The 35 Most Tumultuous Years in Monetary History: Shocks, the Transfer Problem, and Financial Trauma

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Abstract: The past 35 years have been the most tumultuous in international monetary history. Nearly one hundred national banking systems collapsed, many more than in any comparable previous period. The range of movement in market exchange rates and the extent of the deviations of market exchange rates from real exchange rates—the magnitude of "overshooting" and "undershooting"—have been larger than in any previous period. Similarly, the variability in the ratios of trade balances to GDPs has been larger than in any previous period. There were massive asset price bubbles in Japan; in Sweden and two of its Nordic neighbors; in Thailand, Malaysia, and several other countries in Southeast Asia; and finally in the United States.

These events—the failures of national banking systems, the large swings in market exchange rates, the large variability in flows of national saving across national boundaries, and the bubbles in asset prices—were systematically related.

This essay applies an analysis based on the transfer problem process that links changes in the cross-border flows of funds, changes in the foreign exchange values of national currencies, changes in the prices of financial securities and real estate in countries that experience inflows of foreign funds, and prolonged economic booms to explain why there was so much financial trauma. A central question is whether the financial trauma resulted because the shocks were larger than in previous periods, or whether the impact of a shock of a given magnitude on prices of currencies and prices of securities and other assets was larger because of difference in the institutional structures and especially the absence of parities for national currencies.
[JEL H87, N10, N20]