Today’s currency tensions are the result of a complex set of forces arising from the Great Recession (Claessens et al. 2010 and Evenett 2010). Understanding the present, however, is frequently eased by an understanding of the past.
Today’s exchange-rate system, despite being a hodge-podge of variable, managed, and pegged rates, has served the world economy well during the global crisis (Dadush and Eidelman 2010). Acting as a safety valve, flexible and semi-flexible exchange rates have enabled relatively smooth currency adjustments, and pegged rates have generally held. For most of the 40 largest economies, real effective exchange rates have remained within reasonable bounds and, of the 10 that saw real-exchange-rate appreciation exceed 10%, five countries have current-account surpluses and three have seen large resource finds.
Compared with previous episodes, today’s currency turmoil appears mild. Volatility is less pronounced1 and only five of the 25 major currencies for which comparable data is available are seeing exchange rates shift by more than they did either before the collapse of the fixed-exchange-rate system in 1973 or before the concerted interventions around the Plaza Accord in 1985.
Nevertheless, this currency turmoil cannot be taken lightly. Currency tensions have a tendency to escalate and, as we will see, have been associated with heightened protectionism in the past.