Neocons, Suharto, Stephen Hanke, and Currency Boards

by heehorse on June 11th, 2003
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Here´s an email I got from my far-left leaning friend Irene Lin, and my reply:

Hey Irene,

Thanks for the article link. Here´s the original article, published on the CATO institute website -

A couple of things to think about:
- The choice of exchange rate regimes is one of the most hotly debated issue in the field of economics.
- International crisis are the battle ground for establishing economic reputations. Top dog economists have big egos. Younger economist want a big ego.
- In the Indonesia case, Stephen Hanke was the primary proponent of the currency board regime. Looking through his other literature Prof. Hanke seems to be a huge proponent of currency board regimes in general (Being such a hotly debated issue, various economists firmly place themselves in certain camps. For example there are some economists who often argue (legitimately) for a return to a gold-based bretton-woods fixed exchange rate system.). That he "lost out" policy-wise, and Indonesia and the international community declined his policy recommendation is probably no small loss to his ego.
- At the time, there was so much confusion and uncertainty, there were multiple arguments and counter-arguments for and against various policy choices. It was not clear to any policy-maker which policy choice was good and which policy choice was bad. The economists who were supporting and advising for what eventually happened (continued float of the rupiah) did so because they believed (with rigorous economic theoretical backing) that this was the best that could be done. Whether or not political figures (i.e. Wolfie and the neocons) using, influencing, and taking the advice of these economists thought they could use or misuse (i.e. overthrow a dictator) this for political aims, I´m not sure.

Anyways, hopefully these can be grains of salt with which you can use to try to understand the article.

Also, we did quite a bit of study of Indonesia in the International Monetary System class I just finished last semester. Here´s an excerpt from one of my readings:

" Would the crisis have been so severe if Indonesia had established an operating currency board regime before 1997? ... Owing to the extreme loss of confidence in the case of Indonesia, leading inevitably to a very large outflow of funds, there would have had to be an extremely large monetary contraction if a currency board regime had been adhered to. In particular, the currency board could not have been a lender of last resort. there would still have been a political and social crisis, and the system could not have been sustained. finally, there would just have been an FBAR crisis.
At the peak of the crisis a Johns Hopkins University professor, Stephen Hanke, had the ear of President Suharto and advocated a switch to a currency board regime. This proposal, strongly opposed both by the President´s own economic advisers and by the IMF, was not implemented. Hanke´s basic argument was that the establishment of a currency board would restore confidence and the regime would then be credible. The currency board would be established at an exchange rate that was significantly depreciated relative to the original value of the rupiah, as determined by an initial period of floating. this exchange rate would reverse the extreme movement of the exchange rate that had actually taken place, an extreme movement that was not justified by fundamentals. To be specific, it might be established at a rate of 5000 or 6000 rupiah to the dollar, which would be considerably depreciated relative to the pre-crisis rate of 2500 rupiah but would be appreciated relative to the then-prevailing market rate of around 9000 rupiah.
The criticism of this proposal can be put as follows: Everything would hinge on successful establishment of credibility. The market would have to be convinced that the exchange rate chosen was justified by fundamentals. But political uncertainty and lack of confidence would throw doubt on any concept of fundamentals. could lender of last resort activities be given up in the midst of a drastic banking crisis and recession? Could the monetary discipline required by a currency board regime actually be maintained? It is more likely that a currency board regime would turn out to be just another FBAR case, leading to losses by the central bank to the benefit of successful speculators or inside traders. Above all, the demand for dollars would deplete the commercial banks´ reserves. Of course, if the exchange rate chosen were at the highly depreciated rate that existed at the time of the proposal the currency board regime could have survived, but naturally the aim was to stabilize the exchange rate at a much more favorable level. Finally, establishing such a regime at a time of crisis, apart from being difficult institutionally, raises the question whether it is meant to last for the long-term. Indonesia is not an obvious candidate for such a regime for all the reasons discussed in chapter 9" (Max Corden, "Too Sensational: On the Choice of Exchange Rate Regimes", MIT press, 2002, p. 208-209)

To explain some things in the article excerpt above:
- FBAR means "fixed but adjustable exchange rate regime". It implies a medium to long-term stable exchange rate that is not institutionally credible (i.e. it is only credible as long as political support is credible). This is the exchange rate regime that the "Asian Five" had going into the Asian financial crisis. It has been proven to be highly crisis-prone.
- Under a currency board regime, huge capital outflows will automatically result in huge monetary contraction (this is the underlying mechanism of a currency board). A huge monetary contraction causes huge recession (think of what would happen if Greenspan raised interest rates to 30% overnight).
- "Lender of last resort" activities refers to the activity when a central bank lends money to banks and firms in a liquidity crisis (e.g. a bank run). This helps prevent the collapse of banks and firms who are still fundamentally sound but lack short-term funds.

On Wednesday, June 11, 2003, at 09:59 AM, Irene Lin wrote:

Can anyone confirm this about the IMF and Suharto??? i had never read about this before...