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Chapter

John Odell - The U.S and the Emergence of Flexible Exhange Rate : An analysis of Foreign Policy Change

11 Pages
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Department
Political Science
Course Code
POLI 354
Professor
Mark Brawley

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Odell John S The U S and the Emergence of Flexible Exchange Rates an Analysis of Foreign PolicyChange Some Historical eventsBretton Woods conference of 1944creation of fixed exchange rates 1Nixon shocks of August 1971flexible exchange 2February 1973devaluation of the dollar by USThe author explains these two shifts in US policyFive factors which influence foreign monetary policy 1the balance of payments situation2the international militarypolitical situation3 the domestic political situation4organization and internal bargaining 5the policy beliefs or ideologies of senior officialsIn the mid1960s US officials continued their traditional rejection of changes in US exchange rate policy They rejected discussion of a depreciation of the dollar repeating that the dollar was as good as gold and convertible into gold They agreed to greater flexibility of exchange rates and remained committed to the Bretton Woods principle that exchange rates must be determined by joint international decision The United States tried before 1971 to discourage other governments from exercising the right to convert their dollars into US goldIn 1971 US unilaterally ended all US measures to maintain the dollars exchange value they explicitly ended convertibility of the dollar in to gold and other US reserves and halted foreign exchange market operations and external borrowing In addition the US actively demanded a general depreciation of the dollar plus unilateral trade concessions and greater military burdensharing from Europe and Japan as part of a fundamental change of international relations The administration imposed a 10 percent tariff surcharge on dutiable imports to be removed when US conditions were met Soon the other major governments under heavy market pressure allowed their currencies to float upward temporarily and negotiations began US demanded depreciation without devaluation Depreciation can be defined as a declinein the price of a currency measured in another currency or currencies Eg from 1004 DM to 1003 DM Devaluation can be defined as a decline in the value of the currency declared in terms of some numeraire Eg from 100135 ounce of gold to 100140 ounce of goldIn late 1972 the US government put forth a proposed set of new rules that were designed to assure greater flexibility of currency par values on the part of surplus as well as deficit countries and that might have reduced the international roles of the dollarIn early 1973 the Americans ended mandatory controls on most domestic prices and announced their intention to end controls on international capital outflows two programs which could have been expected to reduce the continuing US payments deficitUS officials told the Japanese and Europeans in that the US wanted them either to free their currencies to float upward against the dollar in response to supply and demand forces or to assent to a second devaluation of the dollar Heavy speculation ensued almost immediately All the major governments had effectively abandoned the Bretton Woods regime of agreed par values Their currencies were floating against each other eight of them floating as a fixed group1US balance of paymentsAuthor hypothesis that policy will change in accordance with the market or the balance of paymentsIn economic theory of policy the rate of exchange between two currencies is a price in a market for foreign exchange Price movement in any market serves to send a signal to entrepreneurs to shift resources relatively from lowerreturn to higherreturn activities and to shift purchases from higherprice to lowerprice suppliers When a country develops an international payments deficit the excess supply of its currency on the foreign exchange market puts downward pressure on its exchange rate upward pressure in the case of a surplus If the government failed to change its exchange rate policy and instead intervened to defend the existing parity it would generate a number of avoidable economic costs Unless a deficit is due to a temporary disturbance the deficit will continue and will drain away the governments international reserves Meanwhile in cases of fundamental imbalance the prevailing exchange rate will continue to send signals to put resources into industries no longer favoured by market conditions thus reducing economic welfare and intensifying the eventual adjustment problem Moreover the imbalance will attract the attention of speculators and set off rapid disruptive shifts of shortterm capital between countries Thus downward market pressure against a currency is reason to expect that government exchange rate policy if rational will shift to a new levelThis argument implies that governments will allow freely fluctuating exchange rates they will pursue a policy of floating and refrain from all market intervention In this version any government intervention is likely to
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