Fear and Floating
Many emerging market countries have chosen to float their currencies only as a last resort and only when they have been forced so to do. Even those who have eventually floated have still sought to manage or interfere in otherwise floating currency markets in some way. From this, we have the idea of “fear of floating”, which Calvo and Reinhart set out in a major research paper. While it is understandable that emerging economies fear — or at least are nervous about — the risks of allowing the market free rein, in my view this is like democracy — the worst option apart from all the rest. Government intervention in the economy inevitably creates economic distortions, which can have significant costs. Similarly, if intervention is anything other than occasional in order to smooth price action and correct market overshooting, it can create pricing distortions, which in any case will eventually be reversed.
This notwithstanding, the move from pegged to floating exchange rate regimes has frequently been done with considerable reluctance within the emerging markets, that is to say in many instances it has been forced by the market. Countries such as Mexico, much of Asia, the Czech Republic, Brazil and Turkey did not adopt floating exchange rates willingly. These were forced on them as a result of the breaking of currency pegs and maxi-devaluations that in many cases resulted in catastrophic economic contractions. It should be no surprise therefore that the relationship between the emerging markets and the idea of freely floating exchange rates is an uneasy one. However, barring a major reversal in terms of trade or capital market deregulation and liberalization, there is no going back on this trend towards freely floating exchange rates. The question now is no longer whether emerging markets will choose freely floating exchange rates as one type of exchange rate regime, but when and how they will move to that.