To the Editor:

Benn Steil ("The End of National Currency," May/June 2007) argues that many poor or small countries should replace their national currencies with dollars or euros, thereby filling a gaping hole left open by an economics profession that "has failed to offer anything resembling a coherent and compelling response to currency crises." But Steil badly oversells the benefits of curtailing national sovereignty over money. The idea that currency crises could be avoided by handing the reins of monetary policy over to Washington or Frankfurt misses the true sources of these events, which often originate with fiscal, not monetary, policies. His policy prescription is also out of step with the state of monetary policy in much of the world today.

At the core of Steil's argument are two basic concepts from international macroeconomics: first, that a country that allows its citizens to borrow from and lend to the rest of the world freely can choose either to manage its interest rates or to manage its exchange rate but not both (the "policy trilemma"), and second, that a country benefits from the perception that its central bank will run policy in a responsible manner (credibility). Steil argues that the best (or even only) way for a central bank in a small or poor country to achieve credibility is through abandoning its national currency, effectively putting in place a strong currency peg. But events over the past two decades or so, a period dubbed the Great Moderation, have shown that central banks have become much more adept at achieving and maintaining credibility by eschewing efforts to manipulate monetary policy on a quarter-to-quarter basis in favor of pursuing long-term objectives.

But what of the spectacular, and often tragic, events associated with currency crises, such as the one Argentina suffered in 2001-2? Steil discusses the case of Argentina, citing the poor performance of this "poster child for monetary nationalists" after it abandoned its currency board. But considering the fate of Argentina during the past five years without reference to the events leading up to that time is like attributing the labored breathing of an emphysema victim to a lack of smoking in the most recent past.

Of course, if Argentina had not abandoned its peg to the dollar in December 2001, it would not have had a currency crisis at that time, but this explanation is tautological. The roots of the Argentine crisis were as much political as economic and were associated more closely with fiscal issues (especially those linked to the relationship between the provincial governments and the central government) than with monetary problems or challenges coming from the international sphere. Political uncertainty and fiscal challenges spill over into monetary and exchange-rate issues, and efforts to address problems by looking at symptoms (that is, pressure on the exchange rate) rather than causes (such as fiscal profligacy) can only provide temporary relief at best.

Michael W. Klein

  • Professor of International Economics, Fletcher School, Tufts University