Currency board system not legal tender in the U.S.

By Peter Hartcher

SYDNEY: It is the last blast of departing winter in the North American city of Baltimore. Sub-zero winds whip across the pristine lawns and trim Georgian buildings of the town's most famous institution, Johns Hopkins University. It is along way from Indonesia.

Yet along one side of the main quadrangle, in Room 209 of Ames Hall, with a bright rug on the floor and a small, colored candle alight on his desk, the special economic adviser to President Soeharto sits smoking a pipe.

Prof. Steve Hanke, wearing a cravat, navy blazer and braces, gold-rimmed spectacles perched on the end of his nose, keeps the door shut. "Even then the smoking police come around and say people can smell it. It's this new American obsession. But I've been here 30 years and it's my own office."

But we are closer to steamy Jakarta than it seems. Hanke -- pronounced 'Hankie' -- says that he has had more access to Soeharto in the past few weeks than any of his cabinet, and talked to the President daily as he drew up Indonesia's economic recovery plan.

Indonesia's crisis is dominating his life. "For two months, I haven't had a chance to read anything or do any of the things I like. That's the worst part."

He has advised the governments of six countries, including the United States government during the Reagan Administration, but Indonesia's situation is the most dire of any he has worked with.

"Soeharto knows there's a big fire burning, and it's going to eat everything up. the meltdown scenario is you get a complete collapse of the rupiah to 20,000 or something like that, a hyperinflation blowoff and complete social chaos."

That's where Steve Hanke comes in. He has persuaded Soeharto that he has a fire extinguisher: "Soeharto knows the only way to end the fire is to introduce a currency board. Period. That's his view. It's straightforward." But it turns out that there is nothing straightforward about it at all.

In fact, this proposal has become one of the hottest controversies in global politics and economics.

It galvanized Bill Clinton into phoning Soeharto in an attempt to dissuade him from adopting Hanke's proposal. It united all the governments of consequence to Indonesia in a chorus of protest. Steve Hanke has come to personify this controversy.

His Baltimore office may be just 40 minutes from Washington DC, but it feels closer to Jakarta than to the U.S. capital.

In the two months that the Indonesian controversy has been raging, with the U.S. frantically ferrying special envoys and cabinet ministers back and forth to lobby Soeharto, not one U.S. government official has approached Hanke.

Why not? "It's voodoo," says a U.S. official in Jakarta. According to a senior State Department officer in Washington, "You've seen the guy on TV; he wears his glasses on the end of his nose, he wears a cravat with a pin, he believes in the gold standard -- why would I want to let a guy from the 1930s?"

Hanke thinks there is more to it. "I don't think they are interested because they have already come to their own conclusion -- that the solution is the IMF (International Monetary Fund) program and only the IMF program. I have written an alternative package, the IMF-plus package," which includes the currency board proposal. "If you are not interested in that, why would you want to meet me? They have even gone to the point of saying I never wrote a report, that it doesn't exist."

Hanke produces a copy of the 36-page plan and flicks through the pages. "But when President Soeharto announces that he is going ahead with this plan, they might want to know what's in it."

He is not certain of when this might happen, but says he has told Soeharto that speed is of the essence. He is traveling to Indonesia in the next few days.

So what is so terrible about Hanke's proposal that it makes him an untouchable among officialdom in his own country? Hanke's office wall is decorated with sample bank notes. Each is from a country that took his advice in introducing a currency board: Argentina, Bosnia, Bulgaria, Estonia, Lithuania. And so far, so good. The most famous case of a successful currency board is Hong Kong's.

Indeed, it was Hong Kong's 1983 decision to use a currency board as refuge from financial panic that first introduced the term to Hanke's vocabulary. "I said, currency board, what's that?"

A currency board system is the strongest possible mechanism for fixing a country's exchange rate. Whenever the board issues domestic money, it must back it up fully with a hard currency - usually the U.S. dollar.

But this total inflexibility of the exchange rate means that an economy sacrifices other flexibilities. It sacrifices the power to control its own money supply or interest rates.

These become hostage to capital flows. In the vent of a big outflow of capital, the money base drains away, and interest rates soar. And that's the rub.

Says a senior U.S. Treasury official: "We don't have religion on currency boards, and they can work well in the right conditions, but at the moment Indonesia just doesn't have those conditions."

Specifically, most economists believe that confidence in Indonesia is so poor that, if a currency board imposed even a modestly strong value on the rupiah, it would give Indonesian firms and the Soeharto children an opportunity to swap all their rupiah for dollars. Interest rates would soar, the banking system collapse, the economy die.

Hanke argues that the dispute over Indonesia is less about economics than politics. He does not say so, but he gives the impression that he suspects the U.S. would be pleased to see Indonesia melt down. It would, after all, put terrible pressure on the Soeharto regime.

For Hanke, the case is clear: You're driving a car (Indonesia) down the road. The engine (currency) catches fire. You need to put out the fire; that's what the currency board would do. These other guys are standing around talking about whether to rebalance the wheels.

"They are asking Soeharto to put a gun to his own head," says Hanke.

"After he has finished forming his new Cabinet, his priority will be to stabilize the rupiah."

And Room 209 will, hopes Hanke, have one more exotic currency hanging on the wall.

-- Australian Financial Review