The Hard Facts About Fixed Exchange Rates

When Finance Minister Vladimir Panskov announced that the Russian government was setting a three-month exchange-rate target for the ruble, the reaction of economists and bankers in Moscow and abroad was generally favorable. Here, it seemed, was hard evidence that the authorities were taking serious steps to get the Russian economy into shape.


But exchange rates are not always what they seem. A country's currency can often benefit from trading at a stable rate against other currencies, but at other times it may be better to let the currency rise or fall. The overall health of an economy is determined by many factors, of which the strength of the currency is only one.


European Union governments are beginning to appreciate this point more and more as they prepare the way for creating a single currency, a project due to start in 1999. In particular, the new Gaullist leaders of France are worrying whether membership of the single-currency club may enable some of France's most important trading partners -- such as Britain, Italy and Spain -- to gain a competitive advantage by staying out of the monetary union and letting their currencies fall in value.


One of President Jacques Chirac's most sharply worded statements at the recent EU summit in Cannes concerned French exports of calves to Italy, which he claimed had slumped because the franc had strengthened so much against the lira. It works the other way round, too: Italian wine exports are increasingly competitive against French wines around the world since the lira is cheaper than ever.


French leaders, scratching their heads to find a way around this problem, have come up with two ideas. One is to offer a kind of subsidy to countries within the single-currency area to compensate for being priced out of certain markets. But there is no provision for such subsidies in the Maastricht Treaty and the idea of rich nations getting richer on hand-outs is not one likely to win widespread support.


The other French idea is to group countries outside the single-currency area into a separate exchange-rate system in which they would pledge not to devalue their currencies for commercial advantage. Such a system could be buttressed by the use of fines to punish countries that went ahead with sneaky devaluations.


It is unclear whether this proposal will be any more popular than the first. Certainly, it would prove quite difficult to enforce in practice. When, for example, is a devaluation planned, and when does it happen against a government's wishes?


As long as international foreign-exchange markets exert the kind of pressure that can send currencies soaring and plunging in a matter of minutes, defying the combined efforts of all the world's central banks, it is hard to see how any currency can be kept forever within a fixed trading range. Currencies such as the lira, pound, peseta and Swedish krona have sunk in dramatic fashion against the mark in the last three years, but not necessarily because governments wanted that to happen.


Still, France's leaders have touched on an important point about the risks involved in moving to a single currency. Some countries could easily suffer from the project, by losing competitiveness and locking permanently high levels of unemployment into their economies. The more that EU governments ponder these issues, the more interesting it will be to see how many countries have the courage to proceed with monetary union.