INTERNATIONAL CONFERENCE ON 

THE NEW ROLE OF GOVERNMENT IN A MARKET ECONOMY

Jointly Organised by

Osaka School of International Public Policy, OSAKA University, JAPAN

and

Nanyang Business School

Nanyang Technological University, SINGAPORE

On 5 - 6 February 1998
at
Conference Room 2
Nanyang Technological University

SINGAPORE

EMBARGO:
10 AM, 5 FEBRUARY 1998

THE SOLUTION TO
THE ASIAN CURRENCY CRISIS
(Key-note Address)

by

LIM CHONG-YAH*

*  Professor Lim is Professor of Economics at the Nanyang Business School, Nanyang Technological University.  At various times, he served as the Economic Consultant to the UNESCO-International Association of Universities’ Commission on Higher Education and Economic Development in Southeast Asia, Economic Consultant to the World Bank Lester Pearson Commission on International Aid and World Development and on several occasions, President of the Federation of ASEAN Economic Associations (FAEA).  He was Co-founder of the Pacific Economic Co-operation Conference (PECC), Founder Vice-President of the East Asian Economic Association (EAEA), and Senior Adviser to the Pacific Trade and Development Conference (PAFTAD).  

(1)	Extent of Currency Depreciation
There are two broad groups of East Asian economies: the fundamental current account deficit economies and the current account surplus economies.  The fundamental deficit economies are Thailand, Malaysia, Indonesia, the Philippines, and South Korea.  The current account surplus economies are Singapore, Hong Kong, Taiwan, the PRC and Japan.  All the Governments in the five fundamental deficit economies have significant foreign debt liabilities.  But all the five surplus economies, except for the PRC, have no official foreign debt at all.  Besides, all the surplus economies, including the PRC, have impressive foreign exchange reserves.

The current Asian foreign exchange crisis takes the form of the spectacular unprecedented downward slide in the foreign exchange rates of the five East Asian fundamental deficit economies.  Between 1st July 1997 and 30 January 1998, the Indonesian rupiah fell, for example, from 2,432 per US dollar to 10,500 per US dollar, a fall of 77% of the original value.  The Thai baht fell by 53%, the South Korean won 42%, the Malaysian ringgit 40% and the Philippine peso 38%.

The East Asian surplus economies, partly because of the regional contagion effect, have not been spared either, but the decline has been less spectacular, with the Singapore dollar falling by 17%, the Taiwanese dollar 17%, and the Japanese yen 9%.  The Hong Kong dollar has been able to keep up with the fixed peg to the US dollar at $7.75.  The Chinese renminbi in fact appreciated slightly by 0.1%.  Singapore, Taiwan and Japan did not defend their pre-crisis US dollar parity.  Japan, it must be remembered, runs a trade surplus of US$100 billion per year, and $100 billion is about the total sum promised by the IMF for the rescue operation for South Korea, Indonesia and Thailand combined.

With the drastic decline in the exchange rates, it must be expected too that the stock market and property market also show serious declines.  The Indonesian debtor is unable to pay back his loan, when he borrowed at 2,400 rupiahs per US dollar and has now to pay back 10,500 rupiahs for the same US dollar he had borrowed.  He gets into trouble and the trouble soon spreads.  Good assets become bad assets.  Good loans become non-performing loans.  Good collaterals become bad collaterals.  Borrowers are in trouble, and so are lenders.  Indebtedness, insolvency, lay-offs and unemployment become the order of the day in a circular cumulative causation process.  According to Pentasena Securities, of the 282 listed companies in the Indonesian Stock Exchange, only 22 remain viable; the rest of the companies have are all become technically bankrupt.  About 6 million workers have recently joined the new growing army of unemployed in Indonesia.

(2)	Causes of Currency Depreciation
The root cause of the exchange rate depreciation was the unexpected steep appreciation of the US dollar.  The East Asian deficit economies could not keep up with the steep rising exchange rates, and with free capital mobility, the external values of their currencies have thus been given a very thorough beating.  The first serious speculative attack was on the Thai baht.  The then Thai Government defended the original peg with some US 23 billion dollars in the forward market.  The Thai baht fell all the same.  Of note is that subsequent IMF rescue package of US$17.2 billion is in fact less than the amount of foreign exchange loss in the initial defence of the Thai baht.
All the other East Asian countries, except South Korea, the PRC and Hong Kong, let their exchange rates float downwards.  South Korea, being a deficit country with heavy accumulated foreign debts, like Thailand, could not successfully defend the won.  Like Thailand, the Korean foreign reserves were exhausted.  Both countries removed their Minister of Finance.  The IMF was invited in.  Hong Kong being a surplus country and with no official debt, has been successful in defending the peg, at least thus far.

No concerted concrete action has been made by the much-acclaimed ASEAN, APEC or the WTO to prevent the meltdown of the East Asian exchange rates.  Only IMF came to the rescue, if invited.

The Chinese renminbi, however, has remained strong, partly because of current account surplus, huge foreign exchange reserves, and very importantly, the existence of control over capital account.  Thailand, Malaysia, Indonesia, the Philippines and South Korea, though having current account deficits, have also no control over capital outflow.  They believe in free convertibility of capital, as is advocated by the IMF, the World Bank, the WTO and the almost omnipotent Western mass media and rating agencies.

Of note too is that the Asian exchange rate depreciation is not caused by a fall in the internal values of their currencies, as in the typical Purchasing Power Parity model.  It is not a fall in the internal value leading to a fall in the external value.  The fall is the result of an excess of speculative and transactional demand for the US dollar relative to its availability.  In the case of current account surplus economies, the fall in the exchange rate arises from exposure to the fundamental deficit countries and from the fear of the loss of competitiveness when the neighbouring countries have depreciated substantially.  These factors and an uncertain future of exchange rate values together with their extreme volatility contribute to the lack of will to defend their currency from falling further.  The Indonesian rupiah, for example, plunged by 36% in barely three days between 5 January and 8 January 1998.

Once confidence in the currency falls, and once there is a fear of further depreciation, the further fall is guaranteed.  This is how it has come to pass: a fall leading to a further fall.  This can also be explained in terms of the theory of circular cumulative causation.  When the US exchange rate was weak, as had been the case for several decades, the problem did not arise.  The East Asian economies expanded by leaps and bounds without worrying about exchange rate depreciation against the US dollar.  It must be remembered that to them, the US is running a trade deficit of more than US$200 billion per year and owes the rest of the world more than US$1000 billion.  Money, however, is a matter of confidence.  The rest of the world has confidence in the US currency as an international means of exchange and therefore also as a store of value, and this leads to a steep rise in the US exchange rate.  The very prominent coverage given in the mass media of woes and impending woes in the troubled economies in Asia have aggravated the psychology of fear and the spread of fear.  When the fear of a racial riot is reported and discussed in a very graphic way, that may actually spark off the riot.  The silence of Asian Central Bankers also adds credence to the impending storm.  The professionals should be more pro-active in fighting the battle of confidence in their currency.

(3)	Coming Global Great Depression
The fear of the further deterioration of the Asian exchange rates is still there.  Once the contagion is spread to Hong Kong and China, this can easily lead to another round of free fall throughout East Asia.  As it is, China and Japan have both huge trading surpluses with the USA.  A further fall in East Asia currencies, particularly the Won, the Yen and the Yuan, in all probability will eventually lead to a fall in the US dollar, sparking off the much dreaded Global Depression Crisis.  In the last Global Depression of 1929-31, also started with competitive exchange rate devaluations, saw the US economy dropped by 20% in real GDP in 1929, another 20% in 1930 and another 20% in 1931.  Unemployment rate was many folds more serious than the current double-digit rates faced by most West European countries, such as Spain, France, Germany and Italy, with Spain's unemployment rate reaching 20.6%..

The longer the present Asian exchange rate crisis is prolonged or aggravated, the tougher is it for the Hong Kong dollar to hold on to its currency peg.  Once Hong Kong is forced to abandon the peg, China is likely to be forced to give way. That is the greatest fear in the near horizon.  As it is, Hong Kong is paying the price of very high interest rate, including falling stock prices, falling property prices and fear of falling export competitiveness.  So, pegging to the US dollar in the current circumstances is not a panacea.  Neither is free floating, if there is no bottom to the fall.  The fear in either case is fear itself: fear of decline in the peg or fear of further fall in the free floating system.  If this fear is there, investors will sell their domestic assets and if the fear is serious, this will lead to a run on the domestic currency.  In some instances, social and political unrest can easily follow.  Indeed, this was how Hitler came to power: the destruction of the German currency in the inter-War years, leading to extremism, including anti-Semitism, in seeking solutions. 

(4)	Proposals for Anti-Crisis Measures
To find a real solution to the Asian currency crisis, rhetoric, exhortations and platitudes aside, the focus of attention must be on the restoration of exchange rate stability.  To this end, the following five specific new initiatives, in my view, should be explored and implemented nationally and more desirably, regionally and internationally.  The perception of the seriousness of the crisis in each society will no doubt affect the choice of suggested options or the need for such options to be pursued, since, as pointed out earlier, not all Asian economies have suffered from the same level of exchange rate meltdown and therefore also the consequences.

	(i)	Only Legal Tender
One, the effective and nation-wide reaffirmation and implementation of the only legal tender status of the national currency.  Airports, hotels, shops, banks and all other institutions within the nation should not accept any other currency as a means of exchange.  In other words, as a means of exchange, in Thailand, only Bahts are to be used; in Indonesia, Rupiahs; in Malaysia, Ringgits; in the Philippines, Pesos; in South Korea, Wons; in the PRC, Renminbis; in Hong Kong, HK Dollars and in Singapore, the Singapore Dollar.  Otherwise, there may come a time when the National Budget will have to be presented in US dollars, instead of, say, in Indonesian Rupiahs.  Not very long ago, but already unknown to modern day Malaysians and Singaporeans, the Mexican silver coins were used in Singapore and Malaysia replacing the local legal tender currency.

	(ii)	Tax on Hoarding
Two, the effective and nation-wide re-affirmation and implementation of the legal tender position of the national currency must be reinforced by increasing as a temporary measure the transaction costs of conversion between the national currency and the US dollar.  In my opinion, a 5% tax, called it Currency Conversion Tax (CCT) to distinguish it from the already in force GST for a conversion from the national currency to the US dollar and a 10% tax for conversion back to the national currency would suffice.  As the objective is to discourage US dollar hoarding, and not to discourage trade, visible or invisible, and investment, all trades and investments must be exempted from the tax.  Administratively, a system of refunds may also be resorted to.

Why is it that the PRC, despite its very heavy public and private sector external debts, has been able to maintain its exchange rate at the pre-Asian currency crisis level of 8.29 renminbis to one US dollar, and not the much stronger Singapore dollar, which has in fact depreciated by 16.7% since 1st July 1997?  The main reason is that the PRC has not given up its control over the capital account.  Had it opened the floodgate, China would have similarly been fully exposed to the onslaught of US currency speculators and US currency hoarders.  That would have also made it much more difficult for Hong Kong to defend the Hong Kong-US dollar peg.  Can it be believed that the PRC has a stronger and better-developed banking and financial system with so numerous inefficient state-run enterprises to support than that of Thailand, South Korea or Malaysia?  Definitely not.  Thailand, Malaysia and South Korea are definitely much better developed in the banking, financial and stock-broking institutions and yet, the PRC has been spared, at least for the time being, from the foreign exchange meltdown.

	(iii)	World Central Bank
Three, to stop the exchange melt-down contagion spreading to Hong Kong and the PRC and from there directly and indirectly to the USA, the US should initiate moves to halt the rise in the US dollar.  The best policy option I can think of without raising more taxes for Americans is to set up a Special Fund through a special fiduciary issue to help prop up and stabilise the exchange rates of South Korea, Thailand and Indonesia, and if needs be, also the Philippines and Malaysia.  This modus operandi will also help to lessen the US worsening balance of payments deficit and save the US from getting unwillingly sucked into a Global Recession to usher in the world’s new millennium.  Indeed, I think, the Special Fund of US $20 billion would more than suffice to save the entire depressing situation.  No IMF or the World Bank or ADB need be involved here.  The Special Fund could only make their hitherto very difficult rescue operations much easier and lighter.  An innovative and unorthodox remedy is required, as the current crisis in itself is new and unprecedented.  Public opinion, particularly in the US, will have to be cultivated first.  That is by no means an easy undertaking.  The gestation period must be expected to be long.

But the Special Fund must be an interim special emergency measure.  The long term aim must be to use it as a nucleus to establish a World Central Bank (WCB) to serve as a lender of last resort, and maybe, in the still more distant future, also assumes the global currency issue function for participating central banks.  This new World Central Bank will not in any way impinge on the post-World War Two created institutions of the World Bank (otherwise properly known as the Bank for Re-construction and Development) and the IMF.  The latter two institutions were created to handle the problems arising from the global fixed exchange rate system and immediate post-war reconstruction.  The World, however, has moved on to a freely floating exchange system, with much more free mobility of capital, information and trade.  A new global institution is thus required to handle the new problems, one of which is international exchange rate market failures, which we are witnessing in East Asia today.  As the US will have to play a critical role in this new initiative, the first President of the newly formed World Central Bank should be an outstanding American.  Part of the fiduciary issue may also be tied to buying food from the US.

(iv)	Yen Exchange Rate
Fourthly, the above three measures can be effectively reinforced by Japan taking concrete positive steps to help to stop the Asian Crisis from deepening and spreading.  With Japan’s huge balance of payments surplus and with Japan having the largest foreign exchange reserves in the World (about US$227 billion), Japan is in a unique position to help herself as well as her neighbours.  Japan can help her Asian neighbours to get out of their current exchange rate problem by simply selling some of her huge US dollar reserves.  In other words, let the yen appreciate to the pre-crisis level of 100 instead of letting it depreciate to the present level of 127.  A stronger yen will also lessen the trade imbalance and the trade frictions that go with it with the US and other Western countries, many of whom, as mentioned earlier, have serious unemployment problems to get over with.

(v)	Undervalued Stocks
Fifthly, the Asian balance of payments surplus countries such as Singapore, Brunei, Taiwan and also Japan should mount, if possible co-operatively, an acquisition strategy of buying selected now highly undervalued stocks in the neighbouring countries.  This move will be helpful to themselves as well as to their troubled neighbours.  The flow of foreign funds into these countries will strengthen their exchange rates and are helpful in the confidence restoration process.  Here, a concerted action is particularly helpful.  Western Europe and the other more developed APEC countries, like the US, Australia and New Zealand can also help in this direction.  The East Asian exchange rate crisis is caused by serious short-term capital outflow and domestic US dollar hoarding.  Once the inflow takes place again, the hoarding will stop, and the crisis will soon be over.  Other pressing issues, such as those found in the corrective measures wanted by the IMF, can then be attended to with much less difficulty.

(5) 	Role of State in New Market Economy

(i)	Pressing Problems
As this Conference is on the role of the State, let me add that, in my view, the first function of the State must be to solve the most pressing problem faced by the country.  And the most pressing problem faced by the countries in East Asia now is to restore confidence in the exchange rates.  In ancient China, when Shun was faced with large-scale flooding, he had only one mind and one purpose, he left no stone unturned to seek the service of Yu, who being an irrigation engineer, knew how to solve the flooding.  Shun himself knew the limits of his ability.  Shun and Yu later saved China from inundation.  They are still remembered today, more than four thousand years later, for their good deeds.

	(ii)	International Dimension
Secondly, in economic literature, the international dimension of the function of the State is similarly neglected.  The World has become much more integrated, consequent on the miraculous advancement made in transportation, communication and trade, capital and information flows.  The international function of the State has thus assured a proportion not experienced in the time of Yao, Shun, Moses, Adam Smith or Monroe.  How many governments elected nationally can really perform this international role effectively?

	(iii)	Sequencing Problem
Thirdly, the functions of the State must take into consideration the stages of development of the State.  When the centrally planned command economies of the East Europe and the Soviet Union wanted to move, and wisely so, to a market-oriented one, they unfortunately also dismantled the legal and political power structure as well, so that market reformers lacked the machinery and the authority to carry out the market reforms.  The result is well known: economic chaos, with run away unemployment, galloping inflation, and currency collapse.  In the case of East Asia, the parallel of ignoring sequencing in another form is also present today.  All the East Asian deficit countries have not freed their domestic economies from curbs and restrictions first, instead they have completely freed their financial sector.  They have all treated the role of money as a means of exchange, as a unit of account and as a store of value like that of other commodities like gasoline oil, palm oil and kerosene oil.  Money has a special general function, which other commodities do not perform.  In money, confidence is the most critical.  Paper money itself has no intrinsic value.

The sequencing strategy is important.  Japan and Taiwan followed the proper sequencing path, and thus today they are much stronger financially and economically.  Similarly, China today is also following the proper sequencing strategy.  Until she has developed a good public service system, a strong banking and financial framework and frees the real domestic economy from all forms of monopolistic and distortionary practices, it is wise for China to continue to exercise some monetary and capital control.  Many countries in East Asia unfortunately have put the cart before the horse.  They are still saddled with a restricted, over-regulated and encumbered domestic economy. Some still suffer from population explosions and nearly all a very weak public service, but instead, they have gone very freely over capital and exchange mobility.  The priority should have been mobility of goods and services, in production, in distribution and in all their facets and matrixes.

This sequencing strategy is particularly emphasised in the S Curve development theory.  In this theory, the world economy is divided into three broad groups, namely, the very poor low-level equilibrium trap group, the middle level high-growth group and the affluent high-level equilibrium trap group.  Economic strategies and the role of the State, the S Curve theory postulates, need not be the same for all the three groups.  Indeed, they may differ.  The affluent group is likely to face the problem of de-population, whereas the poor group the problem of population explosion.  Should all States all follow a pro-natal policy, irrespective of the stages of economic development of the countries?

Another two examples may suffice.  The affluent economies have a high consumption function, whereas the poor economies simply do not have enough to consume: under nourishment is the latters’ problem.  The greying of the population is a challenging problem for the developed countries, but for the third world countries, not many can even survive to witness real old age.  Must we advocate one and the same prescription for all, so that we all can have a common playing field?  My point is thus that the role of the State must also depend on the stages of development of the economy and society. 

	(iv)	Government in Economics
Lastly, in the EGOIN theory of development and underdevelopment, the emphasis is on EGO: the man-centred co-determinants.  Of these three co-determinants, the centre one G, the Government, is the most important.  On his left is Entrepreneurship (E) and on his right is labour or Ordinary Labour (O).  If G falters, the whole house collapses.  And yet, in economic literature, G is not considered worthy enough to feature as a distinct determinant.

Perhaps, on the role of the State, as food for thought for academic economists, I will conclude by quoting from the Prime Minister of Singapore, Mr Goh Chok Tong, who was himself trained in Economics both in Singapore and in the USA.  In a very recent article, he said, “A good government will practise sound economic policies, share the fruits of growth equitably and perpetuate a virtuous cycle.  But how do we produce a good government?  This is not taught in economics - a fatal omission”.