Foreign Exchange market on its own initiative has gone a long way

In respect of Foreign Exchange policy the trend towards liberalisation which prevailed from the late 17th century till the first World War resumed its course during the 'fifties and early 'sixties. But 19th-centurylaisser-faire has gone. That system was no doubt the best amidst conditions of economic and political stability of the Pax Britannica -- though even then there were differences of opinions as to whether stability had not been achieved at too high a cost. As things are nowadays, a very high degree of active Government intervention in the Foreign Exchange markets appears to have come to stay. Restrictions, too, are still in force to some extent in most countries, and experience gained in their application has made it easier to revert at short notice to more drastic forms in times of crises. What is more, dogmatic opposition to their application that was so much in evidence during the early phases of both World Wars, and again in the 'thirties, has weakened, and decisions for or against them have come to be looked upon as a matter of expediency rather than one of principle.

As for active intervention in the markets, it is now looked upon as 'respectable' even in normal conditions, since it has become obligatory under the rules of the International Monetary Fund. Official resistance to unwanted exchange movements by means of Foreign Exchange operations is now part of normal routine. In this respect even the differentiation between the official attitude towards spot and forward operations, which had lingered on until recently, is now in most countries merely one of degree.

Another modern development in the sphere of Foreign Exchange policy has been the increased tendency towards international co-operation. The very existence of the International Monetary Fund bears witness to this. There appears to be a higher degree of awareness than ever before that it is a very shortsighted policy for a Government to concentrate its attention on the defence of its own currency without regard to repercussions on other currencies. It has come to be realised that panicky flights from exchanges are like conflagrations -- if we abstain from doing our best to help our neighbour whose house is on fire it is liable to spread to our house. In this respect mentality has changed beyond recognition during the last quarter of a century -- even though up to the time of writing not quite sufficiently to secure co-operation to the extent required.

As for the future of the Foreign Exchange system, no doubt there is ample scope for its further improvement. All are agreed that even closer international co-operation would reduce or mitigate the dangers and disadvantages of exchange instability, although opinions differ widely about the optimum extent and the ideal form of such co-operation. There is much disagreement about the way in which the international reserves out of which transfers have to be financed should be increased.

While the experts are arguing about this and other reform proposals, the Foreign Exchange market on its own initiative has gone a long way towards improving its own facilities, at any rate in normal conditions. Since the war the provision of forward covering for very long periods has made good progress and is likely to continue to progress. The development of the Foreign currency deposit market is also likely to continue. Exchange rates quoted by banks to customers have become more competitive. The resulting reduction of profit margins on routine Foreign Exchange transactions has driven Foreign Exchange dealers to explore new possibilities and in doing so they have provided additional facilities. Progress in this direction is far from having exhausted its possibilities.

Barring some major political or economic upheaval, progress is likely to be made towards the removal of the surviving restrictions on Foreign Exchange transactions. Capital movements are likely to be increasingly liberalised and residents of countries which have retained some exchange control are also likely to be allowed gradually greater freedom to make international transfers. Gratifying as this may be, it must be borne in mind that progress towards internationalisation of investment and the increase of facilities for flight of capital by residents tends to increase the potential extent to which the whole system is exposed to shocks. The larger the amounts of capital invested abroad and the easier it is for residents to send their funds abroad -- relaxation of restrictions is bound to make it easier to evade the remaining restrictions -- the more the exchanges are exposed to sudden heavy outflow of capital and of sudden heavy hedging against the exchange risk on capital as an alternative. A further expansion of the foreign currency deposit market, too, is liable to increase the vulnerability of Foreign Exchanges.

Suggestions have been put forward that some international currency arrangements should be devised to relieve the dollar, sterling and other currencies of the thankless task of acting as reserve currencies, thereby eliminating the disturbing effect of large-scale shifting of reserve holdings in the Foreign Exchange market on the national economies of the countries concerned. It is yet to be proved, however, that such changes would be feasible or that they would lead to the desired ends.

The improvement of methods of intervention, backed up by international support, is apt to tempt Governments to use Foreign Exchange policy for purposes that are, or should be, outside its scope. Instead of confining its use to defence against speculative attacks or the speculative exaggeration of genuine difficulties, it is liable to be used at times for concealing some fundamental disequilibrium which calls for measures that are outside the scope of Foreign Exchange policy. Indeed such measures are apt to be avoided or postponed because Foreign Exchange policy measures temporarily conceal the imperative need for them. It is of the utmost importance that Governments should resist the temptation to misuse their improved weapon in a way that merely defers the day when they have to face realities and aggravates the difficulties that have to be dealt with sooner or later.

At the time of writing it appears unlikely that pressure in favour of reverting to the system of floating exchanges that operated in the 'thirties would be restored in the leading countries. It is less certain whether pressure in favour of somewhat wider margins between support points under the Bretton Woods system would be rigidly resisted. What matters is that all these reform proposals now receive ample attention and their wider discussion makes the arguments on both sides thoroughly familiar. Governments and Central Banks are now incomparably more favourably placed in making decisions. On the basis of ample past experience and of increased theoretical and practical knowledge they are now in a better position to decide on their Foreign Exchange policies with their eyes wide open. What is equally important, expert opinion and public opinion are now in a better position to criticise their decisions.