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Washington Post Monday, December 21, 1998

Dead Ahead -- Monetary Meltdown

By Judy Shelton

Remember those pressured days of budget negotiations in October when Clinton administration officials were imploring skeptical members of Congress to grant $18 billion to the International Monetary Fund? The cogent selling point was that funds were urgently needed to prevent international financial meltdown. There would be plenty of time to address the failings of the IMF once the crisis had passed.

That time has come -- whether the financial hurricane that has devastated nations around the world these past 18 months has passed or temporarily subsided. We should use this period of relative calm to implement fundamental solutions to those problems that threaten the future of the global economy. We must reassert our commitment to open markets and democratic capitalism if we are to persuade other nations to adhere to free-market principles. But even more, we need to redesign the financial institutions and monetary mechanisms that support genuine free trade and global competition.

The "architecture" of the international financial system must be overhauled to ensure that future global economic performance is not undermined by currency chaos. It's a new world out there, with governments squaring off against currency speculators to see who determines the value of the most basic unit of measurement for assessing economic performance: money. Prior to 1971, fixed exchange rates prevailed among national currencies. If you wanted to buy goods in a foreign country or make an investment, you had to exchange your currency for their currency. But all those foreign moneys were convertible into dollars at a fixed rate. Moreover, the dollar was convertible into gold at a fixed rate for foreign central banks.

Indeed, the IMF was set up to oversee this mechanism, the Bretton Woods system, for governing international monetary relations. Bretton Woods was established near the end of World War II to provide a foundation to encourage international capital flows so that countries could rebuild their economies through foreign investment and world trade. During the prior decade of the Great Depression, nations devalued their currencies to gain a price advantage in world markets for their exports. Not only did this set off rounds of cheaper and cheaper prices, leading to global deflation, it spawned a protectionist backlash as countries imposed restrictions against foreign products.

The parallels with the world today are sobering. Cheap steel imported from countries whose currencies have fallen dramatically against the dollar, countries such as Brazil and Russia, is causing the U.S. steel industry -- justifiably -- to protest "unfair" competition. It's one thing to compete in terms of productivity and efficiency; it's another to be underpriced because of another nation's depreciated money.

If a new stable monetary regime is not established, it is difficult to imagine how the global economy can recover from depressed conditions or achieve increased prosperity. The U.S. trade deficit continues to reach record levels, but we cannot be "consumer of last resort" forever. Meanwhile, global markets wait to see if the latest IMF rescue package for Brazil proves sufficient to intimidate speculators and keep them from making a run on its currency.

Yet even as the IMF engages speculators on their own level, it proposes no solutions to the problem of money meltdown. The World Bank has denounced the IMF for its misguided attempts to "protect" currencies by raising interest rates, which causes economic recession. But shoveling out billions in foreign reserves to artificially increase demand for a currency under pressure is no solution either. Nor is letting a nation's money become the latest profit opportunity for global currency players.

We need a new monetary system. We live in a global economy, we promote free trade and free capital flows -- so why do we limp along with a monetary nonsystem that not only is dysfunctional but dangerous?

The IMF shrinks from discussing international monetary reform -- perhaps out of fear of reminding people that its own justification for existence ended with the dissolution of the Bretton Woods system nearly three decades ago.

Nevertheless, currency disorder continues to pose a threat to the global economy. It should now receive top priority attention from members of Congress -- especially those Republicans who earlier balked at approving more funds for the IMF. They were right to resist. Not for spite, and not because they are isolationists, but out of a profound sense of the need for U.S. global economic leadership.

The writer, an economist and author, is on the board of Empower America.