The Bretton Woods system came into existence to ensure a certain discipline or order in exchange rates of major currencies, which were marred by competitive devaluations in the pre-World War II period. However, this system collapsed because it was found to be too rigid and did not provide an exchange rate tool that permitted flexibility in the adjustment process. After that, there was a long experiment with the unmanaged flexibility in exchange rates between 1973 and 1985, but that too failed. Exchange rates determined solely by market forces responded to band wagon psychology in the markets including interest rate differentials that may or may not have much to do with underlying economic relationships.
In such circumstances, exchange rates, far from being equilibrium exchange rates, would tend to be misaligned. This happened with excessive dollar and sterling over-valuation and yen and Deutschemark under-valuation, which created tensions in the international monetary system. A remedy for avoiding such disequilibriating exchange rates of major currencies lies in the co-ordination of economic policies of major industrial countries so that payments imbalances are moderated, if not eliminated.
The assumption underlying the present international monetary system may have profoundly changed, as manifested in the current East Asain crisis. For reasons now well-known, the East Asian currencies have been in a flux. They have depreciated in a range from 50 per cent, as in the case of the Philippines peso and Malaysian ringgit, to almost 80 per cent in the case of the Indonesian rupiah and the Korean won, not to speak of the devaluation of the Singapore dollar. Though these currencies were tanked initially, due mainly to domestic distortions, they declined in value together with the currencies of the Philippines, Singapore and Hong Kong, even more than they should have as the result of competitive devaluations, as all these countries in the region are close trading partners.
Add to this the travails of the Japanese yen, which has depreciated vis-a-vis US dollar to the extent of 40 per cent in the last one year. Considering East Asias share in the world output and trade, it is clear that the shakeup of the regions currencies will have a profound impact on the international monetary system.
But the response of the major industrial countries as well as the IMF is to treat the Asian competitive devaluations as purely country-specific, except in the case of Japan. Japan is continuously pressed to relax fiscal policy to redirect demand from exports to the domestic economy, relax monetary policy even further, despite their lowest interest rates, and open out its capital account completely. On the other hand, the currency devaluations of other East Asian countries are sought to be countered by the Fund programmes entered bilaterally with the countries. Assuming that these programmes succeed, it would be some years before the currencies of these countries regain their equilibrium level from the present excessive under- valuation.
In this event, fearful of the flood of imports from these countries, the industrial countries would be actuated to raise trade barriers. This apart, the western European countries, which export heavily to East Asia, would face a recessionary threat to their economies. This means that the volatility of the East Asian currencies will affect the stability of the international monetary system as significantly as that of major currencies.
It is time the Fund and the industrial countries woke up to the reality and dealt with the consequences of the Asian crisis in the same way as they would have done in the case of a currency crisis in industrial countries. This would warrant that the industrial countries intervene in the markets for the East Asian currencies to stabilise their rates at some desirable level, in lieu of these countries pursuing appropriate structural adjustment policies.
And yet, the policies along the conventional beaten track may be woefully inadequate. The East Asian crisis is more the consequence of the willingness of the international banks to lend, regardless of the risks involved, in the secure belief that they would be bailed out. In that case, they should be paid to pay the price for their imprudence, so that they do not repeat their reckless lending. With capital account convertibility in the offing, crises of the types of Mexico and East Asia will cascade with ever-raging fury. The guardian of international monetary order, should, therefore, devise new mechanisms which can guarantee international lending at a char-ge graded according to the deg-ree of risk, rather than indulge in the fire-fighting ad-hocry of ephemeral effectiveness.
