Why should there be exchange rates at all?

I’ve been doing something thinking about exchange rates and how hegemonic the terms of trade are. I think the first step is to stop the IMF and World Bank from giving such bad advice to developing countries in addition to Eurozone disbanding or miraculously forming a democratic fiscal union for Eurozone.

After thinking about cryptocurrency and how silly people seem when they talk about it, I asked this question. And I feel like, if all things were right in the world, there would be no exchange rates between countries. They wouldn’t have the same currency, but the exchange rate would be an asymmetric 1:1 with no country promising to pay in a foreign currency, but always promising to pay in their own currency for another at a 1:1 ratio. That might sound weird, but below is my argument.

So for some background for my argument, I’m going to establish some things.

Fixed exchange rate regimes

• Their exchange rate is dependent on the country’s ability to exchange something in a certain amount for their domestic currency that is extant in the universe to some extent.
• This makes it so that they need to export more or use austerity to keep their exchange rate up so that their ability to import important inputs for production (or consumption) is not attenuated such that it would create a crisis.
• Of course, austerity kills. Why would you prevent your country from producing if the issue was that you wanted to keep production up. Seems crazy to me.
• Exporting is tricky because on one hand, sure, you can have export-led growth, some people are going to get jobs that otherwise wouldn’t have jobs.
• But at the same time, you’re devoting more of your domestic resources to producing for the foreign sector instead of the, you’re increasing the money in circulation in the domestic economy, and you’re nearing full employment which could strengthen parties that could engage in a real income conflict that would manifest as domestic demand-pull inflation.
• So exporting more than you import would seem to be more inflationary.
• So you get inflation, and then your exchange rate devalues which was what you were trying to prevent though exporting more.

*Of course, something like eurozone isn’t better because they don’t have a fiscal union that allows a unified democracy to pursue good governance. Some member states are forced into austerity but in a different way due to debt service.

Floating exchange rate regimes

• The exchange rate is dependent on foreign countries and other people in the foreign sector willing to save in the currency and conversely not sell the currency for another at a loss. I think its mostly foreign country’s regimes doing this and not speculators, but I assume speculators can indeed have a hand in the effect as is the case for fixed exchange rates as well.
• So there’s an entirely opposite sort of circumstance. These floating exchange rate regimes can import and this may strengthen the currency because foreign countries would prefer not to sell at a loss generally.
• As well as the notion that importing drains domestic currency from the domestic economy and replaces it with goods which can soak up demand for domestic goods and inputs that can increase productive capacity generally.
• You have may have less job opportunities and more difficulty getting to full employment as well as not having public debt (or private debt) due to sectoral balances, but this is no issue if you denominate all debt in your domestic currency and you have a Job guarantee program.
• You also have potentially more people to do different things in the economy which can lead to more finished products and thus a better standard of living.
• So its ultimately opposite terms of trade for these countries provided that they manage to have an exchange rate to begin with. Importing is deflationary.

So my question is: why would you have a system of exchange rates like this to begin with?

The system as it is seems to say the following:

1. If a country is experiencing domestic inflation, foreigners should be able to continue to purchase the same amount or more goods at higher and higher prices in the domestic currency despite not getting paid more in the foreign currency. That seems inflationary. And why is that at all just? Why should you be able to purchase labor or goods at a discount from a country in some manner that’s almost like arbitrage in that hyperinflationary circumstance?
2. In the way that most people assume the system to work, exporting countries strengthen their exchange rate and this can lead to them importing more. This is how it works in the fixed exchange rate regime model. There seems to be a code of reciprocation there, but clearly it is not without faults and paths that lead to unavoidable austerity and/or perpetual developing-country status. But this code of reciprocal trade breaks down for floating exchange rate regime countries like the US or Japan, so the reciprocal code doesn’t make sense. In addition, there’s some incentive for individuals and firms to export if they can because it increases their income, so it’s not like there is a complete lack of reciprocity in regard to countries that import more than they export.

So I think there’s a possibility of a better system.

For #1, when there’s domestic inflation in a locale of a single currency area and not in another locale that’s part of the currency area — say California prices are increasing, and Texas prices stay the same and/or are decreasing — you’d expect on some level for the some of the terms of “trade” in between those locales to shift towards

• more Californians buying from Texans
• more Texans selling to Californians
• less Texans buying from Californians
• less Californians selling to Texans

*Assuming quality is relatively the same and thus preferences are more or less based on a price alone. You can’t really assume that in the real world, but there are many situations in which this is true and that arbitrage does happen.

**Another assumption is that California is not experiencing stagflation but it’s demand-pull and wages and salaries are indeed higher along with the cost of living.

I feel like you could surmise that California’s inflation would stabilize and Texas would get an economic boost that could increase their employment and potentially drive them to inflationary bias which would eventually reset the trade imbalance. I kind of think that might not happen just as it doesn’t now, but reaching some kind of “equilibrium” would reflect preferences to some extent. Of course, if California’s productive capacity declines as a result of the initial imbalance, this could be detrimental. So you’d want to do a JG as good as you could.

Also, there are lots of different sectors that inflate on a global scale, and substitutions that are cheaper that may occur as a result. E.g. in the 70s, so many countries experienced inflation due to the oil shock. So it wasn’t just a currency area thing. It wasn’t just a “printing money” thing or too much demand chasing too few goods. There were some inflationary biases around the world and the supply shock made those biases come to a head.

So inflation itself isn’t necessarily something that describes the currency, but something that describes a locale within the currency area in particular — it’s productive capacity, it’s demand, it’s bargaining power and pricing power — as well as various global product-specific market that may have different effects on said areas.

Exchange rate devaluation can happen as an effect of inflation with countries and other economic actors less willing to save in a currency because of how much less buying power it might have in the domestic economy of origin.

That effect might lead to more importing from the inflating country, and less importing by the inflating currency both of which could exacerbate any inflation there which leads to the mythology as I see it about inflation being something that happens to a currency in particular and not to an economy that uses that currency or that it is something that happens to a global market-specific good or service that can lead to different gradients of inflation throughout the globe.

So what I’d propose is just a 1:1 exchange rate everywhere. It wouldn’t be a fixed exchange rate as they exist now. The countries would function just as any free floating exchange rate country does with the ability to deficit spend, the ability for the central bank to keep interest rates at 0, the ability potentially for the central bank to buy T-bills directly from the treasury, the minting of coins by the treasury, the ability to collect income taxes, and the ability to always provide a job for anyone that wants one at the wage floor, as well as any other universal public services or social security. All tax liabilities would still be denominated in the domestic currency, and anyone holding a foreign currency that needed to pay taxes would need to go down to some government building and trade their foreign currency holdings for a 1:1 ratio of domestic currency. All legal liabilities, also, would be denominated in the domestic currency. The inconvenience of paying wages or paying for goods in a foreign currency would ultimately lead to use of the domestic currency for all legally recognized domestic transactions. And you could even have some embassy or some country’s government trading 1:1 on behalf of the other country and have them keep track of it in their books. The country receiving the foreign currency would in turn burn the foreign currency (or just make the holdings 0 in their books) as a matter of clarity of operation (It’s not a necessary thing to do, but if every country did that, there would be less confusion about whether or not a country receiving a foreign currency could then go and spend more however they’d like into the domestic economy without any issue. Of course, there could be issues. However, the issues would come from deficit spending in the same way depending on how the money is spent, what the state of the economy and its productive capacity are, etc.)

The difference from a fixed exchange rate system is that it would be asymmetric 1:1 for every participating country. There would be no promise by a country that does not create a currency to pay a foreign currency in exchange for its domestic currency. The person making that transaction would need to go to the country of origin, or the embassy or do it online or whatever. It would be outside the responsibility of each country to pay something that they don’t create in exchange for something they do just as it is outside the responsibility of a country to exchange at a fixed rate for gold or bitcoin or amazon stock or whatever.

Price inflation in a certain area would reduce the buying power of importers to that area and thus less resources in that area would be devoted to exporting. This would slow any inflation, insofar as the price level made importing undesirable. But, just like the california v texas situation, this may not happen if there are consumer preferences, quality differences, etc.

Would there be FX market arbitrage that was different than 1:1? Sure. Let’s say that happens for whatever reason. Just like animal spirits or whatever. Feelings about a country’s currency, what there is to buy from there, inflation expectations or whatever. Well, let’s say they make a favorable trade for the currency that’s increasing in value in that FX market. If they pay it to someone in exchange for the other currency, and that person gets a bad deal, they can just get the 1:1 ratio and then go back to the market and get the better price for the other currency. So maybe it reflects relative convenience of exchange (or something.) Who knows why it would happen. But I think, this asymmetric fixed exchange rate would reduce the chances of that trade ever even happening to begin with.

And maybe you set ground rules or else you lose your privilege to get the 1:1 with other participating countries. For instance, if you were to do economic warfare and floor another country with your currency that you created, they all got the 1:1, created some inflationary bias, yeah, I think that could be considered an act of economic warfare, potentially. Although it could be favorable for many a citizen within the country and has the chance of just being beneficial rather than inflationary. And if the domestic country had properly tuned automatic stabilizers i.e. income taxes, this could just be pointless for the aggressor country. UBI, of course, could be self-defeating for a country in a lot of different ways although it might cause inflation in a different country if it doesn't do so in the country of origin. Or maybe you disallow that kind of behavior too. I think if enough countries did that it could undermine global production in the system and cause a lot of shortages throughout the world (e.g. if every country did that and everyone attempted to import from each other). The violation would come as a result of all countries paying UBI and indexing UBI to global prices. I feel like the system could indeed break in that circumstance. Maybe not. It could be politically difficult or politically easy to undo that situation. But I think there would likely be global finger-pointing. So I think if you set the ground rules in place considering the violations a country could do to abuse the system and cause global production to fail, then yeah, it could be fine.

Inflation should make it harder to buy goods and services from a different country, not the other way around. Inflation rates would determine the terms of trade and something like demand-pull inflation could increase importing and not the other way around. It’s a country’s own responsibility to make sure that their income and capital gains taxes are set so that they absorb income from exports in a way that is functional as well as ensuring that the responses to private sector joblessness are indeed countercyclical.

Is there any huge issues that you could see with this? My first thought is that it kind of seems unfair, but ultimately, I don’t think it’s very much more unfair than the current system that we have that pushes developing countries into not winnable positions. As it stands, the U.S. can basically import a ton and outsource labor so much with no real repercussions. JG would improve any negative consequences of this. If all countries did this, the hegemonic system we currently have would cease and the terms of trade would become more fair.

I’d note that of course every country should want to pursue sustainable energy, intense resource recycling, and ecological mutual symbiosis. It would be in everyone’s interest, and this could also be a vehicle to make it more possible for every country to do it.

I’m really curious to hear what people think of this.

-Optimist