Crux of the crisis lies beyond economics

By Makmur Keliat

SURABAYA (JP): The idea of adopting a currency board system (CBS) has become a contentious issue. The bone of contention can be formulated in the following way. Can the CBS become a panacea to stabilize the value of the rupiah?

For the proponents, the system is certainly a promising alternative. It will peg the rupiah at a fixed exchange rate to the chosen anchor currency, say, the U.S. dollar. So there will be a sense of stability in the exchange rate.

In addition, since every unit of rupiah will be backed by the equivalent of the government's foreign exchange, and because everybody would legally be free to exchange the rupiah for the dollar or vice versa, there would be a sense of certainty in the exchange rate.

These two benefits, stability and certainty, are regarded as vital requirements for the management of economic activities.

However, there are strong reasons for doubting the benefits of the system.

To begin with, the CBS will work effectively if efforts to gain foreign exchange are not impaired. Since Indonesian exports are not immune to external dynamic, and since an export-led economy takes much time to grow, the system will not instantly provide the country with a certainty as conceived by its proponents.

If the amount of foreign exchange gained from exports recedes, the existing situation will be aggravated. There are two possibilities if this situation occurs.

First, the government, according to the game rules built into the system, will reduce the amount of rupiah circulating in society. This means that the Indonesian economy will be forced to stagnate.

Second, by breaking the game rules, for instance, through issuing a new regulation that not all people will be allowed to exchange their rupiah for U.S. dollars, the system in reality will be in contravention of the foreign exchange regime already adopted by the government. The result, the black market will mushroom.

The concept of stability and certainty inherent in the system is therefore totally misleading and inappropriate.

Furthermore, the CBS will be enacted on the condition that the central bank is not permitted to provide financial loans to banks and all banks are presumed to be rational and efficient in setting their lending limit.

At this point several questions need to be raised. If the central bank cannot act as a lender of last resort, what will happen to a bank which is beset with the problem of insolvency?

Second, if a bank defaults and goes bankrupt, what will happen to those who deposited their money in the bank?

Related to this question, there seems to be a contradiction in terms between the recent government decision assuring people's deposits in banks and the CBS mechanism.

Moreover, it has become a well known fact among Indonesians that even under the supervision of the central bank, some banks have violated their lending limits, as clearly shown in the closure of 16 banks last year, let alone without supervision.

In short, the enactment of the system would imply a sort of inconsistency in government policy regarding the issue of national banking management and of how to restore people's confidence.

Finally, there is a strong tendency in the CBS to presume that the usage and management of national currency exists in a political and social vacuum whereas in reality they cannot be mutually exclusive.

Indeed, as also recognized by some government officials, the instability of rupiah value against the dollar is a ramification of the crisis of people's confidence.

To put it in other words, the drastic fall in the value of the rupiah against the dollar is not an antecedent of monetary crisis but a product of deeper economic, social and political problems such as nepotism, political misbehavior, and economic profligacy.

Such widespread practices have corroded people's confidence in governmental institutions including its economic policy. By implication, it would be very difficult for the CBS to work effectively since it starts from a predisposition that people's confidence has already been gained while, in actual fact, it has not.

In consequence, a sort of hesitation raised by some observers to the idea of the CBS is not unreasonable.

Seen from an historical perspective the question of how to stabilize the value of national currency cannot be separated from the question of how people interact with the government.

In conventional terms, money has its origins in the process of economic exchange.

Since the process of economic exchange is as old as human history, money could also be considered an agent of the market. It does not necessarily mean, however, that without money there will be no market. The reason is that the propensity for economic exchange is a natural phenomenon.

History has shown that a long time before money was invented there were trade relations between European and African kingdoms. Therefore, the lack of money will result only in more limited trade and will largely be in the form of barter.

Irrespective of this fact, the introduction of money into a social system and its growing use -- monetization -- has intensified the process of commercialization.

What is taking place in this process is that people's acceptability of money, either as a medium of exchange, a standard of value or as a store of wealth, is not merely a natural phenomenon as many economists believe, but closely intertwined with the interaction between government and market forces.

It is against this historical backdrop that some academics are of the opinion that money derives its value and usage from a political authority, based on the State Theory of Money.

The theory in essence assumes that since the mandate to make money lies in the hands of the ruling government -- seen in this regard as the symbol of the state authority. The value of money would be fully subject to the unilateral decisions made by princes in Europe, in the past, to decrease the precious metal component of its coins or debate that their national currencies undermined the attractiveness of and confidence in their currency.

Such decisions merely encouraged their citizens and traders to hold foreign currencies as they suspected that, for the purpose of a narrow political economic agenda, money was treated by the ruling government merely as an agent of state power rather than as an agent of the market.

In consequence, one could also say that although the government has political authority to make money and force people to accept the value of money at a certain rate, this right of seigniorage is not a sufficient foundation for its broad acceptability.

Especially in this era of interdependence, the people's confidence in national currency cannot be engineered. As a matter of fact, an increasing interdependence has undermined the autonomy of national monetary tools, not only for developing countries but also developed countries.

In conclusion, the government should avoid thinking about a shortcut to resolve the current monetary problem. The following analogy may be useful for comparison.

A monetary system is exactly like a car. The way the car moves forward depends on how the driver drives, and on his or her commitment to observing the traffic lights.

If he or she is careless and does not pay attention to the traffic lights, then no matter whether the car is new or old, made in a developed country or made domestically, it is highly likely that an accident will occur.

Keeping this analogy in mind, it is better for the government to be committed to the old system rather than spending much energy thinking about a new one.

What is more important and urgently needed in this current situation is thinking about and searching for a solution for how to produce and supply adequate food commodities for the nation's population.

The reason is obviously simple, the belly still rules the head for most people. If they cannot get enough food, it will be out of the question to ask them to think rationally.

Unfortunately, many governments, when overwhelmed by a crisis, tend to find a shortcut, or even a scapegoat. Hopefully, the Indonesian government will be an exception.

The writer is a lecturer in political sciences at Airlangga University, Surabaya.

Window: Seen from an historical perspective the question of how to stabilize the value of national currency cannot be separated from the question of how people interact with the government.