REVIEW & OUTLOOK (Editorial): Lawson's Lesson
For the first 25 years after World War II, exchange-rate stability was achieved through the Bretton Woods system. This formed a cornerstone of the postwar economic order, not least as a force for financial discipline. But it began to break down in the late 1960s, and by the early 1970s it had collapsed altogether. Thereafter, with countries pursuing divergent economic policies, and many suffering from high and volatile inflation, a system of floating exchange rates was virtually inescapable. Indeed, many at the time believed this new flexibility to be desirable. With hindsight, some of the arguments for free floating seem much less compelling. And the belief that markets would provide a stabilizing influence, through the operations of medium-term speculators, has not been borne out.</br></br>That summary of our recent experience was offered last September by Britain's chancellor of the exchequer, Nigel Lawson, in a speech to the annual meeting of the governors of the International Monetary Fund. Among those who attend IMF meetings he no doubt found much agreement; indeed, this view has recently dominated international economic management as expressed by the Plaza and Louvre accords. Yet few economists have caught up with the world's finance ministers, and even fewer politicians. So it is not surprising that the economic news in Britain these past few weeks has centered on Mr. Lawson's troubles selling this view to his cabinet superior, Prime Minister Margaret Thatcher.</br></br>Mr. Lawson prevailed last week, at least for now, when Mrs. Thatcher endorsed his policy of trying to stabilize the pound, rather than let the markets continue to bid it up. But the current British experience, repeating as it does American experience, has lessons for everyone in a world economy in transition.</br></br>Britain's problem is its success. Its GNP is expanding at an annual rate of 4.3%. It is the second-fastest-growing country, after Japan, in the Group of Five industrial economies. Britain is now so attractive that it's sucking in investment capital much faster than competing economies. The excitement has been growing following the historic supply-side budget Mr. Lawson delivered in March, reducing top marginal rates of income tax to 40%. Both France and West Germany maintain top marginal rates of about 56%, and France's Socialist government is pledging not to lower its rate.</br></br>With vigorous economic activity and the promise of more to come in that part of the world where money is counted in pounds, there has naturally been a surge in the demand for pounds. If the Bank of England satisfies this demand by creating more money, Sterling-M-Whatever will soar, disturbing the astrologers who follow the movements of these ethereal bodies. If the Bank of England fails to satisfy this new demand, the value of the pound will soar.