[LETTERS TO THE EDITOR]‘Managing’ exchange rates

Shin Jang-sup’s Viewpoint column (“Following Singapore’s example,” Aug. 2) demands a sober response. Professor Shin supports government-managed exchange rates, for the reason that in such a system “the government, not the foreign exchange markets, takes the initiative in deciding the exchange rate.” He also believes the benefits of his favored “basket” system are free, in that “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.” This is plainly a false view.
If it were true, China would not now be holding onto US $800 billion in reserve, accumulated for no purpose other than to stabilize the yuan. George Soros showed the world how this game really works on Black Wednesday (Sept. 16, 1992), when he earned up to $2 billion speculating against the British pound. The British government had been keeping the pound artificially high relative to the deutschmark, so Soros simply borrowed billions of pounds and bought marks, knowing he would be able to repay the loans later, when the marks would buy even more of the devalued pounds, and keep the difference.
This is what happens when governments “manage” exchange rates. While the artificial peg stays in place, behind the scenes the pressure builds and builds, until finally the government runs out of sufficient reserves. By this time, the speculators are in place to make a killing on the rapid correction.
Professor Shin is correct that Korea has been spending great sums of money to enforce its desired exchange rate, but this is not a fault of the free-float system. Just compare Korea and China to see why. Since the start of last year, Korea has increased its foreign exchange reserves by about one-third, to $200 billion. In the same period, China, which has maintained a currency peg, has doubled its reserves to $800 billion. If maintaining an exchange rate is as simple and inexpensive as making an announcement, why is China buying all those U.S. dollars? Because the market is real, that’s why.
Central bank governors cannot simply pretend there is no market and create the trade terms they prefer. If the free-float system really were the favored tool of currency speculators, then Korea, not China, would now be experiencing massive inflows of hot money betting on the won’s appreciation. It is true that the won will get stronger in the near future, but the floating-rate system allows the pressure to be released little by little, day by day, by anyone wishing to participate in the market.

by Brendan Hillson