On history of floating exchange rate

The floating exchange rate is now a popular term with the fluctuating value of the exchange rate of Taka, the currency of Bangladesh, with the United States Dollar [USD]. Bangladesh was in a fixed exchange rate, the polar case of the floating exchange rate, since its independence when the concept of devaluation indicated a weakening currency. The country officially adopted the floating exchange rate on May 31, 2003, intending to increase the effectiveness of monetary policy and integration with the global capital market.

The Jamaica Agreement concluded on January 7-8, 1976, in Kingston, Jamaica, by a committee of the board of governors of the IMF was the beginning of the floating exchange rate that allowed the price of gold to float concerning the USD and other currencies, albeit within a set of agreed constraints. Peter B. Kenen, International Finance Section, Department of Economics, Princeton University invited fifteen economists to write brief papers commenting on the agreements concluded at the Jamaica Agreement and on those reached earlier at the Annual Meeting of the International Monetary Fund in September 1975 and at the meeting of Heads of States and Governments, in Rambouillet, in November 1975. Professor Kenan received eight essays within the set time, and Professor Nurul Islam was one of them. Other distinguished authors were; Edward M. Bernstein, Richard N. Cooper, Charles P. Kindleberger, Fritz Machlup, Robert V. Roosa, John Williamson, and Robert Triffin. All eight distinguished authors contributed papers delineating various issues about Special Drawing Rights [SDR], the disposition of gold, the creation of a Trust fund, and the New Article IV of the Article of Agreement of the International Monetary Fund.

Professor Islam was the Director of the Institute of Development Economics in Pakistan [now BIDS in Bangladesh} from 1964 to 1971. He adorned the post of Deputy Chairman of the Planning Commission of Bangladesh from 1972 to 1975. As a Visiting Fellow at St. Antony’s College and a member of the Executive Committee of the Third World Forum of the Commonwealth expert group on the New International Economic Order, Professor Nurul Islam contributed a paper delineating several aspects of the new arrangement. First, he stressed the necessity of switching to an exchange rate system suitable for developing countries. Second, SDR was endorsed as a reserve asset with gold replacement. Third, it emphasized increasing collective management and control over creating international liquidity and adjustable exchange rate with more flexibility. Fourth, there was to be a symmetrical obligation on the part of surplus and deficit countries to undertake domestic adjustment, including exchange-rate changes.

Between 1970 and 1975 there were extraordinary and abrupt changes in the international monetary scene. The massive liquidity creation generated considerable inflationary pressure through large-scale deficits in the balance of payments of the reserve-currency countries. The quadrupling of the price of oil subsequently accentuated it. “ His assertion conveyed the message contained in the Triffin Paradox. The Triffin Paradox emphasized that the dollar could not survive as the world’s reserve currency without requiring the United States to run ever-growing deficits. The Bretton Woods system collapsed in 1971, and today the dollar’s role as the reserve currency has the United States running the most significant current account deficit in the world. The USD was the currency of choice for much of the 20th century. The U.S. had a stable political climate, did not experience the ravages of world wars like Europe, and had a growing economy large enough to absorb shocks.

The fixed exchange rate prevailed in three phases, the period before World War I [1870-1914], the interwar period [1914-44], and Bretton Woods Period [1944-1971]. The fixed exchange rate was synonymous with the gold standard; the issuance of fiat currency was supported by 100 percent of the stock of gold. The central bank in each participating country was ready to buy and sell gold at a fixed price in terms of domestic currency though prices and wages were flexible in both ways. The United Kingdom was the first on the Gold standard from 1821. However, only a score of major European countries was on the gold standard and maintained a fixed exchange rate. The Gold Standard had its heydays in an environment free from significant shocks such as the Great Depression of 1930 or the commodity price hike such as oil or other primary metals. The Exchange rate could fluctuate only within a narrow range known as gold points and be static in response to demand, supply, and transaction costs. Gold was the common denominator and the only official reserve asset. The gold standard’s golden period ended with World War I when the belligerent nations suspended the convertibility of currencies into gold and put an embargo on gold export.

The period [1919-31] was characterized by violent fluctuations in exchange rate owing to a shortage of gold and the developing Great Depression. The fixed exchange rate or the Gold Standard received a new facelift in 1944 when 44 countries, including the erstwhile Union of the Soviet Socialist Republic [ U.S.S.R], met to design an exchange rate regime conducive to the orderly management of exchange rates and streamline the stalled international trade. The new arrangement is known as the Bretton Woods Arrangement [ 1944-711] with a framework akin to a fixed exchange rate and given the denominator gold exchange standard. The United States emerged as an economic power after WW II, and the dollar became a reserve currency in the global money market.

The gold window kept a provision of convertibility of the dollar into gold at the rate of USD 36 per ounce, a mandate of the fixed exchange regime. The world observed the uninterrupted reign of the fixed exchange rate from 1945 to 1971; the period encompasses surpluses in the balance of payments. The United States’ involvement in the Vietnam War and the consequent pile of the massive balance of payments deficit undermined the confidence in USD, and foreigners began to convert USD into Gold. The Bretton Woods Arrangement collapsed with the unilateral announcement of Richard M. Nixon on august 15, 1971. The President’s package asserted that the United States would no longer convert foreign-held debts into gold; temporarily, at least, the dollar would no longer be the foundation of international monetary dealings, as it had been since 1944. “ The foreign exchange market is a world where winks, nods, and secret handshakes from key policymakers mean a lot.”

The writer teaches at BRAC University and BIDS as an adjunct Faculty in the Master’s Programme in Economics. He can be contacted at [email protected]