Can international trade be free while the international payments system that drives it is based upon monetary protectionism.

During the late 1960s and early 1970s the US borrowed heavily from the Federal Reserve to finance the Vietnam War.  As a result, US gold and foreign reserves were plundered to meet the international commitments that these fiscal deficits placed upon the US monetary system.

By 1971, US gold reserves were about half the level they were after the Second World War.  President Richard Nixon was pressured to act to protect them.  But instead of reducing expenditure on the war or raising taxes to finance the war, he closed the gold window.  Then in 1973, to protect official US foreign reserves, he floated the US dollar.

It was not possible for the US to float the dollar while the value of other major world currencies were tied to the value of the US dollar.  So the US encouraged these other economies to float their currencies.  They would not be convinced to act to protect US gold reserves.  So the US government hailed the floating exchange rate system as a solution to the current international payments imbalances and as the ultimate international payments system that would bring prosperity to the world.

Instead of prosperity, it brought recession (the 1970’s “oil crisis”) and the rate of economic growth in the US declined.  US manufacturing industries collapsed.  These industries were told they were blamed for their own demise. 

They were destroyed by protectionism: policies designed to protect official gold and foreign reserves at any cost.

Australia adopted the floating exchange rate system in 1983, when Treasurer Paul Keating sought to protect Australian foreign reserves from the ravages of international speculators.          

Countries established the floating exchange rate system as a barrier to prevent money flowing out of the economy.  It requires the exchange rate to adjust to ensure that the money leaving the country is equal to the money entering a country.

But the floating exchange rate system is a barrier that prevents money flowing into a country, also.  When exports rise, the exchange rate rises to prevent extra money entering the economy.  It lowers the incomes of exporters and raises imports by making them cheaper than domestic products.

Economists convinced by Nixon of the benefits of the floating exchange rate system hail the advantages of the system when exports fall, such as during the Asian economic crisis.  During such times the floating exchange rate system compensates the economy for the reduction in exports by shifting demand from imports to domestic products.  The growth in import competing industries compensates for the decline in export industries.

When exports increase and cause imports to rise and displace Australian manufacturing industries these same economists sit quiet about the benefits of the floating exchange rate system.  Instead they accuse the ailing industries of being inefficient and unproductive.  They urge them to lift their game.

Free trade cannot exist while the international monetary system continues to be manipulated to protect foreign reserves.  If countries are to  to protect free trade, they must remove the constraints on the monetary system that distort trade prices and created perverse trade outcomes.   

The market may vary exchange rates.  But there is no need for that market to be constrained in the way that it has been.  If Australian exporters raise their exports, they must be permitted to bring the extra money they earn into the economy.  The country must be able to raise foreign reserves and save its export incomes to spend in its own economy.