Exchange-rate debate rages on

SEOUL -- Robert Mundell, last year's Nobel laureate in economics, views the flexible or floating exchange rate system as "an absence of a monetary rule".

"Should we have a fixed or flexible exchange rate is not an option. A fixed exchange rate is a monetary rule. A flexible exchange rate is not a monetary rule -- it's the absence of monetary rule," he said at a two-day Asia Pacific Economic Cooperation forum in Seoul which ended yesterday.

The International Monetary Fund and the United States Treasury Department have been staunch advocates of a floating exchange rate system in the wake of the Asian financial crisis.

After the collapse of the Thai fixed exchange rate system in 1997, most emerging-market countries are apprehensive about the risks of maintaining a fixed currency regime, which are feared to be unsustainable in the face of financial globalisation and market volatility.

"One of the key lessons drawn from recent history thus far is that, for the emerging countries in Asia as well as countries elsewhere with heavy involvement in global financial markets, the policy require ments for maintaining a currency peg have become daunting," said Yusuke Horiguchi, director of the International Monetary Fund's Asia and Pacific Department.

"There are a very few precedents for achieving a smooth exit from a fixed exchange rate regime. Often the exit is forced, after a period of resistance against mounting pressures, with very damaging consequences.

"Against this background, it is clear that floating exchange rate regimes should be the predominant choice for emerging-market economies which, by definition, have substantial involvement in modern global financial markets," Horiguchi said.

Determining an appropriate foreign exchange system is part of a debate over a new global financial architecture. In the aftermath of the crisis, Thailand, Indonesia and South Korea have allowed their currencies to move flexibly with the market forces, but Malaysia has taken the other route, pegging its currency at 3.8 ringgit to the US dollar.

Thailand, according to Finance Minister Tarrin Nimmanahaeminda, is practically following a textbook in its participation in the new global financial architecture. At the centre of Thai financial and foreign exchange policies lie the floating exchange rate system and sound macroeconomic management, he said.

The Bank of Thailand, under the recently amended legislation, will focus its task on maintaining price stability and guarding the financial stability.

Inflation targeting has replaced the fixed baht policy as the anchor of Thai macroeconomic policy.

Tarrin and the Thai monetary authorities are hopeful that if they put the Thai house in order, they can protect the country from the inherent instability of the global financial markets.

Mundell said that the economies of most countries outside the three "islands" of stability -- the dollar land, the euro land and the yen land -- will be either inflating or deflating based on the overwhelming forces of the movements of the world's three predominant currencies.

Over the past four to five years, the US, Europe and Japan have been able to maintain internal stability, with inflation ranging from zero to 2 per cent, but they have created external instability through the volatility of their currencies, he said.

"The fluctuation and volatility of these three principal rates, these three principal areas would cover approximately 60 per cent of the world econ omy." Mundell said. "And if we are ever talking about international monetary reform, or the international financial architecture, you have to be talking about what is happening with the dollar, the yen and the euro.

"If you are not talking about that, you are talking about interior decorating, not architecture. The architecture system depends on the core factors of the world economy. And, as long as those factors are unstable, then there is a real problem."

Between 1984 and 1994, the baht benefited from the weak dollar because it was pegged to it, a situation which created price stability and enhanced the competitiveness of Thai exports. The economy was booming, and an abundant supply of money poured into real estate and over-investment in every major industry.

After the dollar began to surge against the yen in mid-1995, Thai macroeconomic conditions began to worsen. Thai exports' competitiveness was being eroded, and the massive amounts of capital that used to flow into the country began to return to the global financial centres to create a systemic shock in 1997.

Mundell is most famous for his triangle of impossibility theory, which suggests that a country cannot have a fixed currency regime, a free flow of capital policy and an independent monetary policy all at the same time. The Thai pre-crisis economy fell into this trap.

Mundell called for the dollar and the yen to be fixed against each other to create external stability so that other currencies can realign their currencies with these two dominant currencies. In the new financial architecture, Mundell envisioned the euro land and the dollar/yen land in a two-tier global fixed foreign exchange regime.

Paul Volcker, the former chairman of the US Federal Reserve Board, recently said in Bangkok that the Thai, Malaysian or Indonesian currencies should peg to the yen to ensure external stability because economies of their size would not be able to cope with global financial market turbulence.

But so far political leadership in the region has faltered in the push toward the goal of a broader fixed currency regime.

BY THANONG KHANTHONG