The recent flurry in foreign ex­change markets probably signals the start of a process of ­un­winding global imbalances. But it also highlights the fact that global exchange rate arrangements, viewed as a system, are not fit for purpose.

The current consensus favours a laisser faire approach to the choice of exchange rate regime – based on the idea that each country should unilaterally choose a regime that best suits its goals and circumstances. But this free-for-all contains a radical flaw from a systemic standpoint. A small country’s regime choice does not matter to other countries. Not so with a key country. Its exchange rate arrangements and policies affect other key countries as well as the rest of the world. If the key countries are not content with their mutual exchange rate relationships, there is a potential for economic and political conflict. Moreover, if their exchange rate arrangements do not facilitate timely correction of imbalances, there is a danger of disorderly adjustment, with adverse consequences for all countries.