other. With floating spot rates heightening uncertainties and increasing the risks of default on forward commitments, banks would narrow their limits. Einzig does not recognize that This argument begs the question. “facilities” as, rather, specific traders demand and supply not SO mu& currencies for forward delivery against other specific currencies. Forward demands and supplies would tend to grow in step as forward cover against exchange risk became increasingly routine and as world production and trade continued to grow. Einzig overlooks how the forward market would operate more smoothly if its use became a routine matter, rather than a practice plagued, as nowadays, by lopsided
Book reviews
363
variation when speculation mounts about prospective adjustment in fixed exchange rates. “Quite independently of [his] unanswerable practical argument against it”, Einzig has discovered “a fundamental fallacy in the theoretical case for floating exchanges.” That case allegedly rests on the concept of a free-market equilibrium rate at which import and exports would balance. Einzig calls attention to the separate rates that would equilibrate capital movements, speculation, and arbitrage. Only by the most fantastic coincidence would these three other equilibrium rates all coincide with the trade-balancing rate, or would the non-trade factors separately tending to make the actual rate deviate from the trade-equilibrium rate happen to cancel each other out. Not only does Einzig repeatedly stress this supposedly crucial point; he even hints that the required degree of coincidence is still more fantastic, since distinctions must be made between the rate that would balance foreign trade and the rate that would achieve full employment and between forward and spot rates of exchange. Free-rate advocates wouId counter that Einzig had quite misunderstood their case. Einzig hints at further arguments against flexible exchanges, such as that the problem of leads and lags in foreign-exchange transactions, familiar under the current system of fixed-but-adjustable rates, would worsen under free rates. Warning against “leapfrogging competitive currency depreciations”, he fears “aggressive economic nationalism, a revival of the ‘beggar-my-neighbour’ policy pursued in the thirties.” Einzig lays stress on the anti-inflationary discipline of fixed exchange rates and on the scope that free exchange rates would allow to demagogic inflationary laxness. Insofar as exchange depreciation cures a previously existing balance-of-payments deficit, it tends to have an inflationary impact on the depreciating country. (The fact that an inflation-absorbing payments deficit could hardly have been financed indefinitely under fixed exchange rates, however, deprives this argument of a good deal of its relevance). Furthermore, depreciation tends to crank up prices and wages somewhat mechanically. True, depreciations and appreciations may alternate; and anyway, depreciation by some countries implies relative appreciation by other countries. This, however, is no consolation. An asymmetry, Triffin’s “ratchet effect”, is at work: appreciations do not tend to lower prices and wages in domestic currency to anywhere near the extent that depreciations tend to raise them. “Leapfrogging depreciations” can push up, lastingly, the
364
Book reviews
domestic price and wage levels of the countries successively involved. Furthermore - although Einzig’s analysis is not explicit at this point domestic monetary policies, aiming at full employment, will tend to ratify the depreciation-bred cost-push inflations. Even speculative exchange-rate movements can tend to consolidate themselves by their domestic inflationary impacts. Transcending the mere static theory of an equilibrium rate, Einzig argues “that exchange rates, by deviating from their equilibrium levels for no matter what reason, tend to change the equilibrium levels themselves. As a result of this basic tendency, deviations from equilibrium level [sic] do not result in mere temporary discrepancies but tend to create new equilibrium levels. The reciprocal character of the relationship between exchange rates and their trade equilibrium levels is overlooked by advocates of floating exchanges.” Einzig denounces compromise exchange-rate systems - managed flexibility, a wider band, and so forth. The “crawling peg” is “puerile”, “silly”, “absurd”, and “idiotic”. He recommends, instead, improving the existing Bretton Woods system - but not, apparently, by further development of “re-phasing”, “re-cycling”, and “paper gold”; we have already had an “overdose” of such inflationary international cooperation. Among other things, however, “There is a strong case for major changes of parities, and there is indeed a particularly strong case for a substantial increase [sic; an obvious slip] in the gold value of the dollar.” Einzig’s brand of economic theory is quite casual. So are his citations and his apparent acquaintance with the literature (he seems to think, for example, that the purchasing-power-parity doctrine has gone out of fashion, without being adequately replaced). Though he trumpets the lessons of history, his history too is sweeping and casual and totally non-quantitative. Crucial distinctions between free rates on the one hand and adjustable or manipulated rates on the other hand get lost. French and Italian experience during the 1940’s and 1950’s, for example, supposedly provides a grim warning against free exchange rates. Still, Einzig has done a service in writing his book. It makes available, in convenient format and entertaining style, the standard worries about free exchange rates. It provides interesting twists on some of them and introduces a couple of quite novel arguments, particularly concerning the supposed problem of a plurality of noncoinciding equilibrium rates and a feared scarcity of forward-exchange “facilities”. It stresses what is probably the most serious argument against free rates: loss of financial
Book reviews
365
discipline and the danger of asymmetrical inflationary dislocation of equilibrium levels themselves. (This is not to say that the argument is decisive, but appraising it would exceed the scope of a book review. One would have to compare, as Einzig does not, the inflationary tendencies of the free-rate system and those, demonstrated in both theory and experience, of the Bretton Woods system.) The book provides a fair sample of the level of argument commonly used against free exchange rates and reminds supporters of that system of the kinds of misunderstandings they must cope with. It will figure prominently for years on reading lists in international finance. Leland B. Yeager University of Virginia
Charles E. Staley, International Economics: Analysis and Issues. (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1970, pp. x + 285.) This book consists of two parts, the first, entitled International Trade, contains Chapters 1 to 14 (17 1 pp.) and the second, entitled The Balance of Payments, contains Chapters 15 to 22 (111 pp.). The book is written as a text or a supplement to a text, and makes no claims for originality, and I shall therefore evaluate in on those terms. Although the book is plainly meant as a text, it is not clear at what level the book is meant to be used, for there is a great deal of unevenness with respect to difficulty. The discussion ranges from very elementary treatments of the transformation curve and the construction of the factor box diagram, and descriptions of what indifference curves, isoquants, and IS and LM curves are, to the mathematical derivations of such things as the Metzler condition for a tariff to leave domestic prices unchanged (pp. 45-6, p. 11 1), the formula for the optimum tariff (p. 12 l), and the condition for a transfer to improve the terms of trade under both classical and Keynesian assumptions (p. 263 the author does not formally define and pp. 266-7). Furthermore, either the production function or the utility function, returns to scale are never formally defined, and none of the basic trade theorems are derived mathematically. In fact, the standard geometric demonstration of the Heckscher-Ohlin Theorem is not even included.