Despite persistent attempts to wean them, people have always loved two things: alcohol and gold. Even John Maynard Keynes said that his only regret in life was that he had not drunk more. However, he had no time for gold. In 1924 he described it as a ‘barbarous relic’. But this relic managed to survive as the international exchange standard for 49 more years. It was only in 1973 that the world finally moved from a fixed exchange regime that was based on gold to a flexible or floating rate regime.

Keynes’ deep sigh of satisfaction has informed much of international monetary economics since then. This shift wouldn’t have happened had not the US, acting utterly imperiously, said two years earlier that it would not honour its commitment to give an ounce of gold to whoever gave it $35. This was the gold standard that the US demolished because it simply didn’t have that much gold. It had flooded the world with dollars since 1945. With the gold anchor gone, it’s been happily printing away dollars. Since 1973, the exchange rate of a currency has depended on nothing more solid than the whims of the chairman of the US Federal Reserve. The ‘strength’ of a currency has depended since the mid-1970s on the Fed’s hoard of dollars.

But whimsy isn’t always bad and in this case it has actually worked very well although the increase in uncertainty has inevitably raised the risk. The financial markets have managed the former but the latter is unmanageable by definition. So countries that have well developed markets have done well and those that don’t have them have fared less well. But would they have done better with the gold standard with gold in perennial short supply? No.

That said, it was primarily in order to reduce the uncertainty and risk to the less evolved foreign exchange markets that various alternatives to the dollar — like India’s rupee trade — were thought of. The different bridging loan facilities from the IMF were also devised to provide succour to beleaguered economies. But these offered help after a crisis had occurred. So as the global supply of dollars grew because the US could now indulge in ever-increasing deficit financing, and as the dollar nevertheless maintained its role as the gold substitute for the international monetary system, central banks the world over had to accelerate the development of their countries’ foreign exchange markets. This has been the most important positive externality of the adoption of floating exchange rates. Not enough credit is given to them.

Floating exchange rates have also forced governments — except the US — to maintain fiscal discipline as domestic interest rates have become sensitive to global capital flows. The signalling effect of flexible rates has warned governments in advance that profligacy can extract a price in the form of capital outflows and depreciation of the domestic currency. In short, the economic benefits have been multidimensional. These more than compensate for the increased uncertainty and risk.

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