turning point?

Peter Kilander peterk at enteract.com
Fri Aug 21 19:48:14 PDT 1998


I think Mr. Medley is insightful. While browsing the internet, I came upon a piece in the 9/7 issue of Fortune by Paul Krugman http://www.pathfinder.com/fortune/investor/1998/980907/sol.html I don't know much about the guy and had skipped the recent thread on him. In the piece he says the hurting economies need exchange controls (also called capital controls, right?). Here's a piece on the dreaded "E" word (phrase) which followed Krugman's. ------------------------ Saving Asia: A Desperate Remedy Exchange controls have long been out of favor. But they may be just what Asia needs to cut interest rates and pump its economy. Here's how they work.

Jeremy Kahn

Most free-market economists like exchange controls about as much as a vampire likes garlic. It's easy to see why. When a country tries to set the value of its currency artificially, all sorts of inefficiencies can occur. Governments need huge (and expensive) bureaucracies to maintain the system. Black markets in currency flourish along with other forms of corruption. Over the past two decades, most developing countries--including Thailand and Indonesia--have abandoned exchange controls. [look how that turned out] That said, when times are desperate, extreme measures may be needed. Controls would allow Asian nations to keep their currencies steady, giving them the breathing room to cut interest rates and get moving again. How do currency controls work? Exporters are usually paid in foreign currency. With controls, they are required to sell those foreign-exchange earnings to the central bank at the official rate. The bank then uses this foreign money to clear transactions with importers and foreign banks. Rather than allowing exchange rates to fluctuate freely according to market forces, a country's central bank fixes the exchange rate on a regular basis. That is usually done based on data about the supply and demand for currency in the economy. But politics frequently plays a role. Setting the rate artificially low will boost exports. Conversely, governments have been known to fix rates too high in the belief that a strong currency denotes a strong state.

Often there are severe restrictions on the amount of money anyone can transfer in or out of the country. Until 1990, investors needed approval from the Bank of Thailand before moving any capital gains abroad. Individuals were allowed to take only $5,000 with them when leaving the country.

In some cases, a government may refuse to conduct any currency transactions at all, an awkward way of preventing capital from leaving or entering. Or it may allow money to flow in only one direction. And countries have even been known to impose different exchange rates on different sectors of the economy. From 1985 to 1995, South Africa maintained a favorable exchange rate for foreign investment, called the financial rand, and a less attractive rate for all other transactions, the commercial rand.

Of course, the more regulations there are, the more muddled the policy outcome becomes. "Sometimes there are so many layers of controls that it becomes difficult to determine what the incentives are," says Kathryn Dominguez, a professor of public policy at the University of Michigan. For instance, rules that prevent capital flight tend to scare off the very investors they are designed to attract. A mere rumor that a government is about to impose exchange controls can accelerate capital flight, as residents move money out of the country before the rules go into effect. And once fixed rates are imposed, capital often continues to flee the country, especially in today's world of electronic transfers. So Krugman's Plan B [exchange controls] is clearly desperate. But so is Asia's economic situation. And no one seems to have a Plan C.



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