Forbes Point of View by Steve Hanke
The World Moves Backward Oct 5, 1998
Phony Medicine Jul 6, 1998
After Suharto, What? Jun 15, 1998
Cooling Hot Money May 18, 1998
The Reluctant Fireman Apr 6, 1998
Forbes Oct 5, 1998: Point of view
The world moves backward
By Steve H. Hanke
THE RUSSIAN FIASCO, following so closely on the heels of the upheavals in Asia, has given rise to calls for exchange controls as a means of cooling hot money flows. A cottage industry of exchange control promoters, led by Paul Krugman of MIT, has burgeoned in recent weeks. Malaysia's mercurial prime minister, Mahathir Mohamad, installed draconian controls on Sept. 2. Hong Kong also has departed from free-market principles by intervening in the local stock market.
Thus are many countries slipping back into a discredited way of doing things.
The Malaysian controls, among other things, pegged the ringgit at 3.8 to the U.S. dollar; they also will make ringgits worthless outside Malaysia after Sept. 30, require a one-year holding period for portfolio investments in Malaysia and prohibit nonresidents from crossing the border with more than 1,000 ringgits. In so acting, Malaysia has thrown away the lessons of the past half-century.
The idea of exchange controls can be traced back to Plato, the father of statism. Inspired by Sparta, Plato embraced the idea of an inconvertible currency as a means to preserve the autonomy of the state from outside interference. In modern times, Czar Nicholas II pioneered limitations on currency convertibility. Hitler's banker, Hjalmar Schacht, in an attempt to maintain the mark's exchange rate and conserve foreign exchange reserves, pushed exchange controls to their limit.
Hayek wrote that exchange controls are a “decisive advance on the path to totalitarianism and the suppression of individual liberty.”
With that pedigree, it's not surprising that Nobel economist Friedrich Hayek blasted the idea of such controls. In his 1944 classic, The Road to Serfdom, Hayek wrote that exchange controls are a "decisive advance on the path to totalitarianism and the suppression of individual liberty . . . the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape—not merely for the rich, but for everybody."
That doesn't bother professor Krugman or Prime Minister Mahathir. Exchange controls are a fence within which governments can expropriate their subjects' property. Open exchange and capital markets protect people from exactions because governments must reckon with the possibility of capital flight if they behave stupidly or greedily.
From this it follows that exchange controls impoverish a country even as they strengthen the hands of the local politicians. Asset owners attempt to liquidate their property and get out while the getting is good.
Restrictions on convertibility promote other noxious activities, too. Escape from controls can usually be bought by crony capitalists—for a price—stimulating even more corruption. Black markets are always part of the exchange control scene, too. Indeed, black marketers are already flourishing on the outskirts of Singapore, where the ringgit is thumbing its nose at Mahathir and changing hands at 4.25 to the U.S. dollar.
Like all controls, those on foreign exchanges discriminate against particular groups: What might prove to be a powder keg in Malaysia is the fact that the Malaysian controls are perceived as anti-Chinese because that ethnic group has most of the money.
Unfortunately, this dumb idea is spreading. The Red-Brown (communist-fascist) coalition in the Russian Duma has latched on to the idea of exchange controls and an inconvertible ruble.
Why should you worry about a country here and there restricting freedom, reducing its wealth and promoting discrimination and corruption? Because the damage caused by controls is not restricted to the countries that impose them. Bond and stock markets in all emerging countries are close to panic—if not beyond. Even in countries that have so far behaved themselves, a lot of foreigners and locals are getting out while they can. The risk premium in all emerging markets has increased dramatically in recent weeks. Unless this backsliding from free markets is checked, the whole world is going to be poorer.
Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore.
Forbes Jul 6, 1998: Point of view
Phony medicine
By Steve H. Hanke
MADELEINE ALBRIGHT gets on the magazine covers, but Treasury Secretary Robert Rubin runs the foreign policy that really counts: economic policy. At the moment, I wouldn't give him high marks.
Japan is in the middle of a nasty deflationary slump. Indeed, it is officially in the worst recession since 1975. On a year-over-year basis, wholesale prices have declined by 2.7%. Industrial production is off 6.2%. Retail sales for 1998 are also in negative territory relative to 1997, a year in which real GDP growth was barely detectable.
If anyone doubts this is a problem for the U.S. as much as for Japan, he or she need only ask who is the biggest holder of U.S. Treasury securities and who is the banker for U.S. trade deficits. Rubin and Treasury Deputy Secretary Larry Summers are dealing with the problem by repreaching old-time Keynesian pump priming. According to them, fiscal expansion—tax cuts and more government spending—will pull Japan out of its slump.
This is quack medicine. It has been thoroughly discredited as a cure-all. And it is utterly unsuited to the present circumstances in Japan.
Japan's comprehensive fiscal deficit is about 7% of GDP, and its gross debt-to-GDP ratio is nearly 100%. These statistics are by far the worst of any of the countries in the G-7. A century's worth of evidence from many countries shows that, under these conditions, more fiscal stimulation won't work. There is too much already.
Why?
The effectiveness of fiscal stimulation seems to hinge on the mysterious factor of "confidence," something on which Keynes himself laid great stress. When deficits are relatively small, a looser fiscal stance will make everyone feel better and get the economic juices flowing. But this isn't a credible policy when it pushes deficits to unsustainable levels. At that point, more fiscal stimulation erodes confidence rather than increasing it. That's why it doesn't work.
So it's time for the Japanese to wave off Rubin and Summers. Instead of opening the fiscal floodgates wider, the Japanese government should be closing them. It has already wasted enough money on unwanted public works.
Treasury Secretary Rubin is giving the Japanese tainted advice.
The Bank of Japan should expand its balance sheet rapidly by purchasing government paper and thereby putting more money into circulation. Does this sound familiar? It should. The press has been working overtime to heap praise on MIT's Paul Krugman for coming up with yet another original idea when he suggested that Japan should do this. But wait a minute. This recommendation was first made by Milton Friedman in a FORBES interview on Dec. 29, 1997.
The combination of a tighter fiscal and looser monetary policy will do the trick in Japan. Here again, Friedman (and Anna Schwartz) knows what he's talking about. In a reassessment of the Great Depression and recovery in the U.K., Friedman and Schwartz showed that the 1931-37 recovery was associated with a tight fiscal policy coupled with a loose monetary policy. The government simply spent less and got more money into private hands to take up the slack, and then some.
Yet it's not hard to see why Rubin is pushing a fiscal solution rather than a monetary one. If the Japanese central bank pumps a suitable amount of money into the system, the yen will spiral down to the 170-to-the-dollar level. This would send the U.S. merchandise trade deficit with Japan even higher and make life uncomfortable for the powerful U.S. car industry. In short, Rubin and Summers are giving the Japanese tainted advice.
The Japanese may just ignore the quacks and charge them with malpractice. The minutes of the Bank of Japan's Apr. 9 meeting show that its policymakers are leaning toward a monetary stimulus. That's why the markets have started to work over the yen. It's also why Rubin's man in Tokyo, Eisuke Sakakibara (Mr. Yen), will be forced out at the Ministry of Finance.
The Japanese backlash against U.S. economic imperialism is under way. That might be good for Japan, but it promises a weaker yen and a possible second wave of Asian devaluations. That might bring a few Wall Street bears out of hibernation.
Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore.
Forbes Jun 15, 1998: Point of viewAfter Suharto, what?
By Steve H. Hanke
WITH A HIGH DEGREE of self-righteous arrogance, the Clinton Administration has used the International Monetary Fund as a bulldozer to reshape the political and economic landscape in Indonesia. Instead of reshaping, however, the Administration has wrecked it.
Until the Thai baht collapsed on July 2, 1997, the Indonesian economy had registered over 30 years of spectacular economic growth and modest inflation. But there was a flaw: The Indonesian rupiah was extremely vulnerable.
The Bank of Indonesia had managed the exchange rate and domestic monetary policy so as to keep the rupiah-dollar rate relatively stable. This pseudo fixed exchange rate induced local private enterprises to pile up about $80 billion in unhedged foreign debt on the assumption that the rupiah would never be devalued.
With the devaluation of the Thai baht, Indonesian companies worried about the fate of the rupiah and began to cover their short dollar positions. This meant selling rupiahs to get dollars, and it put the rupiah under selling pressure. With dollar reserves dwindling, the Bank of Indonesia floated the rupiah on Aug. 14. The currency didn't float. It sank.
In late October, the Indonesians called in the IMF. Little did the wily Suharto know that he had fallen into a White House trap. Indonesia was facing a potential currency crisis, but the IMF insisted that it do something about rampant cronyism. On Nov. 1, 16 banks were closed. This set off a financial panic. Money was pulled out of banks and took flight to Singapore. The rupiah and BI reserves fell further.
In an attempt to stem the tide, Indonesia signed a second IMF agreement on Jan. 15, 1998. Again the IMF didn't focus on the currency crisis. It insisted upon a large-scale structural adjustment program aimed at rooting out cronyism and opening the economy. Before the ink had dried on the second IMF agreement, the markets concluded that it did not address Indonesia's immediate problem, the unstable currency. The rupiah sank again.
By late January, Suharto knew that his days would be numbered if he couldn't stabilize the rupiah at a realistic level. He also knew the IMF would be no help.
By the last week in January, Suharto knew his days were numbered if he couldn't stabilize the rupiah.
Consequently, he called me in to develop a comprehensive currency stabilization program. I presented such a program on Feb. 26, and Suharto embraced this homegrown program. He called it the IMF-plus program. It contained all the elements of the second IMF agreement, plus a currency board system to address the currency crisis, plus bank restructuring, external debt rescheduling, a bankruptcy law overhaul and a large privatization program. The currency board, missing from the IMF programs, was the linchpin. It would have restored the rupiah to a more favorable exchange rate, mitigated inflation and cushioned the painful rises in the prices of rice and fuel.
The IMF and the White House said no. They wanted Suharto to implement the second IMF agreement—and never mind the pluses. Clinton dispatched Walter Mondale to Jakarta with what amounted to an ultimatum and specific advice on how to shape a new cabinet. Suharto hung tough for a while, but in the end he caved in.
On Apr. 10, the third IMF agreement was signed. It had no currency board in it and thus no assurance of a stabilized rupiah. Instead of a currency board, a "smart" managed floating exchange-rate system was installed. This half-baked setup required the Bank of Indonesia to more than double short-term interest rates in order to strengthen the rupiah. The sharp increase in interest rates was a punishing blow to an already fragile economy. Then came the IMF-mandated fuel-price increases of May 4.
The consequences you have seen on television and in the newspapers: hundreds of lives lost in bloody riots that caused huge property damage. Suharto packed it in after ruling for 32 years.
As it did with the Shah of Iran, the U.S. has eliminated Suharto. Let us hope this triumph of PaxAmericana doesn't end as badly for us as the earlier one did.
Steve H. Hanke served as adviser to former Presedent Suharto and crafted his controversial IMF-plus plan.
Forbes May 18, 1998: Point of view
Cooling hot money
By Steve H. Hanke
AS THE UNDERDEVELOPED WORLD learned the lessons of the Thatcher and Reagan revolutions, its "capital shortage" problems of the 1980s, the lost decade, were quickly erased. Since 1990, net private capital flows to developing countries have dwarfed official flows, with net private flows reaching a record of $256 billion last year, a sixfold increase in only seven years.
Until last summer's crisis in Asia this dramatic turnaround was hailed by all. But now the chattering classes say there is too much misdirected private money flowing to developing countries. Having learned nothing from the past and forgotten nothing of their own statist biases, these people now say we need more governmental controls over capital flows.
Prominent among the chatterers is speculator George Soros. In a piece that ran in the Financial Times on Dec. 31, 1997, Soros asserted that "the private sector is ill-suited to allocate international credit." And that "it follows that international capital movements need to be supervised and the allocation of credit regulated by an international authority."
Economists, led by such luminaries as the World Bank's chief economist, Joseph Stiglitz, and MIT's Paul Krugman, among others, have provided some intellectual ballast for Soros. Their argument goes like this: In a financial panic, companies with loads of short-term foreign debt attempt to cover their positions. In the scramble for foreign exchange, the domestic currency plunges and imposes external costs on other companies because the burden of their foreign debts increases. This motivates even more short-covering, further currency plunges, hot-money outflows and economic collapse.
In other words, economists are repeating their ancient refrain: You can't trust markets. Short-term capital flows must be controlled. Never mind that capital controls have a dismal record, creating huge economic distortions and giving rise to corruption. The dirigistes point to Chile as proof that capital controls work. Thus the question of controls of flows of short-term capital worked its way onto the agenda of last month's joint International Monetary Fund-World Bank meetings in Washington.
Soros and his pals at the IMF should look at the record before they jump to conclusions.
Let's look closer at Chile. Since mid-1991 Chile has required foreign investments to stay parked in Chile for a minimum of one year. In addition, loans and bank deposits originating abroad require a 30% deposit to be placed for one year at the central bank, without interest. This amounts to a tax on capital inflows, with short-term debt being hit with a higher implicit tax than long-term debt.
Chile's capital controls are simple and transparent. And they have been employed in Latin America's most free-market and corruption-free economy. If capital controls are going to work, there is no better place for a test than Chile.
Have Chile's controls passed the test? Hardly. Sebastian Edwards, former World Bank chief economist for Latin America and the Caribbean, recently reviewed all the evidence and has concluded that the record is mixed, at best. The controls have been only partially effective in mitigating hot-money flows, and they have significantly increased the cost of capital in Chile. For example, Chile's borrowing costs are roughly double those in Argentina, where a currency board prohibits capital controls.
Soros and his pals at the IMF should look at the record before they jump to conclusions. Given Chile's less-than-stellar experience with capital controls, I shudder to think what would happen if officials in other developing countries were entrusted with the vast discretionary powers that go hand in hand with capital controls. Give more power to a corrupt government and you get more corruption.
In the two decades prior to World War I, the capital markets were more globalized than they are today; investors were lending heavily to risky, emerging markets; and hot-money flows were rare. Why? Because investors had a high level of confidence that the fixed exchange rates imposed under the gold standard would be maintained. To stop hot-money flows in developing countries, there is only one proven remedy: fixed exchange rates. In the absence of a gold standard, currency boards à la Argentina are the way to go.
Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore.
Forbes Apr 6, 1998: Point of viewThe reluctant fireman
By Steve H. Hanke
FORBES COLUMNIST Steve Hanke has been advising Indonesian President Suharto on how to deal with the Asian economic crisis. Despite intense pressure from, among others, the IMF and the U.S. Treasury, Suharto has insisted that strengthening the currency must precede the implementation of economic reforms—rather than the other way around.
As FORBES was going to press, several IMF members (Australia and Singapore among them) were moving closer to Suharto's position. One way or another, Indonesia is likely to follow Hanke's advice—and Suharto's inclination—to peg its currency at a fixed rate to the dollar rather than having it continue to float.
Here is Hanke's take on the situation, and his explanation of why he thinks Suharto, rather than the IMF, has the right priorities.
SUPPOSE A FIRE BREAKS OUT at your home. The firemen come, take one look and decide that you were in violation of the fire code. Until you correct the violation they won't unfurl their hoses.
Indonesian President Suharto must feel something like that homeowner. The IMF and most of the world's governments have been demanding that he institute basic and far-reaching reforms, at a time when he is dealing with a much more immediate conflagration. The Indonesian currency hasn't just declined: It has collapsed, losing almost 80% of its value since July 1997. It has gotten that low, not because it took that much devaluation to keep Indonesian goods competitive, but because the decline fed upon itself and led to a near panic to get out of the currency. At 10,000 to the U.S. dollar, the rupiah is screamingly undervalued.
The fire in Indonesia started on Aug. 14, 1997, when Indonesia floated the rupiah. Stanley Fischer, first deputy managing director of the IMF, applauded. Unfortunately, the rupiah didn't float. It sank.
On Jan. 15 the IMF presented Indonesia with an amended program to strengthen the rupiah. The markets responded with a resounding vote of no confidence. The rupiah lost another 40% in a week.
Having your currency lose 80% of its value is no joke. Indonesia imports rice and cooking oil to feed its 200 million people. If the price of rice and cooking oil gets too high, a lot of people stop eating. If they stop eating, they look for someone to blame. The handiest scapegoat is the local small merchant, who, in Indonesia, is more likely than not to be Chinese.
Indonesian mobs can easily get out of hand. To escape them, millions of Chinese and other minorities are going to get the hell out. You've heard of boat people. This could be a waterborne exodus that would make Vietnam's look like a Sunday regatta. No wonder Indonesia's close neighbors—Australia, Singapore and Malaysia have become sympathetic to President Suharto's insistence on a currency-board system.
At this point I had better explain what a currency-board system involves. It is similar to the old gold standard, except that in place of fully backing its currency with a fixed amount of gold, a country backs its currency with a fixed amount of U.S. dollars or another strong currency. Under this setup the rupiah would freely trade at a fixed rate against the U.S. dollar.
President Suharto understands that he needs a stronger rupiah so that the prices of basic items don't soar out of control. For some reason the brains at the IMF and the U.S. Treasury can't grasp this. Maybe it's because they never went hungry or faced the fury of a mob.
I was lecturing at Bogazici University in Istanbul during the last week of January. Suharto wanted me in Jakarta pronto. He knew that I knew a thing or two about currency boards, and knew that they had been used successfully in Argentina to stop hyperinflation and currency collapse. He knew Hong Kong's currency-board setup had kept the Hong Kong dollar like a rock last fall when currencies around it crumbled.
The Indonesian president may not be an economist, but as an experienced politician he values a strong currency—and understands that people do not like to see their kids go hungry. He agreed that my proposals for a currency board and a fixed exchange rate would be the best solution. After word of my appointment as President Suharto's special counselor got out, the rupiah appreciated almost 30% in one day.
The IMF was miffed. On Feb. 11 President Suharto received a letter from Michel Camdessus. The managing director of the IMF said a currency board might be a good idea for Indonesia but that it should be postponed until other IMF reforms had been implemented. Sure we'll help you put out the fire, but not until you comply with the fire code. The markets' reaction was another sharp selloff in the rupiah.
Unless the rupiah recovers, 80% of Indonesia's private sector is bankrupt, lacking enough rupiah to buy the foreign currency necessary to service their loans. Inflation has already begun to rear its head. From December through February rice prices increased 25%; cooking oil prices, 97%; and milk prices, 52%. These price increases led to those food riots you have seen on the evening news. With central bank credit growth from November through January at about 12% of GDP, there is more riot-breeding inflation fuel in the pipeline.
There is only one reason the rupiah is trading at 10,000 to the dollar, and that is lack of confidence. A currency board would reestablish confidence, bring the rupiah back up to a more reasonable level and set the stage for the reforms that everyone agrees are necessary.
Fortunately, Suharto is a tough man and is standing up to the IMF. Why is it so damned hard for the IMF and the U.S. government to understand that putting out the fire comes before fireproofing the building?
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