The Dollar, the Yen and European Currencies--Address by Michel Camdessus
IMF News, November 17, 1995
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Bibliographic details
- Published: November 17, 1995
Context and purpose
- Speech delivered at the XIV Sesiones de Trabajo de Tesoreria, Caja de Ahorros de Navarra, Pamplona, Spain, November 17, 1995.
- Purpose: examine roles of the dollar, the yen, and European currencies; assess effectiveness of exchange arrangements for exchange rate stability; explore government and IMF actions to encourage greater exchange rate stability in the face of powerful private markets.
Roles of the major currencies
- Dollar:
- Remains "the most international of the world's currencies."
- Currency in which most official reserves are held.
- Most foreign exchange transactions involve the dollar.
- Most trade transactions are denominated in dollars.
- Yen:
- Has some international role but is primarily a national currency.
- Role not commensurate with Japan's economy or creditor status.
- Limited use as an invoicing currency for Japanese trade and regionally.
- Part of the SDR valuation basket.
- European currencies:
- Primarily national currencies; some important regionally.
- Deutsche mark is the most important European currency and linchpin of the ERM/EMS.
- In some European markets (France, Spain), transaction volume in deutsche mark exceeds that in dollars.
- Extensive use of deutsche mark in Central and Eastern Europe.
- Pegging/zones:
- "23 countries that peg their currencies to the dollar."
- "25 countries whose currencies are linked through the EMS (including 14 African countries that peg to the French franc)."
- "There are no currencies pegged to the yen."
Exchange arrangements and historical performance
- Post-Bretton Woods (since 1973):
- Dollar, yen, and deutsche mark have operated under "managed floating"—no fixed relationship but occasional interventions and policy shifts to affect exchange rates.
- ERM (initiated 1979): intended to reduce volatility; later focused on controlling inflation and macroeconomic convergence; became central to movement toward EMU.
- System resilience and shortcomings:
- System since 1973 "has proven to be reasonably resilient"—handled oil crises 1973 and 1979 and accommodated cyclical differences in 1980s/1990s.
- EMS enhanced monetary and fiscal discipline, narrowed inflation and interest differentials, helped intra-European trade.
- Shortcomings: increased exchange rate volatility since 1973; emergence of currency misalignments that can persist and cause damage (misallocation, protectionism, trade frictions).
Key statistics and market facts (preserved exactly)
- "Daily turnover in these markets is now over $1.2 trillion."
- During 1985-94, official holdings of international reserves averaged:
- 54 percent denominated in dollars
- 15 percent in deutsche mark
- 8 percent in yen
- 3 percent in pounds sterling
- 2 percent in French francs
- Proportion of transactions (Bank for International Settlements survey):
- 83 percent involving the dollar
- 37 percent for the deutsche mark
- 24 percent for the yen
- Invoicing of exports:
- Nearly half of the exports of industrial countries denominated in dollars
- About one quarter in deutsche mark
- Only one tenth or less each in pounds sterling, French francs, and Japanese yen
- Use of yen in Japanese trade:
- Only a third of Japanese exports denominated in yen
- 40 percent of Japan's exports to Asia and Pacific denominated in yen
- 20 percent of Japan's imports from Asia and Pacific denominated in yen
- Footnote observation: "since each transcaction involves two currencies, the sum of all transactions in all currencies amounts to 200 percent."
Problems highlighted
- Exchange rate volatility:
- "Dramatic increase in exchange rate volatility" since breakdown of Bretton Woods.
- Exchange rates of dollar, yen, deutsche mark "much more volatile" than before 1973 and more volatile than consumer price indices or other economic measures.
- Currency misalignments:
- When exchange rates depart from fundamentals for relatively long periods; can cause serious damage (misallocating resources, deepening adjustment problems, fueling protectionist pressures).
- Examples: overvalued dollar in mid-1980s; misalignments within EMS causing turmoil.
- Private-market power vs official resources:
- EMS crises of 1992-93 showed private resources often far exceed amounts monetary authorities can mobilize to defend parities.
- Overreliance on exchange regimes:
- Placing too much reliance on regime mechanics and not enough on underlying policy fundamentals is perilous (lessons from 1992-93 ERM strains).
- Policy attention lapse:
- Failure to maintain Louvre "reference ranges" in February 1987 attributed to reliance on pronouncements instead of policies and domestic preoccupations (US recovery, Japan financial crisis, Germany reunification).
Lessons and policy recommendations
- Correct macroeconomic imbalances promptly:
- "When macroeconomic imbalances do occur, they should be corrected as soon as possible" to reduce risk of market turmoil and credibility loss.
- Exchange market intervention has a limited, temporary role as a signal; policy changes are required to convince markets of alignment with fundamentals.
- Major countries' responsibilities:
- Prominence of dollar, yen, European currencies implies special obligations for the United States, Japan, and European countries.
- United States: pursue monetary and fiscal policies that promote price stability and enhance domestic savings; cooperate internationally to promote exchange rate stability.
- Japan, Germany, and other European countries: ensure economic fundamentals are sound; strengthen economic policies to contribute to global stability.
- Specific domestic reforms:
- Fiscal consolidation: "considerably more action is needed" to reduce fiscal deficits and public debt as a share of GDP, especially given aging populations.
- Expenditure-focused consolidation; reform major transfer programs (pension and health care systems, subsidies, indexation).
- Japan: strengthen domestic banking system; deregulate economy; expose it to greater competition.
- Europe: labor market reforms to reduce structural unemployment and help fiscal consolidation; create a "virtuous circle" of reforms leading to lower interest rates, investment, growth, and improved employment.
- European Monetary Union:
- Continue and, in some countries, intensify efforts toward monetary union.
- Fiscal consolidation should "go much further than the Maastricht criteria require."
- Multilateral coordination and leadership:
- Countries must pursue more effective multilateral coordination: understand others' policies, listen to outside judgments, take enlightened view of national interests, and have leadership to act.
- G-7 should resist significant depreciation of the dollar from then-present levels and ensure commitments are credible by addressing fundamental policy requirements for a stronger dollar and a more realistically valued yen.
- IMF should maintain candid dialogue with the G-7 and encourage continuous policy coordination, not just reactive measures.
IMF role and surveillance
- Surveillance as principal IMF contribution:
- Regular, thorough, candid consultations with each of its 180 members, usually once a year or more often as needed, covering fiscal, monetary, exchange rate, and structural issues.
- Aim: encourage strong and consistent economic policies to lead to exchange rate stability and sustainable growth.
- Strengthening surveillance post-Mexico:
- Ensure more regular and timely provision of data to the Fund.
- Intensify dialogue with country authorities.
- Greater attention to soundness of domestic banking systems, financial flows and sustainability, countries with greater risks, and potential spillovers.
- Developing standards to guide members in provision of economic and financial data to the public.
- Complementarity with market discipline:
- Markets provide discipline but not always smoothly; IMF surveillance can encourage timely policy adjustments before markets force costlier corrections.
Recent developments and outlook (as of speech)
- Encouraged by industrial countries' action "last August" to reinforce the dollar's slight recovery against the yen.
- Judgment that major currencies were "within, broadly speaking, an acceptable range," but:
- "U.S. dollar continues to look weak against the deutsche mark and closely linked European currencies, as well as against the Japanese yen."
- From a macro perspective, a stronger U.S. dollar and slightly weaker deutsche mark and yen "might seem appropriate" given respective cyclical conditions.
- G-7 declaration in Washington in October welcomed orderly reversal in major currency movements, reaffirmed commitment to reduce imbalances and cooperate closely in exchange markets.
- IMF should persevere in candid G-7 dialogue and encourage continuous policy coordination to detect and avert misalignments early.
Source: The Dollar, the Yen and European Currencies—Address by Michel Camdessus, November 17, 1995, International Monetary Fund.