Floating Exchange Rates: The Only Viable Solution
For some, the collapse of Mexico's economy proves that floating exchange rates and markets
without capital controls are deadly. Others find the crash of the European exchange-rate mechanism
(ERM) in 1993 to be proof that targeted rates will always be overturned by the free market. Many
see the breakup of Bretton Woods as the failure of fixed rates. Yet others believe monetary
unification in Europe is the only way to achieve economic and political stability. Many others hold still
different beliefs. There are, however, four main proposals for the management of international
currency exchange rates: monetary unification, fixed rates, floating rates maintained within certain
'reasonable' limits of variability and freely floating rates. Both fixed exchange rates and rates based
on either explicit or unwritten targeting are impossible to maintain, especially in an era of free trade.
Complete monetary unification would be impossible to bring about without extensive integration and
unification of international governments and economies, a task so vast that it is unlikely ever to be
accomplished. Thus, the only option central banks have is to allow exchange rates to float freely.
The European Monetary System, which virtually collapsed in 1993, was an attempt to fix exchange
rates within certain tight bands, to coordinate monetary policy between member nations and to have
central banks intervene to keep exchange rates within the bands when necessary. The reasons for the
collapse were myriad, but, simply put, it happened because Germany, dealing with financial problems
in part arising from its reunification, refused to lower its high interest rates. This meant other European
countries either had to keep their rates equally high and allow themselves to fall into recession as a
result, or devalue their...