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Currency Exchange Fees - UN Finance - Global Policy Forum "Why We Need Sand In the Market's Gears"
James Tobin
Editorial, Washington Post
December 21, 1997
For the peoples of Southeast Asia, the worst is yet to come. The "bailouts" of South Korea, Thailand and Indonesia will be more painful to more people for more months than the currency crises themselves. The International Monetary Fund (IMF) and the U.S. Treasury are making new financial aid for these countries conditional on their acceptance of economic austerity measures. South Korea, for example, is expected to boost interest rates, raise taxes, reduce government spending and lower economic growth from 6 percent to 2.5 percent. South Korea and other Asian countries -- like Mexico in 1994-95 -- are being punished for offenses they did not commit. They have inflation and government budgets under control. They are not sinners, but victims of a flawed international exchange rate system that, under U.S. leadership, gives the mobility of capital priority over all other considerations. It is simply too easy for banks, governments, businesses and speculators to buy and sell huge blocks of a country's currency in panicky moments. Such flows of capital can throw a country literally overnight into a crisis.The lesson of the Asian meltdown ought to be that the leaders of the global economy need to find ways to make the currency exchange system less volatile, so as to protect innocent bystanders from sudden economic crashes that destroy jobs and income. A global tax on currency transactions is one possible solution.
Under the present system, the main priority of the United States and the IMF is to restore and preserve the credibility of national currencies in the eyes of foreign lenders. The main beneficiaries of bailout funds -- which make good these nations' debts -- are big banks, investment houses and speculators who deposited or lent dollars and yen in Southeast Asia. They will be repaid in full, on time and at the high interest rates that attracted them in the first place. Those rates were high to reflect the higher risks of lending to banks in Asia. But since the IMF bailout program is now making sure that lenders are repaid, there really wasn't any risk.
Notably absent from the bailout programs are measures to distribute the burden more equitably between Asian borrowers and foreign lenders. Negotiations to consolidate debts, moderate their terms and stretch repayments over longer periods have been common features of the settlement of international debts in the past, such as in the resolution of the Latin American debt crisis in the 1980s.
Here is the step-by-step breakdown of how capital mobility leads to crisis:
The peg: A country pegs its currency to a "hard" currency -- the dollar, yen, deutsche mark or mixture of them. (These currencies are accepted the world over.) Countries adopt a peg as a way of promoting international confidence in their own currency. Its central bank promises to buy or sell its own currency in foreign exchange markets for hard currency at pegged values. To meet this commitment, the central bank holds reserves of hard currency. Usually the commitment is to a range rather than a precise value, and often the peg crawls down at an announced pace.
Overvaluation: If a country's exchange rate is pegged too high, its exports are costly to foreigners, while imports seem cheap to residents. An alarming trade deficit then arises. Speculators begin to suspect the peg won't hold, i.e., that the central bank won't have enough reserves to fulfill its promise to convert on demand its own currency into hard currencies at the pegged rate. What can make a pegged currency overvalued? A government's own inflationary monetary and fiscal policies are often culprits, but external events can afflict the currencies of even prudent governments. Before the Southeast Asian crises, the IMF regarded South Korea and Thailand as models of capitalism. The IMF's 1997 Annual Report praised "Korea's continued impressive macroeconomic performance" and "enviable fiscal record," likewise "Thailand's remarkable economic performance and...consistent record of sound macroeconomic policies."
Japan was a big source of trouble for the Southeast Asian economies in recent years. Because of Japan's economic weakness, the dollar has appreciated 56 percent against the yen over the past two-and-a-half years. Because Southeast Asian countries had pegged to the dollar, their currencies also rose against the yen, damaging their industries' competitive position in Japan, the region's largest market. To make things worse, Japan's imports were also down because of the country's prolonged depression.
The panic: In free global markets, vast amounts of private money move anywhere at the speed of light. Speculative movements can quickly clean out a central bank's currency reserves once its ability to defend its peg becomes suspect. As in a run on a bank, a sauve qui peut herd mentality takes over, forcing the country to abandon the peg and let its currency fall, trying to conserve the remnants of its reserves.
The bailout: Suddenly, IMF and U.S. officials judge South Korea, Indonesia and Thailand very harshly. They attribute the plight of South Korea, for example, to the same corporate-state institutions that brought the nation from Third-World destitution in 1960 to First-World opulence today. They prescribe heavy doses of free-market liberalization and globalization. It is hard to escape the conclusion that the countries' currency distress is serving as an opportunity for an unrelated agenda -- including the obtaining of trade concessions for U.S. corporations and expansion of foreign investment possibilities. This is certainly an increasingly popular interpretation among South Koreans.
What can be done to make the world system of exchange rates and financial markets less prone to these sorts of crises? First of all, let the currency -- won or baht or ringgit -- depreciate and "float" in the market to its own level. Don't invite another crisis by pegging again. Floating is a preferable permanent policy. After all, the big three currencies -- dollar, yen and deutsche mark -- have not been pegged to one another since 1971. The advantage of floating is illustrated by the recent appreciation of the dollar and depreciation of the yen -- no crisis, no headlines, no bailouts.
Second, as the IMF points out, local banks' short-term debts in dollars and yen contributed to the crisis. Private banks must not be allowed to have debtor positions in foreign currencies that threaten national reserves. Emerging economies have been too ready to imitate the facades of Western financial markets -- without the prudential regulations and legal frameworks that make them work.
The fundamental question is: How open should these countries be to international financial transactions, currency conversions, bank deposits and withdrawals, security purchases and sales? The position of the IMF and the U.S. Treasury is that more freedom to make international transactions and to allow banks and other financial firms (wherever they are based or chartered) to function everywhere is always good. But one conceivable outcome of such a policy is that dollars become the effective unit of account and medium of exchange, whether pegged or floating with the local currency. The country then loses its monetary sovereignty. If the dollar becomes the effective currency of South Korea, then the country's interest rates will essentially be set in New York. The drawbacks are that the Federal Reserve and the U.S. Congress don't have to worry about workers and businesses in Seoul (or Bangkok or Kuala Lampur), and that America is resented for both its dominance and its indifference.
One way to make the international exchange system more stable would be to establish a tax on currency transactions, a measure I first proposed in 1971. The tax would have to be the same wherever a transaction takes place, so it would have to be agreed upon internationally. It might be administered by the IMF, with the funds retained by the national jurisdictions collecting the tax. The nations involved might also agree to devote some of the proceeds to international purposes. Because this tax would be the same whether funds are moving on a round trip of hours or years, it would be a significant deterrent to short-horizon speculation but a negligible factor in commodity trade and long-run investment. It would diminish unproductive volatility in exchange rates. The "Tobin Tax" could not be expected to protect overvalued exchange rates. But it could moderate their declines and buy time for adjustments. Events like those in Southeast Asia call into question the claims that liberalization and globalization of financial markets are the path to prosperity and progress. As long as the world is divided into sovereign nation-states, some sand in the wheels of international financial transactions is likely to be beneficial.
James Tobin, Sterling professor emeritus of economics at Yale University, won the Nobel Prize for economics in 1981.
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