The dramatic events in Asia, Russia and Brazil have generated a torrent of comment about exchange rates, hot money, exchange controls, currency boards, "dollarization" and the need for a new global financial architecture, most of it half-baked or dead wrong. Let's try to unravel the good from the bad.
Follow Friedman
If only developing countries could produce sound money, hot money would cool down and become less volatile. Exchange-rate crises of the type that have battered emerging markets during the past two years would find their way into the dustbin. In his 1972 Horwitz Lectures, Nobel prize-winner Milton Friedman presented a clear diagnosis of the currency problem facing developing countries and a correct prescription.
Friedman concluded that any developing country with a central bank was doomed. He recommended dumping central banking and either unifying a national currency with a strong currency via an orthodox currency board system or via official "dollarization".
The evidence supports Friedman. I recently evaluated data from 98 developing countries during the period 1950 to 1993. The countries were separated into two groups: those with central banks and those that were either operating with currency boards or were dollarized.