The Alignment of Foreign Exchange Rates

[Front Matter and Publication Details]: Title page, publication information, and dedication for Fritz Machlup's 'The Alignment of Foreign Exchange Rates'. It identifies the work as the first series of the Horowitz Lectures on Money and International Finance, delivered in January 1970. [Preface and Table of Contents]: The author outlines the main thesis: realignment of foreign-exchange rates is the best option for correcting persistent international payment imbalances. The table of contents details the structure of two lectures covering adjustment policies, costs, timing, and flexibility. [First Lecture: Adjustment Policies and Processes - Alignment and Equilibrium]: Machlup critiques the terminology of 'equilibrium' in economics, arguing it is often misused to mean price stability or full employment. He defines the equilibrium exchange rate theoretically but notes that in practice, fixed rates are usually disequilibrium rates maintained by official intervention. He references Ragnar Nurkse's ten-year period definition and the IMF's concept of fundamental disequilibrium. [How Exchange Rates Get Out of Line: Causes of Disalignment]: Machlup analyzes the causes of exchange rate disalignment, distinguishing between structural and monetary factors. He provides a detailed classification of forces including differences in rates of increase for effective demand, money supply, real national product, and price levels, as well as changes in behavioral propensities like the marginal propensity to import. [The Conjuncture of Forces in Exchange-Rate Disalignment]: Machlup discusses how various economic forces, including money supply, demand for money, and real national product, interact to cause exchange-rate disalignments. He emphasizes that differential rates of price increase are often insufficient explanations, highlighting the importance of the marginal propensity to import and income elasticity of demand, specifically citing the United States and Japan. [Techniques for Redressing Imbalances: Market Segmentation and Selective Devaluation]: This section examines how governments use market segmentation and selective devaluations to address foreign-exchange imbalances. Machlup provides historical examples of 'concealed' devaluations, such as the U.S. Interest-Equalization Tax and tied foreign aid, the UK's 1965 import surcharge, and West Germany's border-tax measures (Ersatzaufwertung). [Real and Financial Correctives vs. Real Adjustment]: Machlup distinguishes between 'correctives' (selective measures affecting specific flows) and 'real adjustment' (fundamental changes in supply and demand). He critiques the operational definitions used by balance-of-payments accountants, arguing that many financial correctives are merely temporary stopgaps or financing devices rather than true adjustments. [Monetary Policy and the Classical Adjustment Process]: Machlup explains the classical mechanism of adjusting supply and demand to a fixed exchange rate through monetary policy. He details how central banks in surplus and deficit countries manage the monetary base and the 'multiplier' effect, noting the political difficulty of allowing automatic contraction in deficit countries. He references Michael Michaely's empirical studies on these policies. [Adjustment in Reserve-Currency Countries]: This section analyzes how the adjustment process differs for a reserve-currency country like the United States. Machlup argues against the notion that reserve-currency status prevents adjustment, explaining how changes in liquid liabilities to foreigners affect domestic money supply, liquidity, and aggregate demand through various banking channels. [Fiscal Policy and the Theory of the Policy Mix]: Machlup critiques the 'policy mix' approach which assigns fiscal policy to domestic goals and monetary policy to external balance. He argues that fiscal and monetary policies are inseparably linked in practice and that fiscal ease is only expansionary if supported by monetary expansion. He defines the characteristic roles of each in controlling the supply and demand for credit. [The Mechanism of Exchange-Rate Adjustment]: Machlup explains how adjusting the exchange rate itself (rather than aggregate demand) shifts supply and demand curves in the foreign-exchange market. He emphasizes that for devaluation to be effective, it must be accompanied by monetary restraint to prevent the dissipation of its effects through domestic inflation. He argues that exchange-rate adjustment is the 'least-cost' option compared to demand deflation. [Interprovincial Adjustment and Optimal Currency Areas]: Machlup compares international adjustment with interprovincial adjustment within a single country. He notes that provinces lack exchange-rate tools and rely on demand effects and labor mobility. He introduces the concept of 'optimal currency areas,' suggesting that while a single currency serves a large area's combined welfare, individual nations often prioritize their own welfare through monetary sovereignty. [The Social and Economic Costs of Adjustment]: Machlup evaluates the costs of different adjustment techniques. He argues that selective correctives are the most costly, while aggregate-demand adjustment (inflation or deflation) inflicts unnecessary hardships like unemployment. Exchange-rate adjustment is presented as the most efficient method, as it uses the price mechanism to steer resources with minimal disruption to total output. [Second Lecture: The Problem of Timing and Resistance to Realignment]: In his second lecture, Machlup addresses why governments resist exchange-rate realignment despite its theoretical advantages. He categorizes reasons for resistance, including fear of change, moral objections, 'elasticity pessimism' (the belief that rate changes won't work), and the persistent hope that imbalances will reverse themselves without action. [Political and Economic Arguments Against Upvaluation and Devaluation]: Machlup details specific political pressures against currency adjustments. Surplus countries resist upvaluation to protect export industries and avoid 'paying for others' faults.' Deficit countries resist devaluation due to concerns over national prestige, the risk of government collapse (citing Richard Cooper), the cost of serving foreign debt, and the vested interests of exchange controllers and protected monopolists. [Inflation, The 'Right Moment', and the Shock Theory]: Machlup refutes the argument that devaluation should be avoided because it accelerates inflation, arguing that it actually reduces price distortion. He also critiques the 'shock theory'—the idea that only large, abrupt changes are effective—by explaining that small changes are sufficient to influence marginal buyers and sellers, thus supporting more frequent, smaller adjustments. [Objections to Greater Flexibility: Discipline, Speculation, and Trade]: Machlup addresses common objections to flexible exchange rates. He argues that flexibility does not destroy monetary discipline, nor does it necessarily lead to competitive devaluations or harm trade (citing the growth of trade during the 1960s crises). He explains that systems like the 'wider band' or 'crawling peg' actually reduce the incentives for massive, riskless speculation compared to the 'jumping peg' system. [Market Signals and Indicators for Small Adjustments]: Machlup defends the signaling function of flexible rates against the charge that they provide 'false signals.' He argues that private traders are often better at interpreting market needs than officials. He also explains how central banks can use indicators like reserve trends and spot prices to guide small, frequent parity adjustments, similar to how they manage discount rates. [Floating Rates as a Transitional Tool]: Machlup discusses the use of floating rates, particularly as a transitional mechanism between fixed pegs. He distinguishes between 'pure' floats and 'managed' floats (Canadian and German types). He argues that a period of floating allows market forces to reveal information about the appropriate rate level, reducing the political and economic risks of premature repegging. [Conclusion and Author Biography]: Machlup concludes that the system of rigid, disaligned rates supported by controls is discredited. He advocates for more frequent, smaller adjustments to avoid the 'agony' of large fundamental disequilibria. The segment includes a biography of Fritz Machlup, noting his academic positions at Princeton and NYU, and his leadership in economic associations.