Currency boards still left on the drawing board
Currency boards still left on the drawing board
By James T. Areddy
HONG KONG (Dow Jones): It's back to the ivory towers for currency board proponents.
When exchange rate instability began rocking Asia two years ago, the relatively obscure method of locking one currency against another was touted by many as a safe harbor from the turmoil.
But despite flirtation with the concept by Indonesia and possibly other countries, the score for currency boards in Asia remains exactly as it was before the crisis: Only Hong Kong has one.
A workshop scheduled for next week in Hong Kong should show how much the enthusiasm for currency boards has retired back into the world of academia.
"This is not going to be an eye-catching sort of meeting. All of this will be of relatively little popular interest," concedes the event organizer, Hong Kong Baptist University Economics Prof. Tsang Shu-ki.
The situation is a far cry from early 1998 when currency board proponents found themselves center circle in the raging debate about how to end Asia's financial crisis and drew followers with promises of an easy route to stability.
Steve Hanke, a Johns Hopkins University professor most identified with currency boards, was hired as a special adviser to Indonesian President Soeharto at a time some of the president's own cabinet ministers said they were having trouble scheduling meetings with him.
When done by the book, a currency board should keep one currency absolutely stable against an "anchor" currency, such as the U.S. dollar. The foreign currency is held in reserve by the monetary authority, backing the local currency 100 percent based on the set exchange rate.
The currency board system is theoretically immune to breakage because any weakening demand for the local currency triggers a lift in interest rates, ultimately to a point that revives confidence in the currency. The mechanism works the same in reverse, letting interest rates -- rather than the currency exchange rate -- reflect changing monetary conditions.
Malaysia took a slightly different route last year by administratively locking its currency exchange rate and making it illegal to conduct trade at any rate but the fixed one. With a currency board system, the exchange rate is supposed to hold automatically with virtually no administrative input.
Hong Kong's currency board has provided the city a lot of stability since it was adopted in 1983 and that was an attraction in early 1998 around Asia.
But the system has had only mixed success in the past few years. And because of the way it managed its currency board, the government was cornered into a costly -- and embarrassing -- fight with speculators in August, 1998.
After some changes, the Hong Kong system is technically more orthodox and stronger today. But persisting high money market interest rates suggest lingering concern about the Hong Kong government's political commitment to it, analysts say.
Now, the recovery of Asian growth and currencies and the reversal into deep recession for Hong Kong suggest that the countries wouldn't have been better off with currency boards. Some currency board supporters don't see much opportunity for their use in this region.
Even Megawati Soekarnoputri, a leading candidate to be Indonesia's next president, quietly dropped her backing for a currency board immediately before Indonesia's June national election.
Don Hanna, an economist at Goldman Sachs & Co., says currency board proponents start with a "defeatist" view that policy makers can't do a good job, since the currency board mechanism replaces many of the central banking functions.
He says terrible mistakes were made by Asian policy makers in recent years, but the recovery shows that decisions "by and large have been very good."
Governments realize what they would have given up for that stability, analysts say.
Unlike the situation with Malaysia's currency controls, governments adopting currency boards would have lost control of some of the policy tools that helped them revive, such as the ability to lower interest rates to boost economic activity. A currency board is completely undermined if interest rates are adjusted.
Hanna says the loss of lender-of-last-resort functions with the adoption of a currency board would have left countries without a key policy lever, which would have been dangerous amid a banking crisis.
"You need to have a very solid banking system to have a very convincing currency board," he says.
Tsang says the Oct. 9 currency board workshop will lack the "high-level ideological debate" of recent years.
"We are going to have a technical debate," he says, noting the seven papers so far prepared focus on Hong Kong's system and discuss issues such as lender-of-last-resort facilities and how much of the money supply should be backed and guaranteed by U.S. dollars.
Tsang says currency boards may have dropped from the popular agenda, but remain interesting to monetary experts.
A paper published this month by the International Monetary Fund says "the conventional wisdom" is that emerging-market economies in Asia and elsewhere will increasingly migrate toward pure floating exchange rates or fully locked currency-boards or dollarization.
But the report adds, "These extremes have the attraction of logical consistency, but suffer from a decided lack of political realism."
Asia's financial crisis showed just how fraught with risk the decision can be.
For example, when his currency slumped to more than Rp 15,000 against the U.S. dollar from a pre-crisis level of around Rp 2,000, Soeharto came so close to implementing a currency board in Indonesia in the first quarter of 1998 that he ousted his skeptical finance minister.
But the dollar now buys Rp 8,250, so it's doubtful policy makers wish Soeharto had gone through with his plan.
"Commitment is a very delicate matter. Sometimes when you start from scratch, it's better," says Tsang.
He explains that since there are such high stakes in making the decision to adopt a currency board, mostly over which exchange rate is best, few countries are likely to try it.
The exception would be new or war-torn states, he says, pointing to Albania as a possible candidate for currency board.