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.