International Issues

Gary S. Becker: Fixing a Currency's Value Cures Inflation

Several rapidly growing Asian economies have been in monetary turmoil since Thailand devalued the baht in early July. The problem, says economist Gary Becker, 1992 Nobel laureate, is that many developing countries use free-floating exchange rates to determine the international values of their currencies.

While flexible rates allow rapid adjustment to changes in supply and demand, they also allow nations to debase (inflate) their currencies by printing money to finance government spending. The alternative is to fix the exchange rate of the local currency with a strong one -- such as the U.S. dollar, mark or yen -- and fully back it with foreign reserves.

  • Argentina hyperinflated in the 1980s, causing its peso to become almost worthless and prices to rise at an annual rate of more than 1,000 percent.

  • Inflation was broken when the government set the peso at a fixed one-for-one rate of exchange with the dollar and backed the peso with dollar reserves.

  • Using a similar arrangement, Brazil drastically cut its inflation rate from over 900 percent in 1994 to 10 percent in 1996 and a still lower rate in 1997.

Thailand's baht fell in value by over 20 percent compared to the dollar after the government was forced to devaluate. The devaluation was necessary because the government printed money to finance a rising budget deficit -- caused by bailouts of politically powerful companies.

In contrast, the Hong Kong dollar has been tied to the U.S. dollar at a rate of about seven to one since 1983. The former colony has foreign reserves of about $70 billion and has prospered as the U.S. dollar has increased in value.

Source: Gary S. Becker, "Fragile Economies and Floating Currencies Don't Mix," Business Week, September 8, 1997.

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