Guest Post: Floating Exchange Rates - Unworkable And Dishonest

Tyler Durden's picture

Submitted by Keith Weiner, president of the Gold Standard Institute USA

Floating Exchange Rates: Unworkable and Dishonest

Milton Friedman was a proponent of so-called “floating” exchange rates between the various irredeemable paper currencies that he promoted as the proper monetary system.  Many have noted that the currencies do not “float”; they sink at differing rates, sometimes one is sinking faster and then another.  This article focuses on something else.

Under gold, a nation or an individual cannot sustain a deficit forever.  A deficit is when one consumes more than one produces.  One has a negative cash flow, and eventually one runs out of money.  The economy of a household or a national is therefore subject to discipline—sooner or later.

Friedman asserted that floating exchange rates would impose the same kind of forces on a nation to balance its exports and imports.  He claimed that if a nation ran a deficit, that this would cause its currency to fall in value relative to the other currencies.  And this drop would tend to reverse the deficits as the country would find it expensive to import and buyers would find its goods cheap to import.

Friedman was wrong.

To see why, one must look at the concept known to economists as “Terms of Trade”.  This phrase refers to the quantity of goods that can be purchased with the proceeds of the goods exported.  For example, country X uses the xyz currency.  It exports xyz1000 worth of goods and it can thereby pay for xyz1000 worth of imports.  But what happens if the xyz drops relative to the currency’s of X’s trading partners, because X is running a trade deficit?

The country exports the same goods as before, but they are now worth less on the export market.  So X can pay for fewer goods than before.  Buying the same amount of goods will result in a larger deficit.

At this point, one may be tempted to say “Ahah, Friedman was right!”  But remember, we are not talking about a gold standard.  We are talking about an irredeemable paper money system.  Money is borrowed into existence.  Looking at the trade deficit from the perspective of Terms of Trade, we see that trade deficits lead to budget deficits, which leads to a falling currency, which leads to increased trade deficits.  It is not a negative feedback loop, which is self-limited and self-correcting.  It is a positive feedback loop.

There is no particular limit to this vicious cycle until the country in question accumulates so much debt that buyers refuse to come to its bond auctions.  And this is not a correction or a reversal of the trend; it is the utter destruction of the currency and the wealth of the people who are forced to use it.

And, of course, Friedman had to be aware that America was likely to be biggest trade deficit runner in the world.  Its currency, the dollar, was (and is) the world’s reserve currency.  That means that every central bank in the world held dollars as the asset, and pyramided credit in their own currencies on top of the dollars.

What would happen if the dollar weakened because the US was importing real goods and exporting paper dollars?  The US would simply import the same goods next year and export even more paper dollars to compensate for the drop in the dollar!

Friedman would have also been aware of the economist Robert Triffin, who wrote in the early 1960’s about a problem that became known as Triffin’s Dilemma.  In essence, the issue is that the world needs to expand credit to grow and so has demand for more US dollars.  But this can only occur if the US runs a perpetual trade deficit, which would weaken the US dollar.

To the central banks that hold dollars as the reserve asset, this is deadly.  Like any bank, a central bank has assets and liabilities.  If a significant component of the assets are composed of US dollars, and the US dollar falls, the central bank’s balance sheet deteriorates.  The liabilities side, of course, is the central bank’s own currency.  So the asset is falling and the liability is not.  This is a dangerous situation and unsustainable.

And to blithely propose this as a system is to propose open theft.  Why should any country agree to allow the US to dissipate its savings, defaulting on the US dollar obligations in slow motion, a few percent per year as Friedman proposed?

The scheme of floating exchange rates of irredeemable paper currencies is therefore dishonest as well as unworkable.  Today, some 40 years after the plunge into the worldwide regime of irredeemable paper currencies, it’s starting to matter.

Copyright Keith Weiner, president of the Gold Standard Institute USA

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Teamtc321's picture

Silver Bitcheez!!!

Peter Pan's picture

Exactly. With silver for daily transactions there would be no currency fluctuations just goods and services price fluctuations to reflect what people are prepared to pay or be paid. Imagine how many useless and damaging currency traders, bank employees and other time wasting positions could be eliminated.

In the meantime we will be subjected to currency fluctuations which in some respects are nothing more than the efforts of nations to circumvent some of the problems that free trade creates.

ArkansasAngie's picture

The greater fool theory at work.

CH1's picture

This article is riddled with statist assumptions, which makes it of null value.

"Between countries" is an immoral construct, presenting the economic slavery of millions as if it were acceptable. It ain't.


Evil Bugeyes's picture

The US is able to run a perpetual trade deficit because countries like China and Japan are willing to buy our debt. We can continue to import from these countries a long as they are willing to buy our "exports" of USTs with the dollars they earn by selling their products to us.

Even if the US were to switch to a gold standard, these countries could still continue to export to us by buying US debt just as they do now. The only difference is that with a gold standard when US debt eventually becomes unservicable, the US would be forced to devalue the dollar or default. Whereas with fiat currency, the US government can inflate. So switching to the gold standard would not automatically correct trade imbalances.

But since the Chinese and Japanese are currently being kind enough to support the value of the dollar by buying our USTs, we should take advantage of the dollar's strength to buy up all the precious metals that we can. Because if they ever decide to stop, PMs will become much more expensive in dollar terms.

GoodMorningMr.VanRumpoy...'s picture

A big stick keeps them buying.


Particularly useful when the U.S.A. has the ability to weaponize the ionsphere. Makes any attack look like a natural disaster, so domestic populace doesn't know about the extortionist practices to ensure buyers.

Caviar Emptor's picture

Friedman's Monetarism was all about how to stiff creditors out of the gold they were was the ultimate "The Check is In The Mail" lil ole lie delivered with a silver tongue and a few other things

slewie the pi-rat's picture

the check is in the mail, BiCheZ!

trust me

Sudden Debt's picture

Lets just hope the mailman doesn't lose it again like he did the last few 400 times...


Stuck on Zero's picture

A gold standard would solve nothing. Mercantilist states will gladly enslave their population to grab all the gold and hold it.  States that respect the rights of their citizens always lose when trading with mercantilists.  The only solution is for nations to prohibit trading with mercantilists.



Sudden Debt's picture


it would make me rich :)

lasvegaspersona's picture

The ECB has addressed this issue in the components of it's asset column. Gold and Reserves. As the reserve currency decreases in value, gold increases. Originally the ECB held 15% of it's assets in gold. Without any further accumulation the gold now comprises about 50% of the assests held. If gold is allowed to move freely and reserves are not double counted gold works just fine in maintaining balance. Note gold is not 'money' just an asset. If the dollar were to collapse the gold would then be 100% of the ECB assets....with no decrease in value, after all as the dollar falls the dollar price of gold rises to keep asset values stable.

AldoHux_IV's picture

Floating rate, free markets, inflation, deflation, etc. are all terms that mean something entirely different for those who say it in media and those who have to hear the garbage and to those who truly understand the topics.

While it makes sense to most people, unfortunately central bankers feel they can change the rules and not be proned to their own weak balances sheets nor laws of limits.

People won't care until it's too late unless there is an agent of change now.

Flakmeister's picture

I'll quibble...  Call it , Workable and Dishonest....

Fiat currency is always limited by the exchange rate into oil and gold...

suckerfishzilla's picture

Now that it has been established that there is a dishonest currency system he in the good ole US of A maybe just maybe we can all do something about it.  Like before the zombies get here.

hairball48's picture

Do away with Central Banks, fractional reserve banking, make gold legal tender and let it freely circulate as "real money".

That would solve a lot of problems imo. But Im not so naive to believe any of that will ever happen in my lifetime

Nussi34's picture

You do not even need it to pay physically. Pay with credit card in gold units. Very simple.

tony bonn's picture

first let me dispose of milton friedman - he was a fascist murder loving creep. i can thank naomi klein in the shock doctrine for exposing him for the totalitarian punk that he was....

regarding the problem of trade deficits: nations do not hold account balances with trading partners.....individuals and organziations do!!!!!

thus it matters not one whit that company abc imports gazillion dollars worth of widgets from shangrila....if it sells the widgets for a profit it can continue to import until the cows come home and it has a legitimate need for money.

dollars are shipped overseas but cannot be repatriated except through recycling procedures because there is no convertibility except through is thus the nature of the money which is the problem. debt has become cancerous.

Augustus's picture

Some brain diseases are difficult to treat.

RECISION's picture

There is nothing wrong with a floating exchange rate.

In fact, the opposite is a nonsense in itself.

The problem is all the other little lies and manipulations that go on behind the scenes.  Like governments trying to manage interest rates.

Whenever governments decide that they don't like what the consequences of the rules are, they change the rules, or come up with some mechanism to subvert them.

The discipline required by a floating exchange rate is that you need to take heed of the messages it is sending you and stop acting improvidently. 

jeff montanye's picture

i get the feeling that, down the line, the answer to the crisis by the current cartel will take the form of "there wasn't a central bank for the world".  the dollar as reserve currency will be replaced by imf special drawing rights or similar fiction and a further empowered international monetary authority as their issuer.  seems like the problems of the euro writ large but i think they will keep on trying.

ebworthen's picture

If you lend me $1,645 today I'll gladly pay you back Tuesday, of next year.

I'll even give you back $1,655 next year, in fiat dollars.

Think Ben would take me up on it?

Gringo Viejo's picture

Some float, some sink, they all get flushed.

Zero Govt's picture

"Under gold, a nation or an individual cannot sustain a deficit forever.."

Under both Gold and Fiat money nations cannot debt-spend forever. Gold based money makes zero difference as a solution.

What the politicos are doing is trashing (printing) the Fiat currency to dig themselves out of debt. But that is the exact same process as Govt and Royalty debasing Gold and Silver money as has happened dozens of times in history

Neither Gold based money nor any Fiat currency (floating exchanges or not) is a 'solution' to Govt with a monopoly on money who debt-spend it into oblivion. Gold based money does not stop, and has never stopped, politicians or Royalty driving their nations into oblivion. Period

The solution therefore is not Gold or Silver money.

The solution is a free market in money.

Get the Govt and its freedom-strangling rules and monopoly laws out of every sector of the economy, including their grimy hands off the money supply

Sudden Debt's picture

Gold based money does not stop, and has never stopped, politicians or Royalty driving their nations into oblivion.

True. But the reason was because they always overindebted themselves. But it did protect the citizens from rampant inflation.

and once they stopped using silver and gold inflation killed the middleclass.

For gold and silver: If you make like 3000 dollars in silver a month, you know that you'll be able to buy as much with the same ammount of money in the next 10 years.

With paper fiat: 3000 buys you what 2700 dollars did last year.

Sean7k's picture

+100 You must eliminate legal tender laws. As for Friedman, Bernanke, Greenspan, Keynes, Eccles, Strong, Volker- they were all wrong- because they were supposed to be. They delivered well wrought rhetorical arguments to questions of economics that befuddled the people and allowed the continued transfer of wealth to their masters.

These types of arguments just muddy the waters. No standard works only the freedom to choose whatever you want. The beauty of liberty.

kita27's picture

The buying of US debt is the recompensation for US technology and access to the US controlled global market. Dollars may be intrinsically worthless, but to gain access to 'the club', other nation states have no choice but to participate. In the end, it is they who are able to grow and prosper, while the US gets cushy high tech service jobs by ditching manufacturing.

If another country can produce something cheaper than your country LET THEM DO IT. The money saved can be invested in high technology ventures or allow more domestic market opportunities to open up for those people with little brains or expertise to gain employment they might not otherwise be able to get. (Dog washers, car washers, ironers, cleaners etc). It all fulfils demands that would not be there if it werent for the savings allowed for by cheaper foreign products.

While everyone talks of capital, and manufactured exports, i do not hear much about the service sectors. Service economies fulfil demands of the people just as much as material objects do, if not more. Liquidity is not capital, but it facilitates velocity, which facilitates the bulk of GDP.

100's of billions of dollars exchange hands and not a single commodity may be used, except the labour, or knowledge of some person. Knowledge is capital, people are capital, not just buildings, machinery and technology. A strong healthy service economy means strong demand for the local currency. Another reason for foreigners to be interested in that countries bonds.

The problem of course is central planning, over regulation, and manipulation of currencies. Politics and the economy, you will never be able to separate them. 

But is a gold standard the answer? A Gold standard is like an anchor on an economy. Economies grow, thats just what humans make them do, we progress, we become more efficient, we demand roads for the invention of the car, we demand traffic lights to create order out of the ensuing chaos. These capital intensive products for example require liquidity, and produce even more liquidity when they are finished. Gold doesnt grow enough to keep up with the ingenuity and growth of societies. Societies will be choked into low growth and lower living standards.

i have been trying to play a devils advocate here, i know in reality, things just dont seem to be working out this way. Floating currencies should work, but due to politics, they dont. 

juggalo1's picture

The article was internally contradicting.  It attempted to compare and contrast a gold standard and a dollar standard.  The gold standard was virtuous because trade deficits were unsustainable.  The deficit currency would drop in value in relation to gold restoring equillibrium.  The floating currency would continue to run deficits because it only would drop when buying appetites run out.  BUT his conclusion is: "the US dollar falls, the central bank’s balance sheet deteriorates.  The liabilities side, of course, is the central bank’s own currency.  So the asset is falling and the liability is not.  This is a dangerous situation and unsustainable."  He is in essence saying the floating currency schemes are bad because they ALSO make deficits unsustainable.  He snuck back onto the same side of the table as Milton Friedman!  I've never heard of the gold standard buffoons accounting for lending of gold or lending between states either which would introduce the same unsustainability into a gold standard.  Oh well.

Diogenes's picture

The problem is not the lack of a gold standard. The problem is lack of principles and honesty.

A gold standard is supposed to force politicians to be honest. But nothing can force politicians to be honest if they don't want to be. Any student of history knows there was plenty of chicanery by the leaders, and hardship on the populace under a gold standard.

The gold standard was done away with because of its deficiencies. We would all be better off if gold had remained a "barbarous relic" which it would have, if governments were honest. But they couldn't resist chiseling, just a little bit, just this once. And of course once you start chiseling it becomes harder and harder to stop until finally you can't stop without crippling the economy.

So, if we had an honest virtuous populace, which elected honest virtuous leaders, who were capable of planning in generations rather than weeks or months, we could have a peaceful, prosperous and dynamic economy free of most of the defects we suffer under today.

Without that, we will have crisis after crisis gold standard or no gold standard.