Foreign Exchange Market

To avoid monetary muddles, stick to the rules and come clean

PUBLISHED : Thursday, 08 September, 2005, 12:00am
UPDATED : Thursday, 08 September, 2005, 12:00am

'It is always very difficult to strike the right balance, particularly in exchange rate management, between withholding key information for the purpose of retaining some constructive ambiguity on the one hand, and transparency that theoretically enhances efficiency and credibility on the other.

... the free market does not always give priority to public interest. It is indeed advisable to keep something up our sleeves, whether it is key information or the right to change the rules of the game.'

Joseph Yam Chi-kwong,

Hong Kong Monetary Authority

AND THAT WAS Mr Yam's way of saying that he will not himself be pushing the People's Bank of China to reveal the weightings in the currency basket that now govern the foreign exchange rate of the yuan.

He likes that phrase 'constructive ambiguity'. It is central banker talk coined by St Alan Greenspan, who uses it to mean that traders will not be able to make easy money by second-guessing him if he does not tell the market exactly what he will do in monetary affairs.

But St Alan runs a real central bank. Thanks to our peg to the greenback, Mr Yam's equivalent is technically only an exchange rate mechanism with a few bells and whistles. It does not allow him St Alan's freedom to set monetary policy, much as he might like to have that freedom.

Let us be grateful that this is the way things are. We had ambiguity before we had the peg and it was more destructive than constructive. There is a great deal to be said for making the rules clear and binding without ambiguity of any sort if you are going to run a fixed exchange rate regime. Beijing's new undisclosed basket approach has more of the hallmarks of a policy muddle than of a policy reform.

But notice how Mr Yam says that transparency theoretically enhances efficiency and credibility.

There is nothing theoretical about it, Joe. St Alan makes interest rate decisions and has reasons not to show all his cards before doing so. You make no interest rate decisions. There is nothing you need to hide. For you, transparency enhances efficiency and credibility, period.

And I have news for you when you say 'the free market does not always give priority to public interest'.

It never does so. It reserves its priority for members of the public who deal in it and serving members of the public is a pretty good way of serving public interest, better, in my view, than serving the government policy muddles that I suspect you mean by public interest.

I raise the point today not because I require myself to have a regular monthly rant at the HKMA (could be a good idea, however) but because government policy muddles once again threaten to unsettle monetary affairs in Asia. The last time they did so the result was the Asian financial crisis of 1997.

On that occasion it was exchange rate rigging in Thailand that set things off. At present it is fuel price subsidies in Indonesia that have come unstuck because of higher oil prices. This has led to rupiah interest rates soaring and the rupiah plunging.

The sad history of Asian central banks since 1997 has been one of first blaming others for their troubles and then resorting to the same old pre-1997 game of rigging their US dollar exchange rates without adopting a formal and transparent mechanism such as we have in the peg.

The US dollar may have fallen dramatically against major currencies over the past three years but you would not know it to look at the exchange rate history of most Asian currencies over that period.

We have certainly had constructive ambiguity at work here but not St Alan's sort.

All that Asian central bankers have done to stave off a repeat of the 1997 experience is starve their domestic economies of capital investment by building up massive foreign reserves in the hope that this will scare off the speculator.

Perhaps they will succeed on this occasion but, if they are determined still to rig their currencies, there is only one good way of ensuring that Indonesia's troubles go no further than Indonesia. It is to do what we did in 1997 by having a formal fixed currency system in place and sticking to the rules it imposed on us in a transparent manner that served the public interest.

I found it a little alarming yesterday to see an investment banker quoted in this newspaper as saying 'after sinking Indonesia, the same contrarian group is looking for another target'.

Joe, now is not a good time to invite them to Hong Kong by indulging in talk of hiding key information up your sleeve and changing the rules of the game.

Let's stick to the way we did it in 1997.