Choice of a monetary system 65 transactors.In contrast,a regime of freely floating exchange rates and no controls on private international transactions,that is,a regime in which governments agree not to interfere either with transactions or with the foreign exchange market in any way,is definitely not a system without rules;indeed,it involves extraordinarily stringent proscriptions. A free-for-all regime does not commend itself.It would allow large nations to try to exploit their power at the expense of smaller nations.It would give rise to attempts by individual nations to pursue objectives that were not consistent with one another (e.g.,inconsistent aims with regard to a single exchange rate between two currencies),with resulting disorganization of markets.Even if things finally settled down,the pattern would very likely be far from optimal from the viewpoint of all the participants. A well-analyzed sequence from the realm of trade policy that encompasses all three of these disadvantages illustrates the possibilities.A large nation attempts to exploit its monopolistic position at the expense of other nations by imposing an optimum tariff.Other things being equal,it can gain by imposition of a tariff,the appropriate size of which depends on the monopoly position of the country.But other things do not generally remain equal,for other countries can also gain through the imposition of tariffs.Such retaliation creates a new situation for the first country,which should then alter its tariff,perhaps by raising it,to exploit fully its monopoly position.And so the tariff war goes,creating much turmoil with trade during the process,until a point is reached at which no country can gain further through unilateral action.Furthermore,the resulting pattern of tariffs will almost certainly leave all countries worse off than they would have been if the first country had not attempted to exploit its advantage.2 A regime that prohibits or limits tariff warfare would be mutually beneficial. Similar examples can be found in the monetary realm.For instance,a general shortage of liquidity under a gold standard regime might lead various countries to devalue their currencies in terms of gold in order to improve their payments positions for the purpose of adding to their stocks of money.This behavior would lead to competitive depreciation all around,with an ultimate write-up in the value of gold in terms of all currencies and possibly some stimulation of new gold production,but only after a painful and acrimonious transition.It would be far better to agree together on a"uniform change in par values"(in the language of the Bretton Woods Agreement)of currencies against gold,thus avoiding the needless change in relative currency values and the disruptions to national economies that would obtain under the hypothesized circumstances.It would be better still to abandon reliance on a commodity in short supply and create,by agreement,some 2Harry G.Johnson has pointed out that in the final equilibrium it is possible for one country to be left better off than in the free trade situation;but both countries taken together will certainly be worse off,and I judge that in most circumstances each country taken separately would be left worse off.See his "Optimum Tariffs and Retaliation,"in his International Trade and Economic Growth:Studies in Pure Theory (Cambridge,Mass.:Harvard University Press, 1967). This content downloaded from 211.80.95.69 on Mon,24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and ConditionsChoice of a monetary system 65 transactors. In contrast, a regime of freely floating exchange rates and no controls on private international transactions, that is, a regime in which governments agree not to interfere either with transactions or with the foreign exchange market in any way, is definitely not a system without rules; indeed, it involves extraordinarily stringent proscriptions. A free-for-all regime does not commend itself. It would allow large nations to try to exploit their power at the expense of smaller nations. It would give rise to attempts by individual nations to pursue objectives that were not consistent with one another (e.g., inconsistent aims with regard to a single exchange rate between two currencies), with resulting disorganization of markets. Even if things finally settled down, the pattern would very likely be far from optimal from the viewpoint of all the participants. A well-analyzed sequence from the realm of trade policy that encompasses all three of these disadvantages illustrates the possibilities. A large nation attempts to exploit its monopolistic position at the expense of other nations by imposing an optimum tariff. Other things being equal, it can gain by imposition of a tariff, the appropriate size of which depends on the monopoly position of the country. But other things do not generally remain equal, for other countries can also gain through the imposition of tariffs. Such retaliation creates a new situation for the first country, which should then alter its tariff, perhaps by raising it, to exploit fully its monopoly position. And so the tariff war goes, creating much turmoil with trade during the process, until a point is reached at which no country can gain further through unilateral action. Furthermore, the resulting pattern of tariffs will almost certainly leave all countries worse off than they would have been if the first country had not attempted to exploit its advantage.2 A regime that prohibits or limits tariff warfare would be mutually beneficial. Similar examples can be found in the monetary realm. For instance, a general shortage of liquidity under a gold standard regime might lead various countries to devalue their currencies in terms of gold in order to improve their payments positions for the purpose of adding to their stocks of money. This behavior would lead to competitive depreciation all around, with an ultimate write-up in the value of gold in terms of all currencies and possibly some stimulation of new gold production, but only after a painful and acrimonious transition. It would be far better to agree together on a "uniform change in par values" (in the language of the Bretton Woods Agreement) of currencies against gold, thus avoiding the needless change in relative currency values and the disruptions to national economies that would obtain under the hypothesized circumstances. It would be better still to abandon reliance on a commodity in short supply and create, by agreement, some 2Harry G. Johnson has pointed out that in the final equilibrium it is possible for one country to be left better off than in the free trade situation; but both countries taken together will certainly be worse off, and I judge that in most circumstances each country taken separately would be left worse off. See his "Optimum Tariffs and Retaliation," in his International Trade and Economic Growth: Studies in Pure Theory (Cambridge, Mass.: Harvard University Press, 1967). This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions