Download NBER WORKING PAPER SERIES WHY CLASHES BETWEEN INTERNAL AND EXTERNAL STABILITY GOALS END

NBER WORKING PAPER SERIES
WHY CLASHES BETWEEN INTERNAL
AND EXTERNAL STABILITY GOALS END
IN CURRENCY CRISES, 1797-1994
Michael D. Bordo
Anna J, Schwartz
NBER Working Paper5710
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
August 1996
This paper is part of NBER’s research programs in Monetary Economics and International Finance
and Macroeconomics. Any opinions expressed are those of the authors and not those of the National
Bureau of Economic Research.
@ 1996 by Michael D. Bordo and Anna J. Schwartz. All rights reserved. Short sections of text, not
to exceed two paragraphs, may be quoted without explicit permission provided that full credit,
including O notice, is given to the source.
NBER Working Paper5710
August 1996
WHY CLASHES BETWEEN INTERNAL
AND EXTERNAL STABILITY GOALS END
IN CURRENCY CRISES, 1797-1994
ABST RACT
We argue that recent currency crises reflect clashes between fundamentals
and pegged
exchange rates, just as did crises in the past. We reject the view that crises reflect self-fulfilling
prophecies
that are not closely related to measured fundamentals.
Doubts about the timing of a
market attack on a currency are less important than the fact that it is bound to happen if a
government’s policies are inconsistent with pegged exchange rates. We base these conclusions on
a review of currency crises in the historical record under metallic monetary regimes and of crises
post-World
War II under Bretton Woods, and since, in European and Latin American pegged
exchange rate regimes.
Michael D. Bordo
Department of Economics
Rutgers University
New Jersey Hall
New Brunswick, NJ 08904
and NBER
mbordo @phoenix .princeton.edu
Anna J. Schwartz
National Bureau of Economic Research
50 East 42nd Street, 17th Floor
New York, NY 10017-5405
aschwar [email protected]
WHY CLASHES BETWEEN INTERNAL AND EXTERNAL STABILITY GOALS
END IN CURRENCY CRISES, 1797-1994
1. Introduction
The Mexican crisis of December 1994 and the European Monetary System (EMS)
crisis of September 1992 have aroused interest in the subject of currency
crises. Academics seek to understand their causes and propagation mechanisms,
Policy makers debate the need for new mechanisms to prevent them.
In the traditional view, a country faces a currency crisis when
inconsistencies arise between preserving pegged exchange rates, whether fixed
or crawling pegs, and protecting domestic monetary and fiscal policy -- the
fundamentals
-- for the sake of internal stability and competitiveness.
For
countries that are part of a pegged exchange rate system, such as Bretton
Woods or the EMS, crises are an endemic part of the system. They arise because
of unexpected shocks that may make unsustainable policies that were previously
compatible with existing exchange rate arrangements. Market participants
understand this tension and precipitate an attack on a currency by selling it
short when destabilizing shocks occur.
Recently, the traditional view and its modern extension, speculative
attack models based on rational expectations, have been challenged by the view
that currency crises reflect self-fulfilling prophecies that are not closely
related to measured fundamentals. Crises instead can happen under conditions
of multiple equilibria in the foreign exchange market. In this paper we argue
that recent crises reflect fundamentals, just as did crises in the past. The
trick is to identify the fundamentals.
We define a currency crisis as a market-based
attack on the exchange
value of a currency. It involves a break with earlier market judgment about
2
the exchange value of a currency. If a devaluation, which also involves a
change in the peg, does not occur because of market pressure, it does not
qualify as a currency crisis. In both cases, however, it is imperative to sort
out the inconsistency between fundamentals and the pegged rate. 1 A currency
crisis is also different from a banking panic, which sharply increases the
demand for currency, but the two types of crises may feed upon one another
(Krugman, 1991; Bordo, Mizrach, and Schwartz, 1996).
We report in section 2 the discussion in the literature of the two
competing theories of currency crises: the classical view based on
fundamentals , and the recent view based on self-fulfilling prophecies.
judgment on
For a
the validity of the competing theories we believe the crises of
experience offer guidance. In section 3 we examine famous historical
examples
of crises from 1797 to World War II. In section 4 we examine post-World War II
crises . In section 5 we offer lessons from history.
2. The Literature on Currency Crises
In the traditional view on currency crises, pegged exchange rates are durable
only as long as monetary authorities are credibly committed to maintaining
them. This requires that domestic policy always is subordinated to the
objective of maintaining
the fixed exchange rate. Under the classical gold
standard, the commitment to the fixed price of gold was credible for the core
countries of Western Europe and the United States. Speculative attacks on
1 Frankel and Rose (1996) define a currency crash in emerging markets as
a nominal depreciation of at least 25% that is also at least a 10%
increase in the rate of depreciation. Eichengreen, Rose, and Wyplosz
(1995) distinguish between a devaluation and a currency crisis. Both
are preceded by monetary and fiscal expansion and the deterioration of
other fundamentals, but in a devaluation inconsistent policies are
reversed with a change in parity, whereas in a currency crisis
inconsistent policies continue after the parity change.
3
their currencies that forced abandonment or alteration of the parity rarely
occurred.z
Under special circumstances,
such as wartime emergencies or financial
exigency, the commitment might be temporarily suspended, but the market
understood that the original parity would be restored once the emergency had
passed. These events, moreover, were rarely characterized by the type of
duress crises today are subject to. For peripheral countries, such as the
Latin American countries, however, the pattern set by the core countries is
not observed. They suspended convertibility and altered parities when
subordinating domestic needs to the dictates of external balance proved
onerous (Bordo and Schwartz, 1996) .
Of two recent interpretations of currency crises, both based on the
postulate of rational expectations, one extends the traditional view,
maintaining that speculative attacks on a currency are driven by the
incompatibility of the pegged exchange rate and expansionary domestic
financial policy, the other, maintaining that currency crises are not
necessarily driven by a conflict between deteriorating fundamentals and the
pegged exchange rate, but reflect self-fulfilling prophecies. The innovation
of the first interpretation is that the timing of the attack is predictable,
It occurs before the monetary authority has exhausted its reserves, In the
second interpretation, the timing is not predictable.
Crises may be self-
fulfilling prophecies of market participants. Because their expectations are
that the monetary authority’s policies will be inconsistent with the peg, they
2 Incipient attacks on the Bank of England and other central banks were
countered on several occasions by central bank cooperation and, more
important, stabilizing short-term capital flows by market participants
confident of the credibility of the commitment to gold parity (Bordo
and Kydland, 1996; Eichengreen, 1992).
4
take actions to force the authority to abandon the peg and thereby ratify
their expectations. Crises occur in circumstances of multiple equilibria
indeterminacy
--
-- in foreign exchange markets, in which random shocks called
sunspots can trigger an attack.
2.1. Classical Currency Crises
Two seminal articles by Krugman
(1979) and Floyd and Garber (1984a) argue
that, in a world of perfect foresight, a speculative attack on a currency with
a fixed exchange rate will occur when a monetary
the
inconsistency
a budget
deficit.
exogenous.
the point
currency
maintaining
The path
Unlike
abandonment
eince
with
the peg,
of domestic
the traditional
of the peg and adoption
at which
short
reserves
would
in anticipation
international
reserves
expands
credit
view,
authority,
domestic
a speculative
have been
are declining
attack
exchange
exhausted.
of the depreciation
pari
to finance
that
rate,
forces
occurs
before
Speculators
sell
is bound
to occur,
that
passu
credit
of
is assumed to be
expansion
of a floating
in disregard
with
the
domestic
credit
when
shadow
expansion.
In this
literature,
exchange
rate
floated,
determined
demand
zero,
determined
attack,
money
-- the exchange
-- equals
the
nominal
by the
rate
by the growth
the decline
is determined
by the
The
prevail
the attack
and nominal
supply
size of the decline
semi-elasticity
of
demand
the
if exchange
of money
occurs,
supply
rates
freely
and money
fall to
rise,
At the
equals
depreciation
rates
reserves
demand.
supply
of expected
place
interest
and money
and the money
a reflection
rates.
takes
of the growth
When
depreciates
of money
attack
that would
peg.
in reserves
in turn
interest
rate
interaction
the existing
exchange
demand,
a speculative
on a path
time
a decline
of the
in real
incorporated
in money
demand
for money.
Thus
in
and reserves
the money
5
market
is always
in equilibrium.
The equilibrium
determined.
This
exhau~ted,
attack
opposite
pegged
taking
were
rate
occurs
fundamentals,
the ratio
the
can be driven
fueled
an expansion
of a depreciation
of a trading
1976 Mexican
Argentina’s
postmortem
crises,
has been
exchange
citing
applied
(Gerlach
peg
on Mexico’s
1994
and the Finnish
strand
1992
in the
rate,
with
Chile
Chilean
exchange
in the
rate
of domestic
increase
equals
profits
of ways.
arise.
In one
credit
a jump when
the
1992) . In addition,
other
the
deficit,
current
in 1982,
authorities
account
deteriorate
argues
the
up to the collapse,
with
the extension,
currency
(Blanco
that
and
before
currency
by bailing
and actual
that
1994;
out
crises
insolvent
1986);
as the
(Dornbusch,
the
and Rose,
the attack
1989);
1996);
on
the
and Mexican
and Valdes,
of the
case
competitiveness
1982 Chilean
Goldfajn,
is a critique
crises:
the
and Van Wijnbergen,
as well
literature
damages
Eichengreen
and Garber,
(Cumby
crisis
alternatively,
for arbitrage
to hypothetical
crisis,
for arbitrage
currency;
steadily
are
credit.
and Smets,
in 1981
shadow
to rise
rates
reserves
for arbitrage
the path
and Flood,
of domestic
devaluation
crawling
Another
rates
until
in a number
over
interest
crises.
the
extended
of one country’s
partner
when
ia precisely
opportunities
opportunities
consistent
(1987),
by banking
The model
the
to GDP,
providing
opportunities
interest
real
delayed
in the domestic
Only
Bhandari,
as the
Velasco
too soon,
model,
(Agenor,
of debt
crisis.
banks
nominal
such
jump,
positions
has been
of the attack
the attack
uncertainty
in the original
collapse
would
do no further
model
permits
were
arise.
incorporating
expansion
whereas
short
would
The original
extension,
rate
staged
direction
exchange
and the timing
is so because,
the exchange
by Bpeculators
if the
is unique
classical
1995].
model
of
6
crises
currency
by a number
1992 EMS exchange
Obatfeld,
1995;
rate
appear
money
differentials
financial
Krugman
1992
variable
The
subject
domestic
This
and self-fulfilling
credit
approach
low, and
interest
the
until
environment.
choices
becomes
crisis
has been
between
are influenced
expansion
budget
of the
of the policymaking
opens
speculative
1992
is exogenous,
that
did not
adequate,
assumption
making
in most
of credibility
September
The basic
agents,
to constraints
attacked
-- a measure
1995;
critique,
were
credit
account
as optimizing
expectations,
1992 EMS crisis
occurrence
is cited
to the behavior
by market
an endogenous
up the possibility
of multiple
attacks.
can be triggered
by Flood
the classical
equilibria.
of multiple
by random
events
and Garber
currency
In Obstfeld
as an example
of fundamentals.
is the presence
from articles
that
of domestic
were
1993,
the
Currency Crises Reflecting Self-Fulfilling Speculative Attacks
unrelated
that
1994).
explain
reserves
were
and Germany
to take
are viewed
1995).
rates,
rates
to the
currencies
-- did not predict
it fails
(Obstfeld,
equilibria
EMS members
the growth
objectives,
participants’
inflation
it cannot
and Wyplosz,
According
their
exchange
(Rose and Svennson,
that
governments
and
find that
Rose,
1995).
before
pegged
monitored
because
competing
2.2.
between
model,
challenged
When
growth
markets
late August
and Rogoff,
with
who
(Eichengreen,
fundamentals
inconsistent
deficits,
crigis
Obstfeld
of the countries,
of authors,
crisis
(1986),
of a currency
The explanation
equilibria
model
and Obstfeld
could
The
on the assumption
for
exchange
approach
(1986),
accommodate
seemingly
offered
in foreign
like sunspots.
(1984b)
crisis
its
markets
derives
which
showed
multiple
that domestic credit growth
in normal circumstances is consistent with the currency peg, there are two
possible equilibria, which depend upon the expectations of market participants
7
about
monetary
authority
an attack
never
an attack
happens,
the Diamond
will
comes,
the
of rational
Ozkan
based
on unemployment
peg.
decide
to abandon
expansionary
cost of maintaining
participants
of the
central
potential
the peg,
against
Market
the cost
loss of credibility,
scenario
If unemployment
is low and the
likelihood
that
the peg will
low. Hence
there
sluggish,
external
will
likelihood
shock
is high.
that
Hence
such
it can
and an
a shock,
weighg
the
a loss of credibility.
in light
of their
of the economy
assessment
relative
of multiple
is sound,
to a
then
equilibria.
the
of an external
is high
be abandoned
are likely
in
an attack.
in the event
If unemployment
speculators
to
it, i.e.,
of the economy
the peg will
the
and a rise
the possibility
be abandoned
the expected
to output,
rate
in
function
mechanism
exchange
or may not provoke
state
a loss
of abandoning
shock
given
analysis
and Rogoff,
from potential,
cost
to
in output
and,
state
creates
be no attack.
the
choice
of the
may
that
(Obstfeld
of a large
bank,
decision
bank minimizes
of a floating
this
judgment
model
peg as a commitment
of abandoning
extends
a run on a bank
by a cost-benefit
of output
i.e. , a decline
understand
bank’s
It is this
the central
The central
(2) if
approach
authority’s
of the credibility
in favor
the
(1) If
expectations.
In a typical
in the event
attack:
indefinitely;
-- whether
the monetary
the currency
policy.
runs
is determined
1994),
but
the peg
monetary
unemployment,
models,
survives
Essentially
of bank
or the deviation
low inflation,
rate
collapse.
peg or float
adopts
of a speculative
on depositors’
and some measure
The authority
maintain
may
depends
and Sutherland,
rate,
exchange
expectations.
1996;
inflation
in the event
(1982) model
equilibria
the currency
a world
fixed
system
not occur
In multiple
maintain
the
and Dybvig
or will
actions
shock
is
and the economy
is
in the event
to attack
the
of an
currency.
8
The
attack
may
be triggered
an increase
in interest
temporarily
repulsing
weakening
effect
likelihood
affect
likelihood
to the peg under
could
economy
were
The
interest
rates
with
situation
that
competes
makes
of a speculative
As noted
the
rates,
thereby
debt,
Similarly,
interest
above,
the
rate
response
succeed
1992,
increase,
may be path
(Kenen,
future
bank which
is
in
but the
heightens
the
dependent,
1996) . Past
attacks
had high
(Davies
if the
can
adherence
and Vines,
credibility
on its currency
and Masson,
in the
state
of the
1994) .
is not the only
speculative
system
factor
attack.
debt,
(Obstfeld,
the commitment
attacks.
that
could
Another
mortgage
1994).
create
factor
interest
Concern
to maintain
is rising
rates,
for each
a peg,
and
of
and creates
the peg prohibitive
caused
of the September
Obstfeld
of the
the government’s
the devaluation,
on the Swedish
on unemployment
(1994)
16 September,
a devaluation
threatening
the attacks
events
Wednesday,
expecting
which
rates
it may
in September
which
forestall
on government
with
If the
in the event
attack.
lira on Black
participants,
bank,
cost of maintaining
of self-fulfilling
Italian
term
(Drazen
of the banking
did
interest
to an attack
effects
heights,
of an attack
a central
of the economy
objectives
model
help
for a self-fulfilling
stability
these
success
be exposed
bad enough
state
conditions
the
still
hand,
event.
attack.
central
the gun may
1995) . On the other
past
and
as Sweden
of the
successful
of the
trivial
to astronomical
on the economy
credibility
the
rates
the attack,
of a later
The
by a seemingly
and the
1992 EMS
crisis
explains
the
in this
lira,
ability
reflected
stability
attack
to roll
their
the
on the
Market
bid up domestic
and validated
krona
way.
spawned
over
interest
its short-
expectations.
the effects
of the banking
of high
system.
The
a
9
rise
in German
triggered
interest
~elf-fulfilling
Sutherland,
fulfilling
attacks
that what
occasioned
would
therefore
The
would
news
race
(Buiter,
other
strategy.
evidence
the outcome.
Dornbusch,
money
that
and
and debt
1993).
would
patterns
become
was
“rules
more
preceded
refused
attacks.
collapse
is
arrangements
reunification
to reflate,
moderate
there
and the
devaluation
of the EMS,
market
suggest
were
(Krugman,
that
all the EMS
1996;
the market
the exchange
by surprise
crises,
of
augured
of unemployment,
for virtually
shock
is no dearth
as in earlier
deterioration
rapid
and the
the peripheral
of German
of the game”
explanation,
ratios
policies.
members.
in the EMS crisis
to GDP
shock
a coordinated
on individual
reunification
These
crisis
of the
includes
and among
The Germans
to adopt
self-fulfilling
fundamentals,
the
rate
is
(EMU) and
led to the
the cooperative
countries
1996).
unwilling
attacks
EMS
Union
in June
September
that
argument
devalued,
conservative
for the EMS exchange
perceptions
The
if members
Monetary
to adopt
in early
for self-
1993).
on the referendum
following
the breakdown
the German
the
down
that,
to the European
“no” vote
to market
The evidence
growth
Moreover,
factor
(Ozkhan
responsible
and Wyplosz,
an incentive
and Pesenti,
were
competitiveness,
following
was the
currencies
held
the belief
explanation
broke
to the
that
was
and the peripheral
staged
Contrary
have
systemic
Sensing
participants
attacks
on the referendum
themselves
countries
(Eichengreen
of the Danish
Corsetti,
has been
for admission
a response
Germany
countries
the
in France
it was
between
reunification
on EMS member
itself
on the EMS
no longer
A different
that
attacks
Treaty
not qualify
adverse
tight
following
1994).
The Maastricht
they
rates
political
Branson,
devaluers,
1993;
anticipated
rate
that
unpegged.
developments
(the
10
results
of the Danish
marketa
assessed
the
For Krugman
distinguishes
that
they
do not
his model,
will
that
on a more
that would
a predictable
and that
produces
deteriorate
loss function
speculative
deteriorate
attack
of fundamentals
is uncertain,
but the range
speculators
attempt
even
rate.
fact that
The
markets
it is bound
logical
important
about
to happen
context
arises
equilibria
the
Historical
The examples
expectations
case
in which
then,
they
just
in
as in
if the evaluation
Moreover,
will
limit
the
historians
That
approach
Examples
we briefly
policy
objectives
equilibria
events
task
involves
function
is a useful
of Currency
describe
way
important
inconsistent
in foreign
not mean
have
is to uncover
and a pegged
is less
pursue
does
crises occur
currency
that
been
can also be explained
and the preference
classical
that
if governments
the events
for economic
process
3. Famous
that
and the equilibrium
be narrow.
of the attack
of multiple
In every
lead to inconsistency.
political
domestic
the timing
of rational
prophecies,
task
between
possibility
occurred.
fulfilling
that
Doubt
in a world
actually
from multiple
time,
follow,
will
but
is not
If the parameters
over
equilibria
it is incontrovertible
of inconsistency
exchange
to profit
will
that
more.
In our opinion,
because
the way
equilibria,
function
predictably.
of multiple
range
altered
models
multiple
objective
A possibility
who
have
of the new crisis
sophisticated
fundamentals
authority’s
be unique.
the key aspect
from his own,
are based
the monetary
referenda)
fundamentals.
(1996),
them
assume
and French
they
world
an understanding
to study
exchange
have
as self-
fundamentals.
the real
The
forces
of the
authorities.
currency
In this
crises.
Crises
in this
section
were
the
policies.
explained
by
of monetary
than
crises
affecting
11
currencies
linked
metallic)
epecie
to
standard.
The
case was typical.
money
creation
maintaining
restraining
features
of only
in order
those
that
might
be the correct
fiscal
occurred
policy
High
collection
optimal
printing
could
if monetary
accounted
case the
common
crucial
create
tax
behaved
element
objective.
must
be retired
taxes
(Vegh,
varied.
failing
to
or
capturee
French
crises
the
franc
as well.
be distinguished
from
of convertibility
to pursue
The
should
an optimal
classical
finance
in peacetime
in wartime
No
standard
rates,
a suspension
government
theory
wartime
(Barre,
might
also
of
1979) .
make
it
1989).
were
financed
taxation,
borrowing,
stability.
Moreover,
wartime
of specie
reserves,
even
arrangements
(the
or external
prudently.
or adventitious
for reserve
to other
the authorities
for currency
internal
Treasury)
authorities
or external
would
loss
deficits
1923-26
(or
a loss of
authority
interest
and seigniorage.
expenditures
authorities
Independent
The
inflation
was
In wartime,
of conventional
how wartime
press)
exigencies
mutiny)
costs
in wartime
a rational
which
reserve
budget
- the
in some respects
that
was
to the commodity
crises
borrowing,
the
government
adhering
to allow
crisis
of the monetary
individual
policy,
debt,
to use the
Thus,
Us.
with
produced
or raising
in peacetime.
postulates
when
occurred
of taxation,
tax smoothing
expenditures
that
that
growth
it applies
a link to) a gold
of an impending
to finance
monetary
crises
of restoring
portrayal
rates,
one of the
-- although
Currency
symptom
stylized
low interest
required
crisis
The usual
The circumstances
reserves.
ltiit
(or in the process
drains
Sometimes
events
legal
(enemy
invasion;
the
military
losses.
in the
individual
episodes
confronted
the dilemma
Giving
up the external
we review
of choosing
objective
between
is that
the
in each
internal
-- convertibility
of
12
the currency
into the weight of specie specified by the fixed exchange rate --
constituted the currency crisis. Besides
descriptions
that
follow
each
show,
the common
episode
element,
had unique
as the
features.
3.1. John Law’s Operations, 1716-20
John
economic
Law
in 1705 theorized
project
that
would
employ
raising
support
by establishing
a note-issuing
to take
over
on trade
conglomerate
right
with
company
to collect
He also bought
refund
all French
it at an interest
a major
economic
shares
1720 share
holders
converted
above
of the bank,
terminated
below
debt,
Law’s
trade
ones
at market
a company
the tobacco
Europe.
new coinage,
and then
prices
by the
state
while
The
and the
direct
below
the conglomerate
theory,
the Regent’s
outside
to issue
indirect
with
adding
a major
real wealth
and organizing
then
right
that paid
in the company,
their
100
made
began
gains
livres.
of the
led the bank
shares
into banknotes.
note
had disappeared.
the bank
into
specie.
price
to peg the price
The pegging
circulation
At the
10,000
taxes.
par,
to
collecting
never
Law
countered
for payments
by note
creation.
at 9,000
operation
and price
same time
Law
its note
livres
1720 the company
legal tender
stock
increased
to fall below
In February
its notes
support
tender
national
Despite
prices
decline
legal
first
in France
all French
the
finance
undertook
project.
January
payments
taxes,
rate
service.
To sell
stock
in 1719 purchased
could
and expand
in 1716,
Louisiana,
and finally
up the French
the government
the
Africa,
to work
bank
with
creation
resources
He put the theory
a monopoly
trade
currency
unused
without
monopoly,
prices.
that
livres,
ended
level
per
share,
as
by prohibiting
took
above
over
100 livres,
intervening
1720,
had doubled
steps
specie
management
The ensuing
in May
in several
By
issue.
and
price
to convert
by which
and the
devalued
time
specie
specie
13
in terms
of livre
that Richard
Cantillon,
incompatibility
banknotes
specie
domestic
to buy Dutch
proved
reserves
forced
Law to reverse
and a quick
collapse
occurred
to December
1720.
price
declined
level
the
share
as in May
even
The note
1719.
who
recognized
and the exchange
by evading
rate,
the
sold
the exchange
controls
A run on the Banque
Royale’s
his policy,
precipitating
Law presided
from its peak.
reappeared
(Garber,
over
a massive
a deflation
fell by 56% by October
fell to 500 livres
of 1720
is evidence
loss
of his operations.
circulation
Specie
There
and economist,
right.
though
by one-third
price
had at the beginning
Cantillon
collapse
controls.
operations
guilder
Events
The
price
Law’s
exchange
financier
1987).
of confidence,
power,
the French
between
and managed
(Murphy,
and imposed
tournois,
Following
in September
and was
his
1721,
revalued
1720,
fall
about
from May
and the
from
the
same
to the definition
it
1990).
3.2. England, 1797
The Bank
when
the
of England
its bullion
start
O’Brien
between
gold
reserves
external
drain
to a metallic
internal
drain
landed
suspension
Finally,
France,
of war
finance
by a premium
in February
a handful
of men
(because
after
to
finance.
in the
in France
assignat
suspension,
to
increased
from
face of a massive
inflation),
the
at
its
(marking
scare
the government
1793,
The tension
convertibility
of an invasion
in Ireland),
Soon
war
1797,
According
in response
collapse
on gold
the disastrous
1797
of convertibility.
and specie
27,
In February
at E4 million.
by the Bank
the Bank’s
on February
El million.
the government’s
to prevent
after
standard
it had stood
actions
hindered
occasioned
currency
the gold
fell to just above
contractionary
the exigencies
1793 to 1797.
frigate
reserve
of the war with
(1967),
dwindling
suspended
its return
and of
when
a French
authorized
Bank
an
the
was prepared
to
14
resume
payment,
renewed
year
but the government
after
year
until
and the
demurred,
1803,
when
act of suspension
it was extended
until
was
six months
after a definitive peace treaty had been ratified.
3,3. The United States, 1861
War broke out in April 1861. When Treasury Secretary Salmon
The Civil
Chase
took
office
in March,
and Boston,
who
government.
Immediately
coin,
the
issue
3-year
national
large
agreed
remainder
Treasury
in coin.
This
secretary
In New
net
government,
fall
which
a priority
City
the banks
weekly.
By 2 September
charged
them
interest
loan certificates.
exchanged
began
some banks
daily.
To escape
the
the banks
to
from the
the government
to the
Independent
the proceeds
to subtreasuries
1861,
needed,
of
to permit
but
the
he accorded
of the banks’.
to keep
House
subtreasury
had a deficiency
interest
loan certificates
a specie
tried
$35 million
On 19 September
the
until
agreed
in
for other
operated,
on 5 August
to the
Treasurers
had to be transferred
had agreed
to pay the
and
According
the banks
On 19 August
each
secretary
to give
notes
payments.
and the Clearing
short.
and banks
treasury
ahead
The
intended
act was repealed
Philadelphia,
to the Assistant
the Treasury
with
York,
and to reimburse
was
to by banks
of New
of $50 million
as needed.
notes
specie
the proceeds
liabilities,
would
deficiency
under
of the
needs
York
in coin
maturing
subscribed
much
advances
arrangement
to redeem
to leave
the Treasury’s
The
the banks
$5 million
or Treasury
and to maintain
loans
three
paid
to be paid
Act of 1846
government
specie
they
subscription.
disbursements,
against
to make
7.30 bonds
sums needed
he met with
P.
was
to assure
credited
for gold.
no bank’s
to the
in specie
and the Clearing
House
the banks
of 25%
that
$3.5 million
the Clearing
charge,
reserve
House
began
with
On 1 October
to issue
the
the
second
15
$35 million
November,
of treasury
another
registered
loan of the
bonds.
certificates
(These
specie
specie
credit)
of the
that
The
premium
(Myers
paper.
would
demand
notes
followed
suit.
of an overissue
in international
of the
secretary.
have
of specie
that
and on 16
half
value
(greenbacks),
in
the
loan
the banks
of paper
reserves.
Given
further
It is important
Independent
suspended
to note
money
It occurred
the magnitude
that
(domestic
Treasury,
a suspension
eventually
payments
Resumption
bonds,
to 90% of their
At the end of the month,
it is likely
crisis
suspension
over
issued
peculiarities
followed,
in coupon
banks,
issued. )
because
of the treasury
a currency
amount,
collateralized
House
a decline
institutional
issues
half
and the Treasury
forced
inflexibility
same
secretary
did not occur
that
to the New York
from the banks.
payments,
suspension
with
the
was allotted
issues
the Clearing
In December
draining
notes
because
and the
of the greenback
of payments
associated
occurred.
in 1861
of payments
immediately
did not occur
put gold
until
at a
1 January
1879
I, 1931).
3.4. U.S. Currency Weakness, 1894-96
legal
In the
context
tender
Treasury
Silver
Purchase
the U.S.
finance
tenders.
dollar
of a U.S. budget
for redemption
of 1890,
surged,
in legal
threatened
attempted
offering
for public
the
the Treasury
increase
Treasury
despite
to restore
repeal
tenders
subscription
and the
about
that
its stock
outstanding,
reserve
$50 million
however,
in 1893.
and
and November
5% bonds.
of
To
legal
when
to at a minimum
10-year
of
the Sherman
Act
of gold
In January
creation
the convertibility
of the Sherman
reserve.
its gold
1890
in coin,
uncertainty
ran down
the gold
after
redeemable
Act of 1890 mandated,
the deficit,
The
Notes
deficit
presented
1894,
the
$100 million
The
by
subscribers
16
used
legal
to obtain gold to pay for the bonds with no increment to
tenders
the gold reserve. In January
reduced
the reserve
Stymied,
coin
banking
on terms
Treaaury
restore
the gold
syndicate
to redeem
legal
London
in gold
to sell
syndicate
withdrawn
exports
the
the bonds
five months
campaign
resumed
in response
reservea
declined.
dollar
eased,
The crisis
speculative
as only
6%
advantage
devaluation
(Grilli,
of $68.8
the contract
in 1896,
rose,
domestic
strength
the
of gold
gold
exchange.
delivered
a month.
withdrawala
and borrowed
paid
exchange
the exchange
in
market.
The
million.
was
signed
1895,
syndicate
no gold
when
was
agricultural
was dissolved.
During
of gold
and gold
of the pro-silver
forces,
and gold
won
out
an additional
accumulation
the Republicans
the
to
ounces
It delivered
controlling
for a total
credit
300,000
against
the
and provide
gold
ounces
with
the election,
pressure
exports
on the
time permanently.
gold
standard
and the probability
1990).
of obtaining
(Garber
3,500,000
for legal tenders,
imports
of the U.S.
attack,
tendera
him to purchase
issue
intereat-free
the Treasury
after
authorized
4% bond
At the end of August
gold
to the
Once
this
for legal
contracted
not exceeding
effectively
from the Treasury.
the electoral
of the
or sold to obtain
in exchange
and associated
a 30-year
at a rate
to protect
in New York,
marketed
During
One-half
secretary
a law which
to market
from Europe
tenders
under
line of short-term
reserve.
agreed
$25 million
syndicate,
a 6-month
waa to be shipped
The
1895 the Treasury
he negotiated,
with
in exchange
to $45 million.
in February
Belmont-Morgan
1895 a run on gold
The episode
a line of credit
and Grilli,
1986).
in 1894-96
of the timing
has been
haa been modeled
of the
interpreted
in foreign
currency
attack
as a
eatimated
as displaying
to avoid
a
the
17
3.5. Crisis of 1914
What was distinctive about the 1914 crisis, on the outbreak of war,
unlike earlier gold standard wartime crises, was the breakdown of
international clearance through London that followed. Indeed, it was a crisis
in the sense of a disruption of the foreign exchange market but different from
others in not being
external
balance.
worldwide
gold
Under
ready
Moreover,
standard,
these
for panic
demands
balances.
been
Foreigners
were
established
in the
as a result
to replace
down.
Stock
worldwide
their
Exchange
new
sterling
Fearing
a
securities,
in any event
remittance,
of a
continued
sterling.
to liquidate
in gold
to be
deprived
by refusing
and obtain
Payment
was
not replenish
the London
international
market
loans
and gold
would
embargoes
worldwide.
By 1 August
the
houses
letter
of indemnity
limits
of Peel’s
Bank of England
and the Stock
had raised
Exchange
from the Chancellor
Act.
from banks
at Bank
closed
the entire
short-term
responded
could
and
in isolation.
their
houses
face of an attempt
everywhere
inadequate
rate.
acceptance
internal
affecting
discount
securities
have
Bank
The London
to sell
exchanges
acceptors
for cash.
contracted
it was possible
stock
discount
just one country
banks
between
crisis,
While
collapse
withdrawals
a systemic
ceased.
price
to discount
an inconsistency
credits
Long-term
to operate,
and not
The London
credits.
with
it was
conditions,
flow of new bills.
acceptance
associated
rate
postponement
The Treasury
bills
of payment
On 5 September
Currency
On 13 August
occurred.
approved
to replace
to permit
issued
the Bank
Bank
accepted
on maturity
announced
rate
call
issue
before
loans,
beyond
although
4 August
it would
loans
and gotten
of England
on condition
that
10%, made
of notes
Notes,
the Bank
to
a
the
no panic
undertook
to
and granted
of paying
have
funds
2% above
for
18
repayment of all pre-moratorium
acceptances, thus enabling acceptors to meet
their obligations at maturity, and the banks agreed to finance discount of new
bills. The reopening
of
the London
the end of the transactions
In New York
drain
gold
relieved
lack of sterling.
however,
New York
falling
demanded
September
sterling
gold.
pool
international
rate
strong
in terms
of the belligerent
dollar
exchange
rate
During
the
of the year
melting
was pegged
of gold
sell gold
of gold
note~
reached
was
Defense
coin,
and
against
was
on 1
arranged
obtained
of goods
par.
complete
knowledge
of dollar-
by remittance
the exchange
the gold
7/16,
export
was
rate
would
free
international
movement
the dollar
in January
it illegal
In the United
1919.
of gold
States.
1916,
1916,
market,
a key
States,
of the war.
prohibited
to buy
or
feature
of
the export
Interconvertibility
were
was
sterling-
for the rest
1918, made
1917 to June
sterling-
to the United
but
of the bullion
the
1914,
Act on 5 December
suspended.
from September
over,
in 1915 the
point
it was held
of the Realm
The operation
Early
depreciated,
where
took
By December
currencies.
and the Act of 18 May
standard,
licensed
and gold
for the
London,
from day to day what
sterling
at $4.76
the
gold
They
Act banknote6
needed
York
to
of exchange.
had to be settled
and passed
fell below
at a premium.
a functioning
of $100 million
movement
exchange
In Britain,
in New
was
banks
shipped.
dollar
sterling
led interior
rates
marked
had created.
a solution
credits
New York.
knew
of war
1915,
The Aldrich-Vreeland
but
provided
that
The banks
wartime
rest
banks.
on 4 January
market
at provisional
A gold
indebtedness
gold was
When
banks
in and outside
exchange.
be. Little
of the money
for currency,
due abroad
by banks
of international
demand
Exchange
the outbreak
correspondent
the domestic
obligations
impasse
the breakdown
from their
Stock
suspended
of
in both
19
countries
(Brown I, 1940).
3.6. French Franc Crisis, 1923-26
When the franc was unpegged in March 1919, its exchange value declined
eharply ae the government seemed
1920,
signaled
however,
repayment
of Bank
a shift
of France
limit
on the government’s
franc
reflected
cente
over
this
the next
The national
reputation.
latter
from Germany
readinese
advances
borrowing
on an annual
in fiscal
was divided
reconstruction
after
hyperinflation
of France
under
reaction
to which
the
fell to 3.49
which
reserves
of foreign
to 6.71
increased.
balanced,
epecial
was defused
at the Bank
rose
government
debt
loans
8.99
cente
it required
imposed
the
a legal
rate
from
under
expenditure
issue
there.
of the
6.27 to 8.99
cente
The credits
assured
the Dawes
turned
in October
and a special
expected
budget,
Germany’s
value
By December
of the
1922,
the
was
E4 million
used
few weeke,
that
1925 brought
short.
The
the
unable
1920,
in
a pledge
franc,
would
be
on to finance
failure
down
and
exchange
budget
counted
the franc
franc
month
against
foreign
the ordinary
that were
out to fall
that
to support
and
franc,
1924.
of new taxee
and
the
to be recoverable
concerning
in March
were
Plan
franc’e
of the Law of 31 December
imposition
the next
for the
In 1923 the government
the terms
The new taxes
problem
on the exchange
of $100 million
during
were
Doubte
in April.
by the
of France.
but payments
budget
franc
that
developed
the Bank
of gold
and
rising
affaire,
had an effect
to repay
negotiation
in that
The exchange
a special
Treaty.
to 5.25 cents
crieis
law of 31 December
basis,
into an ordinary
expenses
the Versailles
from
posed
declined
The
policy
from the Bank.
however,
to pay reparations
especially
The
five quarters.
budget,
under
on inflation.
to deflationary
improvement
The budget
detailing
bent
from
of a
4.7 cents
in
20
September to 2.05 in July 1926. Only with
as premier
in office
to 3.95
and
minister,
had proposed,
cents
exchange
finance
by the
rate
was
who opposed
financial
appointment
a capital
stability
end of the year.
at that
the
of Raymond
levy his predecessors
restored.
The Bank
of Franc
level.
The de facto
stabilization
of the
French
gyrations
Poincare
The
franc
then
pegged
became
rebounded
the
de jure
in June
1928.
Interpretations
aspects
of the experience:
government
excessive
debt
to honor
importance
its debts,
spending,
to rise
the
the
as they
fiscal
failure
should
have,
not restored,
political
unsettled
Frenchmen
foreigners
Krugman,
1991;
Eichengreen
of these
interpretations,
causes
related
disappointment
(Brown
Rather
we are willing
between
then
rates
the
to settle
taxes
parity
left and right
giving
pride
of
or
on government
prewar
Makinen
different
ability
to inadequate
that
I, 1940;
emphasized
in the
interest
infighting
1992).
have
of confidence
of short-term
franc was
and
franc
of the
that
and Woodwardr
of place
1989;
to any one
for all of the above.
3.7. Sterling, 1931
A succession
to gold.
In the
of
political
first
half
from depression-increased
trade
balance
shrank
from shipping
trade.
and
Reserve
E150 million,
holiday,
observers
crisis
next month
rates
in May
banking
deposits
with
the
gold
as a critical
capital
budget
The
in Germany
contraction
reserves
and the
in Vienna
made
link
resulted
invisible
fell,
minimum.
flight
of E5 million
difficulties
sterling’s
investments
1930 brought
regarded
fiscal
insurance.
on foreign
declined
unhinged
in the
on unemployment
precipitated
British
shocks
a deficit
services
starting
a level
of a banking
The
outlays
as interest
losses
banking
frozen.
of 1931,
financial
the Austrian
and economic
and
income
of foreign
down
In May
to under
1931
announcement
were
thereby
E70 million
of
21
German
debts
investors
to British
repatriated
bank
in July
fall
in sterling
rate
was raised
below
twice
was
On 1 Augustr
Labour
tough
replaced
achieve
budget
investor
in July
the May
balance
decisions
suspended
convertibility
German
of Germany’s
Committee
against
forecast
large
taxes
the budget
largest
Report
major
led to a
currencies.
changed
Bank
again
The
among
before
With
crowning
reserves
that
and Paris
personnel
that
over
The
on 23 August,
on 10 September
event
would
expenditures.
resigned
New York
navy
deficits
and reduce
problem,
Though
did not halt.
budget
Its attempt
coalition.
was unsuccessful.
to
provided
disturbed
pay cuts
that
the Government
dwindling,
on 19 September.
of analysis
of the events
devaluation
themselves
do not explain
invocation
also
and Hsieh
1995).
Britain’s
reserves
came
investors’
of international
It is hard
up to Britain’s
devaluation
political
to believe
to the point
leading
as a surprise,
of devaluation. 3 That
large
as well
that
did not
were
seems
departure
fundamentals
expectations,
investors
investors
as by fundamentals
and that
and economic
of exhaustion
the probability
and small
point
to raise
to solve
as a mutiny.
described
is that
export
was disaffection
the press
from gold
closing
of the Macmillan
Committee
run on sterling
One vein
The
funds.
same time
from 2.5% to 4.5% but not
by a multiparty
confidence
and at the
suspended.
unable
Government,
the
London
the gold
political
and was
loans,
their
uncollectible,
and the publication
convertibility
require
banks
events
requiring
(Eichengreen
who were
running
associate
that
influenced
by
down
loss with
by events
to us uncontroversial.
The
3 Violations
of credibility
bands (bands within which uncovered
interest
arbitrage prevails consistent with gold point arbitrage
efficiency)
for the dollar/sterling
rate, estimated for the interwar period, begin
after June 1931 (Officer, 1996),
22
other vein of analysis that emphasizes self-fulfilling balance-of-payments
speculative attacks does not fit the facts of sterling devaluation
in 1931.
3.8. The Dollar Crisis, February 1933
From
was well
taking
the date
known
the
of Roosevelt’s
that
dollar
he and his advisers
off the gold
position
to attack
the dollar.
earmark
in New York
or moved
claim.
Fears
States
held more
moreover,
year
gold
amounted
in surplus;,
holdings
U.S.
that
foreign
bankers
were
British
bought
amount
of gold.
was
to 40% of total
gold
held
were
not
deposited
reserves;
three
times
by foreigners
of
in a
they
unfounded.
The
at the beginning.
it
under
all the gold
had proved
investments
way.
there
Private
gold
selling
could
United
U.S.
the trade
gold,
balance
was
as great
as its gold
amounted
to one-fifth
of
withdrawals
of
exchange
The enormous
zoomed,
legally
required
Federal
Reserve
40% of gold
Bank
short,
buying
of Federal
to outstanding
holiday.
exporting
with
lacked
to offset
Reserve
notes.
the
notes
explains
gold.
Private
The
a corresponding
expertise
speculation
as the
reserve
Panic
they
the proceeds.
and earmarked
the System’s
at the end of February
for a banking
began
unfortunately
serve
reduced
domestic
by the threat
sterling
staff
that would
issue
alarmed
for sterling,
Reserve
temporarily
lay in possible
represented,
offered
The Federal
ratio
was,
investors,
policy
dollars
the dollars
deposit
the demand
had already
drain
1932,
the possibility
countries
own countries
world
securities
flight.
in foreign
under
foreign
if danger
Roosevelt’s
dealings
to their
considering
Foreign
In 1932 they
in November
investments.
or capital
perceived
were
standard.
of a European
merican
The danger,
gold
at the polls
at the end of 1932 than
and U.S.
were.
victory
that
currency-
ratio
at the New
its eagerness
in
below
York
to join
the
23
Disconnecting
the dollar
from gold
on the depression-racked
U.S.
United
to take,
States
currency
was
crises
3.9. Gold Bloc,
forced
in other
Poland,
and Switzerland)
into gold
represented
an ever
and resistance
parities
need
flows
ability
of the bloc
foreign
trade,
situation
remaining
Belgium
firm
Poland
and experienced
the only major
For them
barrier
adherence
followed
for domestic
the
austerity
first
standard
to surmount.
controls
itself
Their
sterling
in many
of maintaining
countries,
their
Holland
because
France,
In April
governments
Agreement
In September
with
dependent
France
the pressures
trade
was
mainly
Front
to combine
1936 France
the British
on
was
in
while
that
with
its
deteriorated.
and Switzerland
Popular
it tried
in the
credit
had markedly
Holland,
1936, the
had done,
and failed.
bloc
1935.
domestic
escaped
its foreign
of the gold
heavily
in March
to expand
expenditures.
of confidence
Belgium,
the bloc
but tried
controls.
the Tripartite
parities.
commitment.
losses.
of its parity,
Holland,
freely
by rearmament
of the erosion
their
condition
exchange
defense
still
from the depreciated
was undermined
to abandon
experienced
As previous
ones
policies
effects
as Belgium,
gold
Belgium,
to the gold
to the deflationary
to sustain
France.
negotiating
the
1992).
By 1936 the
imposed
influence
an action
that
(France,
exchange
in its gold
and France
colonies.
were
was one manifestation
was
countries
States,
for fiscal
flight
Bloc
to the United
at home
Capital
same
in no way
the devaluations
in face of competition
(Eichengreen,
The
the
in 1935.
higher
mounted
bloc , capital
unlike
it was
a stabilizing
countries.
of the Gold
convertible
difficulties
but
have been
1935-36
The currencies
Italy,
economy,
may
came
did
to power
reflation
devalued
and Americans
not,
and
after
not to
in
24
engage
in competitive
devalued
devaluations.
and joined
the Agreement
The other
Gold
(Eichengreen,
Bloc
1990).
countries
when countries
Again,
found internal policies incompatible with external commitments,
had to choose
between
4. Post-World
War
each
rate
member
era
the
country
within
1% of its parity
were
It was
conditions
of currency
cases
crises
crises
that
that
declared
or gold.
required
proved
followed
internal
attempts
to maintain
Currency
with
float
Under
for its currency
the dollar.
incompatible
the Bretton
post-1973.
to intervene
in the managed
of failed
punctuated
a par value
with
favored
they
finally
stability.d
Crises
from those
dollar
economic
and the choice
II Currency
We distinguish
exchange
them,
also
crises
the chosen
period
to peg exchange
after
Woods
pegged
Bretton
in terms
Woods,
of the
its exchange
arose
when
parity.
Bretton
rate
domestic
The examples
Woods
collapsed
rates.
A. Bretton Woods
4.1. Sterling in Crisis, 1947-49
Britain,
World
War
as was the
II with
case with
a massive
other
European
balance-of-payments
belligerents,
deficit
in gold
emerged
from
and dollars.
To ensure that she would ratify the Bretton Woods Articles and quickly restore
current account convertibility, the United States and Canada extended a $5
billion
loan.
The ensuing
a month.
Britain
restored
run on sterling
Convertibility
was
current
depleted
suspended
account
convertibility
the U.K. ‘s reserves
on 11 July
by $1 billion
1947.
within
on 20 August 1947.
The return to the pre-World War II parity of S4.03 without accounting for
4
Political factors, such as the ascendancy of a left-wing government
and a politically dependent central bank, according to Simmons
(1994), led governments in the interwar period to abandon their
external commitments.
25
the change
in competitiveness
for the crisis.
confidence
setting
These
conditions
in the official
the
stage
Sterling
that
had occurred
did not disappear.
exchange
for a speculative
was
created
In the
rate of sterling
the
condition6
summer
weakened
of 1949
markedly,
attack.
an international
protect its inconvertibility
since
currency,
with
exchange
controls
to
into dollars. Nonresident holders of
inconvertible sterling, however, had an incentive to get around British
exchange controls, for example, by selling sterling for dollars at a rate of
exchange that was lower than the official rate, then using the proceeds to buy
dollar goods that could be sold at a profit. The buyer could
goods
cheaply.
sterling
Speculating
was devalued
on devaluation
was
a sure bet.
purchase
sterling
On 18 September,
to $2.80.
4.2. Sterling in Crisis, 1967
Internal and external objectives were on a collision
in Britain.
produced
Expansionary
inflation,
international
Government
instead
fiscal
adopted
under
pressure.
payments
assumed
was
evidently
price
to promote
in the current
account,
and declining
in October
on imports,
in the
spring
not possible.
incomes
leaving
loan,
and
followed.
growth
in July
of 1966,
policy
was enacted.
strike
was
and
unchanged.
contractionary
temporarily
and improving
A seamen’s
The Labour
policies
1965
improved
sterling
was
the balance
in May
announced,
Foreign
1964 on
employment
devaluation,
internal
outflow
and summer
monetary
policy
sterling
1964 opposed
on capital
faster
Deflationary
and
against
IMF and G-10
Reconciling
a run on sterling.
compulsory
policies
and restrictions
but
from
fiscal
office
a surcharge
situation,
and
Speculation
a $4 billion
measures
external
a deficit
reserves.
that
In November
monetary
course
again
of
and June
and a
central
the
banks
led to
26
provided loans this time. From May 1967 onwards
Talk
of a possible
and the balance
November
British
devaluation
of payments
preceded
deteriorated.
by one day devaluation
4.3. French Franc in Crisis,
In May
throughout
became
1968,
student
the country.
widespread
An enormous
in sterling
as unemployment
run on sterling
of the pound
ebbed.
to
rose
on 17
$2.40.
1968-69
riots
The
confidence
in France
settlement
touched
raised
off
hourly
strikes
wage
rates
and
lockouts
by
11%,
shortened the work week, and provoked a flight of capital into D-marks and
gold . France tightened price controls, restricted imports and some external
payments,
Credit
from
introduced
restrictions
francs
markets
subsidies
replaced
to D-marks
for exports,
these
and
measures
intensified,
imposed
exchange
in September.
and on 20 November
controls.
In November
major
European
a flight
exchange
shut down.
Between
exchange
April
reserves.
and November
France
France
cut public
lost
$2.9 billion
spending,
increased
of its foreign
indirect
taxes,
imposed ceilings on corrunercialbank lending, and raised interest rates. Yet
these measures did not suffice to reduce the growing deficits in the French
current
account
during
tightened
restrictions
purchase,
and
France
in July
incurred
reserves,
first
on bank
froze
short-term
however,
was devalued
the
funds
raised
for public
minimum
The
again
TO resist
The drain
French
French
requirements
investment.
of $2.3 billion.
On 10 August
continued.
of 1969.
resistance
for hire
devaluation
on French
ended.
The
franc
by 11.11%.
Successful
banks
credit,
debts
4.4. U.S. Dollar in Crisis,
central
two quarters
operation
intervening
1960
of the
with
Bretton
their
Woods
system
own currencies
depended
against
on foreign
the dollar
to
27
maintain
par values,
at $35 an ounce
balance
in transactions
of payments
parities
and the United
other
countries
that
added
weakening
U.S.
balance
of the U.S.
of the
gold
system
declined
holders
that
the
A focu8
1960 was the first
of its total
denominated
account
about
A portent
year
liquid
in which
U.S.
liabilities
gold
to all
Bank of England
Bank
Bank’s
the
internal
getting
victory
over
capital
payments,
outstanding
when
intervene.
agreed
foreign
to move
at the
controls,
to alter
dollars
ahead.
1960 triggered
Gold
the monetary-fiscal
given
with
Bank,
concerns
sold
and
gold
of gold
to
to
occurred
the price
reaching
reserving
for the
after
measures
and to enlist
the election
of the
to improve
mix,
to stem
the Federal
it would
rhetoric
administration’s
The response
policy
that
his campaign
losses
in the
price.
to institute
into gold,
to the
banks
not willing
in the price
On 27 October,
objectives,
fixed
a rise
was
central
in the market.
in November
external
initially
to sell gold
of a lack of confidence
convertibility
to adopt
Hencer
did not
The
Treasury
on intervention
the economy
an expression
for dollars.
but the U.S.
the Treasury
the decision
favor
gold
holdings.
Bank
Kennedy’s
gold
bought
the price,
$40 an ounce,
reserves
pressure on the U.S. dollar was the London gold market. In
of
investors
in October,
future
in dollars.
private
the
sustainability
of the troubled
as European
restore
a steadily
the
March 1960, the price rose above $35 an ounce,
stabilize
The U.S.
of other
to produce
doubts
gold
by the exchange
surpluses
tended
and growing
to buy or sell
authorities.
largely
reserves
commitment.
ready
monetary
Current
dollar
of payments
level
of assets
foreign
established.
to their
standing
was determined
convertibility
was
below
with
accordingly
countries
States
about
were
seen
commitment
to
administration
the balance
conversion
Reserve
as
of
of
in foreign
was
28
exchange
market
intervention.
describe
in the
currency
these
crisis
a decade
of the Bretton
later
Woods
underscores
the
system
that
failure
we
of
stratagems.
The dollar-based
expansionary
middle
rate
The collapse
monetary
of the
1960s.
stability
imposing
international
Other
policies
countries
at the cost
on the rest
sake of their
and fiscal
monetary
own domestic
price
the United
faced the
of a level
of the world,
system
fated
States
choice
of inflation
or giving
was
the
up fixed
to succumb
adopted
by the
of maintaining
United
exchange
States
exchange
to
was
rates
for the
stability.
4.5. Bretton Wood’s Collapse, 1971-73
Once
from
the French
a $1.7 billion
franc
was devalued
deficit
on current
account
overall
balance-of-payments
billion
in 1971.
Its official
reserves
was owing
to increased
U.S. monetary
change
of-payments
expansionary
was undervalued
closed
before
the exchange
The
policy
in relation
A few days
to float
France
to a small
of $2 billion
rose
1969,
in that
surplus
year
correspondingly.
growth
rapidly
moved
in 1970,
an
and of $3.4
Part
and a higher
of this
U.S.
balance-
deficit.
Us.
Germany.
surplus
in August
spot
the German
against
and official
was thereby
of 1969,
reserves
eventually
In March
1971,
election
the dollar
increased
1969,
to
the government
the D-mark
and on 26 October,
there
was
large
inflows
substantially.
the D-mark
it, permitted
appreciated,
were
that
a flow of funds
in October
reopening
Although
by 1970 there
perception
stimulating
and a day after
revaluat: on of 9.29% was announced.
the last quarter
a market
to the dollar,
market,
rate
fostered
a capital
Domestic
outflow
of foreign
inflation
a
in
funds,
in Germany
worsened.
several
European
countries
requested
conversion
of their
29
dollar
regerves
quotas.
into gold
The payout
reduced
to enable
them
to pay
for an increase
in their
IMF
the U.S.
gold
stock to the lowest level since 1936.
A persistent dollar outflow thereafter accelerated in the first few days of
May 1971, overwhelming
foreign exchange markets. On 5 May seven European
countries closed their foreign exchange markets, and five others on several
continents withdrew their support for the dollar. Dealings in D-marks,
guilders, and Swiss francs were suspended. On 9 May both Germany and Holland
announced that their currencies would float, since they could not maintain
exchange rates within the established margins.
The devaluation of the dollar vis-a-vis the D-mark as the result of the
float left unsolved the dollar’s exchange rate vis-a-vis the yen. Japan’s
capital controls were proof against the dollar flows that inundated European
foreign exchange markets but not against the large deficit in U.S. trade with
Japan. That bilateral trade imbalance was a provocation, over and above the
imbalance between U.S. gold reserves and outstanding dollar liabilities, for
the changes the United States introduced on 15 August 1971 to achieve a dollar
devaluation. The convertibility of the dollar was formally suspended, as was
the use of the swap network through which dollars could be exchanged with
central banks for other currencies.
The effect was to oblige other countries to hold dollars or to trade
them for a price determined in the market and so to revalue their currencies.
Foreign exchange markets abroad, except in Japan, shut down. The Japanese
initial
attempt
to maintain
purchase
$4 billion
to float
upwards;
on 23 August.
the pegged
in the two weeks
other
Restoration
currencies
rate
after
floated
of a repegged
of the yen
15 August.
when
system
compelled
them
The yen was then
exchange
markets
of exchange
rates,
were
to
freed
reopened
however,
30
remained
the goal
After
much
at a meeting
December
that
central
rates
official
negotiation,
at the
dollar
were
revalued
of fluctuation
of gold
The
would
appreciation
of the dollar
of other
central
credibility,
revealed.
The London
of trade
Capital
followed
suit.
and suspended
above
and below
with
the
agreement
be $38 an ounce,
currencies.
the
so-called
specified
rather
arranged
on 17-18
percentages,
of the dollar
that
the
implying
than
a
an
The dollar,
continued
and the
surge
pounds,
and Swiss
raised
(this time
currencies.
imposed
although
all
to $42.22
the
floated.
rose
in the
United
however,
crisis
in Holland
central
lira,
yen,
rates
erupted
discontinued
States,
the official
unchanged
did not staunch
in March
pegging
1973.
their
soared,
were
Canadian
leaving
and both
European
rates
This
exchange
markets
few reversals.
its foreign
New
Again,
with
and Japan,
closed
lacked
exchange
deficit
of the major
an ounce),
The new central
countries
of gold
1973 Japan
of the dollar.
franc
and a further
industrial
were
holdings
meeting
and foreign
U.S. balance-of-payments
On 10 February
support
price
to rise
in dollar
controls
at the Smithsonian
in the gold
free market
of negotiations,
abroad,
established
as the participants
corresponding
other
rates
and inflation
balance
round
D.C.
was
inconvertible.
The
Japan.
in Washington,
henceforth
value
growth
parities
Smithsonian
of 7.9% of the gold
value
of currency
at varying
depreciation
remained
its partners.
Institution
permissible.
price
and
a readjustment
2 1/4% margins
were
States
Smithsonian
Currencies
1971.
proviso
of the United
the
with
countries
a
and
and Germany
exchange
set
price
U.K.
flow
rates
and
of gold
the gold
time
market
in a hurried
dollar,
the
Money
value
Irish
was
of
of dollars
the major
to the dollar.
31
B. Managed Float Regime
4.6. European Economic Community Snake
The notion
di~cussion
in June
of a European
for year~.
1971,
but
Implementing
the
the Bretton Woods
monetary
turbulence
system
weak dollar on European
main
targets
the
notion
had been
scheduled
markets
activation
of the
The D-mark
inflows.
not reflect
country
fundamentals
revaluation
of its currency
contributed
to its low economic
occasioned
with
exchange
disturbances.
The
snake
was
collapse
April
the effects
rates
by the dollar’s
growth.
until
of
for a start
the
and the Swiss
European
but dollar
subject
during
snake
was dissatisfaction
currencies.
of the capital
had been
in exchange
delayed
The impetus for the initiative
the
union
franc
of
1972.
of the
were
the
as a result
Germany
problems
supposed
did
believed
the
had
to provide
a
zone of stability.
The technical
fluctuation
agreement
parities
motivation
of EEC
currencies
by a convergence
among
them
Operationallyr
discount
amount
permitted
from
EEC currency,
strong-currency
settlement
currency
was
rate
of another
the weak
stipulated,
acquired
premium
set by the
policies
from
floor
the weak-currency
for a desired
creditor
reserve
which
but as much
currency
so the
over
EEC currency
agreement,
to the dollar,
country.
and monetary
the margin
of
Smithsonian
so that
exchange
be fixed.
if one rose
to floor),
to narrow
the 2 1/4% margins
of economic
by the Smithsonian
in relation
ceiling
below
snake was
if an EEC currency
on the central
and ceiling
another
would
of the
its central
reached
was
and the
asset
or by both.
could
and obtain
floor
to
other
either
fell
by the
A monthly
exchange
repayment
the
(half the
4 1/2% between
was to be bought
country
2 1/4%
as 9% in relation
to ceiling
country,
rate plus
the weak
for its
32
short-term credit facility if it had lent its currency to the debtor. Debtors
were to make settlement in a prescribed mix of reserve assets.
Six countries
(France, Germany, Italy, Belgium, Luxembourg, Holland)
originally joined the snake; three others joined in May 1972 but left in June
(U.K., Denmark,
Denmark
Eire).
rejoined
in October
1972.
Italy
left
in
December 1972. France left in January 1974, rejoined in June 1975, and left
again in March 1976. Sweden
Sweden
left
in August
Many
occasiong
the
changes
between
system.
Countries
subsequently
several
March
rates
within
1973 and October
joined
snake
made.
in May
1972.
the
1978,
were
the D-mark
was
On four
revalued
within
and the Norwegian krone each was revalued once.
Germany
devalued
feasibility
the national
to seek
devalued
in October
again,
as was the Danish
of the
snake was doubtful
governments
convergence
to yield
of economic
up for a replacement
remedy
countries,
1976
The
krone,
Swedish
krona
and the Norwegian
was
krone
times.
The
drawn
in exchange
than
non-EEC
1977.
The guilder
other
and Norway,
the perceived
formally
to the union
policies.
of the
snake
shortcomings
in the absence
direct
of consensus
monetary
In December
autonomy,
1978 proposals
by the European
of its forerunner.
Monetary
In March
and
were
System
1979
by
to
it was
established.
4.7. Chile’s Currency Crisis, 1982
Chile
maintained
Pegging
fixed
its exchange
it unchanged
the exchange
expectations
35% in 1979.
and the
until
rate
at 39 pesos
the peso was
rate to the dollar
actual
rate
to the dollar
devalued
by 18% in June
was a strategy
of inflation,
which
in June
to lower
was
1979
and
1982,
inflationary
at an annual
rate
of
33
If capital
anchor
approach
country
The
would
rate
commitment
bank
in creating
expectations,
rate
established
the exchange
strategy
would
exchange
1976 to 6.6%
roughly
in 1981
nominal
in the
U.S.
until
experience
tightening
than
Tradable
goods
if its commitment
prices,
prices
to a fixed
goods,
however,
wage
in Chile
exchange
indexation
in 1979.
rise
rate
in part
that was
had
adopted
Producer
was
the
5% in
prices
rose
in 1980,
one
that
from
risen
anchor.
in 1981-82
followed
A second
U.S.
averaged
13.3%,
value
by a 29% appreciation
How
did these
and exchange
in 1980-81,
rates
apparently
not abandoned
until
in
affect
Prices
because
of
fluctuations
as would
had credibility.
at
set of
in the exchange
in 1980-82
rates,
Chile
policy
1979 to combat
A decline
declined
of an inflation
country.
a nominal
rates
central
in inflation
continued
history
in real terms.
interest
rose,
prices
with
interest
1979 was reversed
anchor
in late
in 1980.
and 28% appreciation
country
U.S. price
government
higher
anchor
backward-looking
Chile’s
to monetary
late
This
the exchange
of the country’s
at the time
12.7%
that
commitment.
had a low-inflation
1979 rate of price
1982.
long-term
of the
consumer
and
is a firm
to the achievement
country
U.S.
second,
to the decline
to fact
in 1978,
The
and
points
terms
nontradable
to that
contrary
9.0%
affecting
2 percentage
equal
and
two objectives:
on the part
credibility
the anchor
was
rates.
set was the shift
the dollar
that
in 1977,
circumstances
inflation.
about
country
to deliver
contributing
link to the dollar.
similar
by declines
give
record,
anchor
restraint
thereby
it would
established
rate
link to the
enforce
goods
low-inflation
be expected
money,
and
for traded
firmly
rate
then
The assumption
was
two assumptions must be true, one, that the anchor
to succeed,
has a firmly
adopting
do not complicate the strategy, for the nominal
inflows
Chile?
be expected
of
of a system
the peso
of
waB
34
devalued.
As we next
As a result
rate,
which
inflow
note,
monetary
of financial
were
generally
of short-term
applauded,
capital,
with
in 1981 providing
Chilean
surged,
instead
price
of dollars
rate,
the
peso
authorities
not
appreciating
terms
when
the
seemingly
fixed
external
would
intervened.
have
exchange
but
Monetary
from depreciating,
in real terms
consequences
1979,
10% in 1981,
adjusting
balances
bought
to the
in foreign
balances,
initial
credit
to rise more
growth
accelerated.
Trying
tradable
goods
of the
bank.
foreign
rose by a third
their
have
fallen
to keep
sectors
inflow
The base
currencies
in demand
level
foreign
the exchange
By not
declined
because
importers.
unless
While
foreign
By permitting
their
from
exchange
before
meant
than
Chilean
the peso
in 1982,
fully
in 1980
sterilizing
from changing
the nominal
and benefited
in 1981,
fully
In 1982,
of dollars
Keeping
to prevent
spurted.
lost competitiveness,
price
higher
assets,
in real
importers.
the base
in 1982.
changed
growth
rate
but
was two-thirds
for Chilean
balances
importers,
off than
increased
(dollars)
in 1979.
money
better
doubled
in 1980, barely
domestic
than
were
exchange
had the
from
exporters
in
for
fixed
rate
the peso
6.7%
demand
in 1980-81,
not intervened.
hurt
from
at the
and benefited
faltered,
of a large
rising
exchange
a part.
of the exchange
external
and hurt
exporters
than
rates
While
the nominal
exporters
fixing
to the dollar
seemingly
and more
increase
1982 below
yield.
pesos
also played
was the recipient
exporters
hurt
and the
interest
had the authorities
by the central
authorities
would
Keeping
rate
sterilized
fell
real
of 39 pesos
for Chilean
increased,
rate
importers,
demand
Chile
a high
benefited
exchange
apparently
liberalization,
1979 to 59.2%
peso~
expansion
falling
the
in
increase
domestic
domestic
money
that,
when
prices
rose
in
35
relative
the
to foreign
nominal
current
anchor.
account
no problem
ceased,
goods
The trade
deficit,
but terms
deficit.
The banking
and
in pesos,
however,
sold
found
almost
from the middle
30%, the trade
rose.
Inflation
rate would
not
an attractive
U.S.
real
capital
last.
itself
interest
experiment
that
the peso
account
abroad
in dollars
Output
declined
The unemployment
reserves fell,
ended
the United
spread
not only
investors
but
rate
rose
to
and domestic
that
because
also
States
because
credit
the peso-dollar
Chile
the
a successful
Chile
price
relates
had a choice
stability
inflows
to protect
failed.
The other
ceased
to be
steep
rise
competitor
for
between
or letting
we draw
Goldfajn,
the
the
supply
exchange
is that,
was
supply
of pesos
rate.
in
the main
and Valdes,
that
exchange
priority
1995) .
we stress.
of an exchange
of pesos
grow
capital
to do both
chooses
rate
to protect
with
By
The
of the real
It tried
if a country
anchor.
73.43.
experience
consequences
limiting
a nominal
inflation
of the Chilean
to the monetary
the peso-dollar
lesson
of overvaluation
(Dornbusch,
dimensions
with
the dollar
and that making
is a mistake
overlooks
experiment
rate with
as a case
to collapse,
strategy
One dimension
Chile’s
exchange
assessed
was bound
assessment
internal
1982.
foreign
inflows
made
into recession.
and expectations
for foreign
rates
has been
of economic
target.
again
in 1982 ended
the end of 1982,
This
once
posed
inflow~
the current
had borrowed
the
continued,
capital
to
distress.
was plunged
grew,
to settle
which
in dire
When
commitment
Financing
inflows
steadily.
reserves
by their
inflows.
Devaluation
rate
10% of GDP.
of 1981 to June
Capital
economy
by 1981 was
meanwhile,
deficit
soared
stuck
as long as capital
foreign
system,
authorities
deteriorated
At the end of 1981 Chile
sharply
the
deficit
of trade
the authorities
lent
prices,
and
to adopt
a
36
nominal anchor, it would be wige to avoid an anchor
monetary
1976, 1982, 1994
A.1976.
of devaluation
Three
different
episodes
macroeconomic
incompatibility
describe
with
each
one
settings
the
fixed
policies.
Fiscal
financed
base
foreign
financing,
rose
20% per annum
rose
account
mounted
2.5%
regime
were
generated
in
in terms
that
in
of their
prevailed.
We
base
exchange
and they
from
of GNP
in 1971 to 10% in 1975,
rate
As a result
debt
as the main
to grow
in dollar
Accordingly,
flight
while
growth
source
From
of
1974
of deficit
Inflation
the
real
the real
the deficit
price
in the
rose
$5.3 billion
price
of
of
current
in 1971 to $4.4 billion
of approximately
rate
declined.
per dollar,
value
demand
in 1975.
strongly.
investment
of 12.5 pesos
,$1 billion
the
in 1971 to 33.8%
and private
stagnated.
Capital
by expansionary
continued
surged
less than
fueled
bank.
19.6%
domestic
in 1973-74,
and they
5.5% of GNP.
from
replaced
At the nominal
exports
similar
rate
began,
from
accelerated
but the monetary
declined
in Mexico
were
exchange
from the central
debt
imports
that
recovery
deficits
by borrowing
the monetary
about
swings
in turn.
In 1972 a cyclical
above
wide
growth.
4.8. Mexican Devaluations,
to 1976
undergoing
in 1975,
was
a feature
of 1974-76.
The Echeverria
world
prices,
and the
administration
slow growth
attributed
of exports
domestic
to world
inflation
recession,
to higher
justifying
continuing expansionary demand policies. Import controls were imposed, but the
exhaustion of foreign exchange reserves compelled the decision
allow
the peso
devalued
to float.
Inflation
to 23 per dollar.
Mexico
rose to 27%.
then
entered
In October
on 31 August
the peso
into negotiations
was
for medium-
to
37
term
financing
B. 1982.
The Lopez
supported
target~.
was
tripled
adopted,
but
combined
introduction
The
deficits.
real
of government
increase
large
Trade
price
of imports,
quotas
were
imposed
import
volume
substantially,
rose
1978-81,
proven
IMF
oil reserves
to the estimate
in 1975.
IMF program
set aside
restraints
public
exchange
of the
initially
was
on foreign
sector
rate
fiscal
borrowing.
spending,
(crawling
deficit
in
was
at the
with
rate
the
(CETES).
deficits
leading
on many
still
flexible
1977-81
expenditures
liberalization
the
by higher
monetization
bonds
fiscal
compared
1977-82,
in line with
of Mexico’s
and weakened
a more
sector
the economy
in 1980,
in the economy
in public
The
barrels
provided
and reduced
improvement
increases.
policy
with
in office
the estimate
per barrel
stimulus,
annum),
to stabilize
16 billion
at $31.25
demand
of 9% per
huge
to
1990).
administration,
of 1977,
of an expansionary
more
(Buffie
program
course
oil prices
favor
Once
In the
IMF
Portillo
an austerity
nearly
With
from the
were
was bought
that
was
matched
at the expense
not matched
by balance
and real exchange
rate
to rising
account
consumer
by 15.2%.
but nonoil
current
and capital
Dollar
exports
earnings
were
by revenue
of payments
appreciation
goods
lowered
deficits.
imports
the
In 1981
but overall
exports
rose
exchange
rate
from petroleum
hampered
of a
by real
appreciation.
The
foreign
used
increase
in current
indebtedness
to finance
to some
capital
private
sector
debt,
service
including
account
income.
account
$80-odd
flight.
mostly
short-term
deficits
billion
Public
in the
sector
was
financed
by 1981,
debt
amortization
of which
was two
form of commercial
represented
by growth
50% to 83% was
and a half
loans.
in
times
In 1981 debt
an 80% claim
on current
38
By mid-1981
reetraint
increase
was exerted
at premiums
depreciation
wage
increase.
resort
to a dual
system
was
net
rose to
foreign
rate
had not previously
expansion
system
and private
sectors
economy
sharply
increased
prices
output
and the
inflation
rate doubled.
productive
it faced.
Instead
consumption,
C.1994.
continued
demanded.
to
A 40%
followed
by a 30%
and the consolidated
On 1 Septefier
exchange
devaluation
finance
no
controls
quickly
came
the banking
were
introduced.
to a halt,
as did
lending.
By the end of 1982 the Mexican
fell
debt
1982 was
continued,
in August.
and comprehensive
by the public
and foreign
but
Massive capital flight was not halted by the
of GNP.
exchange
unavoidable,
on 17 February
and monetary
nationalized,
service
banks
announced
17.6%
appeared
expenditures,
commercial
Fiscal
debt
of the peso
on fiscal
of the peso
public
Debt
devaluation
investment,
the debt
public
sector
The dominant
the end of 1994
is that
view
in a vast
on the peso
by foreign
instability
in a basically
was
investors
sound
would
having
been
literature
an innocent
frightened
economy.
foreign
not have
flight
contraction.
imported
Had the
capital
investment
Mexico
in a deep
of intermediate
Mexico
financed
was
debt
been
had to endure
and public
wasteful
victim
Real
used
to
the plight
sector
(Buffie
on the Mexican
1990).
peso
crisis
of a speculative
by manifestations
From
inputs.
The
at
attack
of political
1988 on Mexico certainly had
corrected many of the ruinous policies it favored that led to the 1982 debacle
and the subsequent period of stagnation. One feature of the economy
that
had concerned
presaged
a need
also merited
some observers
to devalue
was
the peso.
a growing
Other
current
features
account
in 1993-94
deficit
of the economy,
that
however,
concern.
The condition
of the banks
at the very
least
was
problematical,
with
the
39
percent of nonperforming
currency
denominated
loans rising year by year
loans
firms
borrowed
from
sound
currency
do not choose
liabilities.
close
more
have
The Mexican
the gap between
than
one
rate were
those
local
varied
survived
and real
that
and U.S.
rates,
the
price
the collapse
after
loans.
been
of output,
We next
with
There
was
in as good
1994,
inflation
and the
thus
exchange
it ought
rate
to
a shape
as
to
and nominal
stupendous
review
a
not enough
dollar/peso
in late
in the
Mexican
dollar
1988 but
of a fixed
its fate
it in fact experienced.
with
performance.
economy
jumps
of total
liabilities
the underpinnings
without
1990 on. Foreign-
Borrowers in a country
declined
it did not deserve
devaluation
interest
unemployment
that
rate
to 27.1%
peso
had the Mexican
Moreover,
who believe
to replace
inflation
that
18.5%
in dollara.
the Mexican
indicator
ehaky.
banks
from
from
rise
the origins
in
of the
crisis.
Monetary growth was highly
quadrupled
1990-92
from 25.3
average
introduced
billion
growth
erratic
pesos
from 1988 on. The
in 1989 to 96 billion
of Ml was more
than
level
pesos
100% per year.
in 1991.
The New
In
Peso,
in January
1993,
was equal
to 1,000
Ml and M3 in 1993-94,
which
was
20% per annum, was hardly restrictive.
about
old pesos.
of Ml
The growth
rate
of
During the 1980s and early 1990s Mexico brought the public deficit
under control and reduced outstanding debts. In 1982 domestic and external
public debt was 51% of GDP. BY 1992 the ratio was 27%. In 1992 the budget was
in balance. Fiscal easing in 1993-94, however, unbalanced the budget position
somewhat, but it was nevertheless among the best performers among OECD
countries.
The government
Treasury
bills
until
of less than
1994 financed
its short-term
one year maturity.
When
the
needs
with
interest
Cetes,
rate
it had
40
to pay
on Cetea
laxity,
term
rose
in 1994,
as had occurred
dollar-indexed
government
in previous
Tesobonos
to interest
During
reflecting
1982-88
rate
decades,
that
paid
average
annual
1.9% per year.
December
1987 opted
for an ambitious
open
the
Mexico
latter
mechanism
balance
objective,
was
an incomes
a nominal
On 1 March
its 29 February
policy
for the next
then
per day
In November
in 1990,
1991
at the daily
rater
fluctuation
band
from
a narrower
would
band
was
maintain.
to 40 centavos
offset
the
The permitted
the end of 1993.
Over
appreciated,
current
owing
account
from
that
took
that
down
a role
capita
office
would
in
deliver
enterprises,
inflation.
To achieve
but the primary
the peso/dollar
months
that
and then
peg of 1 new peso
of bands
in 1991,
was
exchange
extended
limit
the
4% annually,
between
annual
but this
Mexico
inflation
capital
of the
inflow
that
revised
per
real
day
limit
early
1993
intervention
in October
was not enough
then
the
The
From
and the United
rate was
inflows.
the capital
was
lower
constant.
range
at
introduced,
and 20 centavos
held
trading
rate
it until
per day was
announced,
rate of depreciation
1988 on the trend
to growing
deficit
fixed
for the day’s
differential
The Mexican
the period
the
86% and per
1.1% to 15% by the end of 1994.
day or around
inflation
was
program
and bring
and the upper
established
per
to short-
exposing
government-owned
40 per day
a system
depreciated
widened
fiscal
shifted
rate,
government
was given
three
In 1989 a crawling
in 1992.
over
anchor.
end of the year.
80 centavos
interest
in Mexico
privatize
1988 the government
level
government
stabilization
the budget,
concern
risk.
The Salinas
to free markets,
to trade,
rate
inflation
contracted
reforms
the
a lower
and exchange
real GDP
structural
the market’s
1992
to
States
until
10%.
exchange
rate
The result
was
a widening
financed.
The
interest
sharply
rate
41
hikes
in the
Mexico
United
and other
investment.
candidate
close
vulnerability
with
would
exacerbate
fixed
until
once
did not stem
peso
policy
to float
would
exchange
to convince
restrict
problems
again
rate.
(OECD
attraction
fluctuation
capital
band,
exchange
of
portfolio
assassination
precipitated
Foreign
the
for foreign
and the
rate,
of the
outflows
signaling
reserves
the central
the market
economic
for the banks
that
growth
sinking
that
that
drove
the
were
between
confronted
authorities
that
out of peso
assets,
1995;
1996).
Meigs
would
was
under
of choosing
Mexico
bank
it would
The dilemma
On 20 December,
shifts
diminished
drawn
down
the end of the year.
the peso
loans.
exchange
1994
rate.
however,
objectives
unrest
of the exchange
monetary
nonperforming
political
in March
however,
as an outlet
of the
To defend
tighten,
markets
to the bottom
no remission
tighten
in 1994,
emerging
In addition,
presidential
the peso
States
a weight
internal
To
subpar,
and
of
and external
a commitment
the peso
and on 22 December
had to
not devalue.
already
had made
devalued
have
to a
by 15%, but that
Mexico
freed
the
4.9. Crisis in the European Exchange Rate Mechanism, 1992-93
In the European Monetary System, Germany was the nominal anchor. Other
EMS countries pegged their currencies to the DM in order
inflation
would
this
reunification
had disruptive
event,
effects
it is claimed,
have
continued
is a realistic
autonomy
its low-
credibility.
German
that
to import
and their
in 1990
on the European
the period
until
of exchange
European
projection.
exchange
is commonly
rate
The
cited
Monetary
rate
System.
stability
monetary
union
conflict
between
commitments
would
as the external
was
But
that
attained.
EMS
for that
began
in 1987
We doubt
countries’
not have been
event
that
monetary
absent,
even
42
had German reunification been accomplished without undesirable side effectO.
The conjunction of many forces ensured that the slightest shock that could
derail the path to monetary union would lead to severe stress on the system
(Eichengreen and Wyplosz, 1993). The forces
included
the elimination
of
capital controls in 1989, the discouragement of adjustments in parities after
1987, the supposition of credible commitment by member countries to policies
consistent with fixed rates, and the unwarranted belief
of unlimited
intervention
on a member to
by the Bundesbank
in the event
of pressure
realign.
To contain the inflation generated by government budget deficits that
financed reunification, the Bundesbank adopted a restrictive policy. It made
no allowances for the blow to its domestic real economy
its European
partners
interest
rates,
Germany.
Hence
nominal
exchange
have
their
devalue,
but
Italy,
currencies.
U.S.
exchange
began
dollar,
rate
rates
The other
countries
enforced
There
incorrectly
Italian
participants
were
thus
priced
lira was the
that
quarter
many
drew
first
were
High
capital
of
German
inflows
to
For the existing
other
EMS
the German
countries
inflation
reluctant
would
rate
to deflate
or
or to
devaluations.
of Spain,
members,
Portugal,
from the
a realignment
that
exchange
currency
the UK,
second
and
half
was predictable.
of 1992 worsened
currencies
in foreign
inflicted.
appreciated.
below
non-EMS
in the first
hikes
to be plausible,
inflation
and Finland,
to market
countries.
The
rate
of loss of competitiveness
that
were
real
in the end the market
indicated
believe
a weak
arrangements
their
and of Sweden
recession
these
rate
its interest
with
the German
Evidence
1991
coupled
had to reduce
realign
that
or to the economies
the
traders
of
A
situation
of
had reason
to
markets.
exposed
to market
distrust
of
43
its parity. Italian foreign reserves began to decrease
in February 1992 and
losses became heavy in June, Lira bond prices then declined
futures
wealth
In July
and spot markets.
tax on deposits
foreign
liabilities
and the government
of a bankrupt
downgraded
Italian
the bottom
of the currency
of Italy
raised
but did
defend
the
existing
equivalent
The
Swedish
next
krona.
peg by raising
markka.
A week
rate
later,
when
company.
to defend
imposed
thereupon
lira was quoted
its parity,
the
at
Bank
to 15%.
pound
was quoted
parity,
on 3 September
slightly
intervention.
the
above
To signal
Bank
its ERM
floor,
its commitment
of England
to
borrowed
$14.5
of DM from the market.
to be sold off were
had been
forced
of its trade
having
short-term
rates
former
Soviet
by about
bands
level
and the
rates
as much
to defend
floated
that
of other
as three
1991
On 8
of 14%,
13% implied
the pegged
fluctuation
Union.
and unwilling
the existing
of the markka
with
the
markka
by 12% in November
its reserves,
above
between
the Finnish
to devalue
with
exhausted
deviation
evaluations,
there
the
the
was
ERM currencies
times
the
size
of ERM bands.
Sweden,
rate
charged
borrowed
Because
Britain,
unlike
by the
a
for the
Moody’s
the
the
Italy
responsibility
On 28 August
heavy
The depreciation
and market
band.
British
Finland
a substantial
holding
from AAI to AA3.
currencies
Finland,
state
accelerated
declined
despite
to the collapse
September
also
the
not recover
billion
owing
debt
the discount
On 25 August
the outflow
in both
Finland,
central
to counter
bank
for overnight
DM to add to its reserves.
home mortgages
the authorities
bore
floating
were
the attack
Sterling
rather
constrained
bank
and
than
on the
regerves
lira were
fixed
in their
krona,
to 75%,
also
interest
response.
raised
the
and
under
attack.
rates
in
For the market,
44
this made the British commitment suspect. The Italians responded by
intervening on their own and with others,
billion
in Frankfurt
September,
next
Italy
capitulated,
day the Bundesbank
interest
devaluing
for the
a day the
sterling.
That
reserves.
Another
below
On
currency
withdrawn
Sterling
markets.
in five years
at 24
On 13
lira by 7% against
Sweden
marginal
lending
that had
survived
ending
Ireland,
Greece,
rate
were
the
D-mark.
decreased
two
The
key
to have
was
lost
and
so was
$15 billion
the peseta
that
in
fell
near
increase
its ERM
floor,
the minimum
lending
to 15% which
and that
rate
was never
evening
put
it was
on 19 September.
Italy
and the peseta
was devalued
by 5% within
the
ERM.
central
bank
raised
under
attack
to give up. The Swedish
On 20 September
their
ERM
its overnight
that
controls,
The Bank
of England
it to 9% on 21 September.
rate
had not
in September.
all currencies
floors.
10%, and lowered
capital
raised
indefinitely
ready
an EC country
tightened
pressure
of its band,
then,
to 500%.
raised
on the drachma
a further
temporarily
not yet
rate to
however,
was thought
of England
fell below
from the ERM
was
at the bottom
that was under
the Bank
from the ERM,
also withdrew
market,
exchange
estimated
ERM rate.
16 September,
into effect.
again
of England
10% to 12% and announced
attack
the
first time
lira was
day the Bank
its central
minimum
in other
D-marks,
rates.
Within
from
and 60 million
using
its
restored
its
The
of
Bank
to 300%.
joined
The Bank
the ERM,
of Greece
and raised
also
suffered
intervened
the official
an
in the
lending
rate
from
30% to 40%
When
de France
the
French
and the
franc
Bundesbank
came
under
intervened
attack
on 23 September,
heavily.
That
attack
both
was
the
Banque
repulsed.
45
On 4 January
1993,
banks
stated
firmly
the
their
when
In November,
the Riksbank
interest
ended
rate
franc
was
again
readiness
the krona
its ERN
to defend
again
its resistance.
to 12.5%.
near
came
The Norwegian
krone
but both
central
it.
under
It floated
floor
attack,
the krona
was
allowed
after
and
a few hours,
lowered
to float
it8 key
on 10
December.
On 22 November
The Bank
of Ireland
2 December
again,
Spain
raised
to defend
13 May,
since
however,
the
Portuguese
escudo
was
followed
under
began,
suit.
There
their
central
by 6%.
26 November
the overnight
rate was
and
raised
by 10%.
in the
first
pressure,
and
it was devalued,
was
parities
to 100% between
January
to subside
again
attacks
rate
was devalued
appeared
the peseta
1992 currency
In early
the punt
of attacks
devalued
its overnight
the punt.
but on 30 January
The wave
and Portugal
another
months
of 1993.
for the third
this
time
On
time
by 5%. The
In mid-July,
interlude.
however, the French franc was only a little above its ERM floor. The increase
in French
interest
convinced
market
rates
traders
its link to the DM. This
above
that
was
already
France
not,
high German
was willing
however,
ones
seems
to have
to pay the price
an unalloyed
triumph
to preserve
for a fixed
rate.
On 30 July all EM
currencies were at the bottom of their bands vis-a-
vis the D-mark. On 1 August the ERM was altered, making it closer to a free
float than a pegged but adjustable exchange rate system. The bands were
widened to 15% above and below the existing central parities. Only the DM and
guilder
exchange
5. Lessons
rates
were
unaltered
(Buiter
et al.,
1996).
from History
Our survey of the historical episodes of currency crises in the past two
46
centuries suggests a number of lessons. First, currency crises occur when
internal economic
conditions
for the currency.
Institutions
and the circumstances
in which
occurred
widely
the countries
surveyed.
across
differed
all these
Second,
the crises
within
standard
currency
apparent
usually
short-lived,
commitment
time
practices;
in order
associated
cases
with
before
standard.
instability.
would
the war effort.
banking
parity
before
instability.
What
Under
War
War
Bet
crises
was
common
II always
a commodity
a government
of war,
when
were
the
it became
to suspend
In peacetime
These
following
affecting
be driven
was restored.
World
conditions
currency
World
Crises
on the outbreak
the government
to pursue
to convertibility
currency
usually
For developed
crises
very
countries
II was paramount,
a norm
the
that
eroded.
The experience
upon
that
and the original
has since
suspended
occurred
external
incompatibility.
for two reasons;
or banking
usually
agents
arise
the
we have
of a commodity
could
with
basic
in the historical
crises
to market
incompatible
was this
context
countries
convertibility
were
the
financial
developed
among
experiences
occurred
unsound
are
of developing
convertibility
the market’s
under
realization
peripheral
the pressure
that
countries
was different.
of speculative
the governments
were
attack
pursuing
They
consequent
lax financial
policies.
Third,
exposed
to currency
individual
rate,
face
crises.
countries.
incompatible
also
in the post-World
with
currency
requiring
Some
They
II period
occurred
countries
a commitment
crises
War
an adjustment
under
followed
to the peg.
if competitive
the Bretton
two
fiscal
Virtuous
trends
of the nominal
Woods
was
sets of circumstances
and monetary
countries,
had changed
parity.
system
Although
policies
however,
the
for
real
Bretton
could
exchange
Woods
47
wag
designed
reluctant
adverse
to voluntarily
capital
revaluation
occurred,
but
was
movements
even
Bretton
unwillingness
affairs
could
they
only
a hint
when
delayed
was possible
because
not avert
countries
were
that
punished
by
devaluation
adjustment
of capital
an attack
were
or
finally
controls,
on the peg that
precipitated.
Woods
itself
of the United
spillovers
because
were
Consequently,
controls
from
was
States,
in a noninflationary
the dollar
in practice,
parities
if there
Delay
set of circumstances
system,
their
in the offing.
end capital
Fourth,
pegged
alter
it was traumatic.
in the
either
as an adjustable
subject
to a systemic
the reserve
manner,
center
country,
and of the nonreserve
U.S. balance-of-payments
crisis.
to conduct
countries
deficits
The
doomed
its
to absorb
the
system.
Fifth,
that
the experience
of Bretton
Bretton
Woods
A lesson
mobile
Woods.
capital
more
parities
under
and deep
international
parities.
However,
rates
to obtain
the price
is often
snake
elaborate
ERM currency
countries
interest
subsequent
1992-93
developed
term
Despite
to defend
of the
of the
these
is that
capital
whatever
of doing
arrangements
attack,
crises
so in the
than
systems
world
of highly
for
to defend
form of astronomical
and the market
is aware
under
succumbed.
it is possible
are required
with
existed
also
in today’s
markets,
resources
prohibitive,
and ERM resonates
their
short-
of this
constraint.
Sixth,
examples
adherence
the recent
currency
of inconsistency
to their
Seventh,
intellectual
in Chile
domestic
and Mexico
priorities
represent
and the demands
clear
of
parities.
the theory
merit
between
crises
of self-fulfilling
but contributes
nothing
speculative
attacks
to our understanding
may
have
of real-world
48
events. In every crisis examined here, the fundamentals are more than adequate
to account for the actions of speculators.
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