[VIEWPOINT]Following Singapore’s example

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[VIEWPOINT]Following Singapore’s example

The Chinese government recently adopted a currency basket system as its foreign exchange rate system, when it made an announcement of a lightening devaluation of its currency, the yuan. As soon as the Chinese government announced the introduction of the new system, Malaysia, which had pegged its currency to the U.S. dollar as China had, switched to the currency basket system too.
Singapore, which has operated on the currency basket system, is proud that the country’s foreign exchange rate system is acting as a template that East Asian countries should widely adopt in the future.
Why is the currency basket system in the spotlight all of a sudden? The currency basket system determines daily foreign currency exchange rates by putting a certain weight on the currencies of major trading partners. The biggest difference of the basket system from the free-floating foreign exchange rate system is that the government, not the foreign exchange markets, takes the initiative in deciding the exchange rate.
Of course, when it decides the foreign exchange rate, the government examines the capital flow in the markets. But the currency weight or daily fluctuations are kept confidential. Market participants exert all efforts to find out this confidential information, but it is not an easy job, because foreign exchange authorities can change the figures as necessity arises.
Korea had also used a currency basket system for more than a decade, from the early 1980s to the early 1990s. But as our trade surplus accumulated, the United States unjustly accused our country of manipulating the foreign exchange rate and put pressure on the nation. As a result, our country moved to adopt the market average foreign exchange rate system and, since the foreign exchange crisis of 1997, we have adopted the free-floating system.
Many free market advocates support the free-floating system as if it is the most efficient one, but nothing has been established theoretically or empirically about the foreign exchange rate system. Each system has its own strong and weak points, and each country needs to find the right system for its situation.
Considering the situation the Korean economy is in at present, I think the government should earnestly review the adoption of the currency basket system. It meets economic needs and strategic needs alike.
In the free-floating foreign exchange rate system, the cost for intervention is huge in order to maintain the exchange rate level suited for the needs of the domestic economy. This is because the government has to buy or sell currency in the foreign exchange market.
It was lucky that the dollar has strengthened recently, but if the weak dollar had continued, our foreign currency authorities would have suffered a substantially great loss due to their intervention.
But in the currency basket system, the government does not need to spend money to adjust the foreign exchange rate. All it needs to do is to issue an announcement about the rate.
Of course, if the announced foreign exchange rate is largely different from the flow of the market, there is room for speculation. But the basket system is far more economical than the free-floating system if the government reads the flow well and takes proper measures against speculation.
In my opinion, we should have further strengthened regulations on the foreign exchange market since the foreign exchange crisis of 1997. The crisis may have been our fault, but the fundamental instability of the international financial market also played a big role.
Under the stewardship of the International Monetary Fund, the government has further deregulated the foreign exchange market in reforming the economy based only on the assumption of our own fault. Consequently, we created a structure that costs a tremendous amount to operate in the foreign exchange market, while we have to read more closely the minds of international financial organizations that are the big players in the foreign exchange market.
It is necessary to review the transition to the currency basket system at the national strategic level too. When we gave up on the basket system in the 1990s, China was not a strategic factor. Our relations with the United States and Japan were the most important variable. We did not have sufficient grounds for refusal when the two countries that adopted the free-floating foreign exchange rate system asked Korea to follow suit.
But now the Chinese economy has emerged as an important factor in the operation of our economy. South Korea is a country caught in between advanced countries like the United States and Japan and a less developed country like China. As such, our country should be equipped with a system that can absorb various changes happening on both sides. In particular, as China shifts to the basket system, a little movement of the yuan is more likely to make the foreign exchange rate in the East Asian region fluctuate.
In this situation, the more desirable foreign exchange rate system seems to be one in which the government can more actively respond to changes in the market. There is also no reason for a small neighboring country not to adopt the basket system when China, a huge trade partner, is using it.
Some may be worried about the shift, saying that the abandonment of the free-floating system is a regression to a less developed economic system. But Singapore has proudly become an advanced country with the introduction of the basket system and positioned itself as an international financial center.
A single established fact about the free-floating system, if there is any, is that it is the most convenient system for the speculative forces in the foreign exchange market.

* The writer is a professor of economics at National University of Singapore. Translation by the JoongAng Daily staff.

by Shin Jang-sup
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