Background Of Currencies And Federal Reserve

We have to go all the way back to the adoption of floating exchange rates between 1971 and 1973.

Let’s review the argument in favor of floating exchange rates from that article:

The premise behind allowing currencies to float was that it would lead to self-correcting trade balances. In a fixed-rate regime such as Bretton Woods, countries in a deficit position (such as the U.S. in the late 60s) see an outflow of gold and foreign exchange reserves. These outflows lead to a reduced capacity to consume, which is detrimental both to the deficit country and to all those exporting to it. In fact, the IMF was created in the Bretton Woods agreement to address the inevitable "balance of payments crises" associated with growing economies importing too much. Theoretically, floating exchange rates would address payment imbalances by depreciating deficit countries’ currencies on the global market, thus reducing their purchasing power. If, for example, the U.S. ran a trade deficit, it would be pumping out additional dollars to exporters. Each new dollar on the world market would have a smaller claim on exporters’ resources and reduce the U.S.’s ability to import more. Also, U.S. exports would become cheaper on global markets and expand American exports. The end result of a weaker currency was supposed to be a move away from a deficit condition. The opposite was supposed to occur with a stronger currency.

The logic behind this argument has been advanced often by trade protectionists around the world and by the International Monetary Fund (IMF) itself in its repeated and usually disastrous advice to debtor countries to depreciate their currencies to improve their trade balances. It was used as a bludgeon against Japanese automakers during the 70s and 80s, against textile exporters in all decades, and has been a staple of senators Lindsey Graham (R., S.C.) and Charles Schumer (D., N.Y.) vis-à-vis China.

Even though the principal advocate of floating exchange rates, the late Milton Friedman, was the antithesis of a protectionist, his arguments have been seized by this faction to the extent that the notion a weaker currency should stimulate exports and reduce imports will be referred to as the “protectionist argument.”