Currency market intervention futile

Currency market intervention futile

Christopher Lingle, Atlanta, U.S.

With many investors converting their funds into dollar-based
assets, Bank Indonesia (central bank) has been selling dollars in
the international currency market. It has also been threatening
to curb currency trading among commercial banks while raising
banks' reserve requirements. Despite these efforts, the rupiah
has shed almost 9 percent of its value against the U.S. dollar
since Jan. 1.

Unfortunately, such actions will prove to be pointless. And
they will be no more effective than attempts to halt the decline
of the rupiah in the months after July 1997.

Part of the decline is due to a contradictory stance by the
Indonesian central bank. It has reduced its benchmark overnight
rate four times this year, allowing higher monetary growth. An
inflated currency can only further weaken the rupiah.

Indonesian importers may complain that the falling value of
the rupiah will cause their profits to erode. And there are
complaints of rising costs to consumers.

However, the doom-laden estimates offered do not consider the
total impact of a depreciating currency. A focus only on the
impact on importers overlooks the fact that a weakening currency
benefits exporters who earn more rupiah and sell more goods.
Regarding the effect on consumers, only a small minority of
households depend on imported goods.

A weaker currency may make some imports more costly. But heavy
global competition is likely to ease some of this pressure.

From the standpoint of production, this impact is mitigated
through an inducement for domestic producers to diversify.
Intervening in currency markets discourages producers from making
decisions that will be in their long-term interest. In all
events, the weakness of the rupiah will boost economic growth in
the export goods sector since they will be less expensive.

While foreign exchange market intervention will be fruitless,
it involves high costs and is a distraction from implementing
other policies that could promote long-term growth. Indeed,
currency intervention goes against the most basic notion of
financial prudence.

In all events, currency values are less important as a
determinant of long-run competitiveness than rising growth in
productivity. Policy makers should be focusing on how to insure
that the investment and regulatory climate is inviting for both
domestic and foreign investors.

There are other and better tools at the disposal of policy
makers in Jakarta if they wish to improve the capacity of their
economy to grow. These include reducing the overall tax burden,
reducing public-sector debt, cutting government spending and
reducing waste or corruption.

Attempting to establish the "right" exchange rate is another
example of hubris displayed by policy makers. History is littered
with failed attempts by government agencies or industry groups to
set prices. Such failures have been recorded with price
intervention on commodities, rental properties and exchange
rates.

Ultimately, decisions by many individual market participants
who are disconnected in purpose and space will determine currency
values by taking decisions that they are not aware they will make
in the future. While politicians and bureaucrats will continue to
exhibit a predilection to meddle, it is better to allow prices of
currencies and other things to be discovered in the complex
interactions of human choices instead of political design.

Consider that the Bank of Japan and Japanese Finance Ministry
spent most of the post-war era fulminating over market valuations
of the yen and fighting a Procrustean battle to move it toward
some specified value. And not so long ago, worries were expressed
about a yen meltdown due to the zero-interest rate policy but
today they fret over the strength of the yen.

Like in so many other areas of government activity, Forex
intervention creates a batch of unintended consequences and
distortion effects. It turns out that there is a remarkably
consistent lack of success when governments attempt to support
prices of commodities or currencies. Therefore, it is likely that
this move may lead to greater instability and lower economic
growth.

The writer (clingle@ufm.edu.gt) is Professor of Economics at
Universidad Francisco Marroqumn in Guatemala.