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"The canonical crisis model derives from work done in the mid-1970s by
Stephen Salant, at that time at the Federal Reserve's International
Finance Section. Salant's concern was not with
currency crises, but with
the pitfalls of schemes to stabilize commodity prices. Such price
stabilization, via the establishment of international agencies that
would buy and sell commodities, was a major demand of proponents of the
so-called New International Economic Order. Salant, however, argued on
theoretical grounds that such schemes would be subject to devastating
speculative attacks.
His starting point was the proposition that speculators
will hold an
exhaustible resource if and only if they expect its price to rise
rapidly enough to offer them a rate of return equivalent (after
adjusting for risk) to that on other assets. This proposition is the
basis of the famous Hotelling model of exhaustible
resource pricing: the
price of such a resource should rise over time at the rate of interest,
with the level of the price path determined by the requirement that the
resource just be exhausted by the time the price has risen to the "choke
point" at which there is no more demand.
But what will happen, asked Salant, if an official price stabilization
board announces its willingness to buy or sell the resource at some
fixed price? As long as the price is above the level that would prevail
in the absence of the board - that is, above the Hotelling
path -
speculators will sell off their holdings, reasoning that they can no
longer expect to realize capital gains. Thus the board will initially
find itself acquiring a large stockpile. Eventually, however, the price
that would have prevailed without the stabilization scheme - the "shadow
price" - will rise above the board's target. At that point speculators
will regard the commodity as a desirable asset, and will begin buying it
up; if the board continues to try to stabilize the price, it will
quickly - instantaneously, in the model - find its stocks exhausted.
Salant pointed out that a huge wave of speculative buying had in effect
forced the closure of the open market in gold in 1969, and suggested
that a similar fate would await NIEO price-stabilization schemes.
This basic logic was described briefly in a classic 1978 paper by Salant
and his colleague Dale Henderson (their main concern in that paper was
with the more recent behavior of the gold price, and in particular with
the effects of unpredictable sales of official gold stocks). Other
researchers soon realized, however, that similar logic could be applied
to speculative attacks not on commodity boards trying to stabilize
commodity prices, but on central banks trying to stabilize exchange rates."
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