Pacific Perspective
Pacific Perspective
|
For us in the United States it's hard to believe that an exchange rate can lead to economic and political chaos. After all, the value of the U.S. dollar versus the yen or the euro is hardly the stuff of which front-page news is made. Yet, Argentina's woes have made the headlines, and we should know why and what other countries, including those in Asia, can learn from them. Argentina offers currency
lessons for AsiaTen years ago, responding to years of financial mismanagement in that country, Argentina established a fixed one-to-one exchange rate of its currency, the peso, and the dollar. The fixed exchange rate forced monetary discipline because the supply of pesos was limited by the amount of dollars the country could earn through trade and investment. This monetary restraint lowered inflation and improved economic stability, and for a while the policy was a success.
Yet, the fixed exchange rate had a downside. Though the peso was pegged to the dollar, Argentina's exchange rate with respect to other currencies, especially those of important trade partners, was not fixed. Most of Argentina's trade is with other South American countries and the European Union. Between 1996 and 2001 the Argentine peso appreciated 55 percent relative to the Brazilian real and 28 percent compared to the euro, not due to any economic forces in Argentina but rather because the dollar strengthened relative to these currencies. As its peso strengthened, Argentina's trade competitiveness declined: Exports became more expensive and imports cheaper. The Argentine trade balance worsened and the country financed this by borrowing dollars abroad. Eventually, the debt burden became unsustainable.
In 1998 Malaysia responded to the Asian financial crisis by fixing the exchange rate of its currency, the ringgit, to the U.S. dollar. The intent was to improve economic stability and reduce volatile capital flows accompanying floating exchange rates. But the Argentine experience raises questions about Malaysia's decision. Being tied to the dollar is good when the dollar is stable or even if the dollar weakens. But when the dollar is strong, as it has been, the ringgit is also strengthened. Since the end of 1999, the ringgit has appreciated 20 percent against the yen and 9 percent versus the Singapore dollar. Since both Japan and Singapore are major trade partners, Malaysia's trade competitiveness has been damaged. But Malaysia is not in immediate trouble. When it pegged the ringgit, the Malaysians set it at a very low value, and the Malaysian trade balance has so far been significantly positive. However, the strengthening U.S. dollar has eroded that balance and there is the potential for a greater weakening of Malaysia's trade position.
Argentina's experience reinforces two lessons. First, a fixed exchange rate requires domestic sacrifices. Hong Kong, whose dollar has been pegged to the U.S. dollar for many years, has been forced to deflate its economy to insure its peg can be maintained. Second, if a country opts to fix its exchange rate, it should be pegged to the currencies of its trade partners. We'll see if these lessons have been learned.
Jack P. Suyderhoud is a professor of business economics at the University of Hawaii at Manoa College of Business Administration. He can be reached at: suyder@cba.hawaii.edu