A number of
readers have emailed me to ask why I
wrote that a currency board would be a bad idea for
, given that the concept is an apparent success in
. It's a good question that gets to the very nature of my fears for Indonesia.
Forget for the moment the rhetoric of the currency board enthusiasts. Let's look at this like traders. Here we have the government of Indonesia with a puny $19 billion left in foreign assets (i.e., foreign reserves). The people are rioting in the streets.
government is swamped with tensions from within and from outside. And these guys want to open up a booth and tell everyone that they can exchange rupiahs for dollars at a fake, overvalued rate of 5,500 when the real value is closer to 10,000 or even 15,000?
Not that I think it's going to be hedge funds that will be allowed to doing the selling at 5,500. But I can see plenty of locals who will hit that bid -- if they are allowed to sell. Just consider two groups that come to my mind:
All indications are that local companies are still deeply indebted in dollar terms: Estimates are that the number is $20 billion in short-term debts alone. They are going to need dollars in sizes that could absorb the entire currency board.
Indonesia has a large number of ethnic Chinese businessmen. Historically, there has been a great deal of friction and jealously between the Indonesian Chinese and the indigenous Javanese. A piece of background: Suharto's "crony capitalism" has been defended on the grounds that it gives the Javanese businessmen a chance to compete with the Chinese. Ethnic tensions are building. People are rioting in the streets and smashing up the Chinese-owned shops. Recently, the chairman of the Indonesian Chamber of Commerce, a
Mr. Aburizal Bakrie
, was reported to suggest that the wealth of the Indonesian Chinese be confiscated for redistribution to the indigenous population. Isn't he a sweetheart? So here we have another group -- the Indonesian Chinese -- who would love to sell rupiahs for dollars.
What do I think will happen? I think they will set up the board unless the
forces them to back off on the plan. Then there will be an initial run on the board. Billions will flow out immediately, and then they will enforce some kind of limits as to who can convert to dollars and in what quantities. Thereafter the currency will trade only in the "black market" and at exchange rates very far away from a currency board peg.
I have been skirting around the darker issues here and it's time for me to come clean. If this effort to stabilize the rupiah fails, the currency will go down to very low levels. A lot of questions are going to be asked as to who actually got to buy the central bank's dollars at the preferred rate of 5,500. All this could end up looking like the greatest central bank robbery in history --
Die Hard with a Vengeance
, Jakarta style.
What About Hong Kong?
Personally, I don't feel that currency boards are ever a good idea. I don't like fixing the money supply to the foreign exchange market. Every time you get a confidence check on the currency, foreign exchange reserves flow out of the country and the money supply drops. In fact, that's the design that the original architects of the currency board had in mind a long time ago. As the money supply shrinks, interest rates rise to make the national currency more attractive. Kind of a self-regulating system. The only problem is that the ultimate success of the currency board is measured by how successful it is in preserving the value of the currency. Never mind that it could send the domestic economy to hell and back because the shifts in the money supply will cause interest rates to gyrate.
And this is what happened a few months ago in Hong Kong. Sellers of the Hong Kong dollar got U.S. dollars at the pegged rate of $7.80. Then the money supply contracted, and interest rates went through the roof. And guess what? The stock market collapsed! So this is a success? Is this good? Fuhgedaboudit! Currency boards are doomsday machines. Even in stable economies they are a menace.
David DeRosa heads a trading research firm and is an adjunct professor at the Yale School of Management. His column on international finance and trading appears Mondays, Wednesdays and Fridays. He welcomes your feedback at