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Hello everyone. Letπs
kick things off with a little note on Indonesia. The following was written several
weeks ago. Since then, as shown by the graphs below, the situation has gotten
rather more interesting. It is rather unpleasant to see the Indonesia central
bank make such a mess of things, as they did such a fine job after the Asian
Crisis, through a strategy of direct base money adjustment.
Huge increase in base money =
weakening currency. Fuel subsidies have nothing to do with it.
The recent weakness in the rupiah
has been blamed on government petroleum subsidies ≠ which hardly seems likely
to me, as no other governments, either those that produce petroleum and even
subsidize domestic consumption (Saudi Arabia, Venezuela, Iran, Russia) or
import large amounts of it (Japan, Korea, Philippines) seem to be having any
forex issues linked to energy prices.
The simplest reason for a
declining currency is that supply has increased relative to demand. An
investigation into currency supply ≠ namely the base money provided by
the central bank ≠ shows a large and anomalous increase in base money in
May-July 2004. Base money in July 2004 actually increased by an incredible
33% from July 2003, well above the average growth rate of base money in
Indonesia over the last ten years.
The central bank is no doubt well
aware of this, especially since base money is one of its explicit policy
tools and targets. It appears that the central bank injected this huge amount
of base money to stop the trend of a rising currency between 2001 and early
2004. Indeed, we see a dramatic reversal of trend to a new trend of a
declining currency (vs. the USD) beginning in exactly June-July 2004.
Given the central bankπs
stated concern about inflation and currency value, its attention to base
money growth, and successful recent history, it is reasonable that the
reaction to this increase in base money has been muted. After all, base money
added so suddenly could also be removed, just as suddenly. However, as time
passes, investorsπ faith in the central bank has decayed (i.e., demand
for the currency has declined), as expressed by the declining currency value.
While the recent moves by the
central bank to support the currencyπs value have been
encouraging, what is really needed is action to reduce base money
significantly, thus undoing some of the action of May-July 2004, as is
appropriate to bring the currencyπs value to a reasonable
level perhaps around 9000/USD.
This is very simple to do, as it
involves simply selling assets from the central bankπs
balance sheet and reducing base money concurrently.
Failure to take such a step would
be construed as more evidence of the central bankπs
negligence, and would likely result, over time, in a further deterioration in
confidence that currency value will be maintained. This could have dramatic economic consequences.
Indonesian
rupiah base money
Indonesian rupiah
(IDR) per USD
Nathan
Lewis
Nathan Lewis was formerly the chief international economist
of a leading economic forecasting firm. He now works in asset management.
Lewis has written for the Financial Times, the Wall Street Journal Asia, the
Japan Times, Pravda, and other publications. He has appeared on financial
television in the United States,
Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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