[Outlook]Currency control

Many feel that the government is excessively intervening in the foreign exchange market. Some worry that if we go against market trends, we may find ourselves in yet another foreign exchange crisis. Some complain that the government wanted a high exchange rate and has now changed direction to punish the market.

Few support the government’s policy of protecting our currency sovereignty. Of course, different people can have different opinions about the right exchange rate and methods of intervention, but I fully agree with the government maintaining the exchange rate at a desirable level for the country’s economy.

Believers in the market hold that the exchange rate may fluctuate, but that it will ultimately settle at the correct level. They believe government intervention won’t change that trend. However, the gap between actual trade and financial trade is too wide at the moment. In 2007, Korea’s exports accounted for merely 1.5 percent of the entire financial trade volume of 802 trillion won ($800 billion). That was like the tail wagging the dog. More often than not, the exchange rate in the market is not desirable.

In 1995 and 1996, right before the financial crisis, the won went up while the current account deficit expanded. In 2006, the current account surplus shrunk by half but the won went up by nearly 9 percent against the dollar because of a massive influx of foreign capital. The drastic depreciation of the won these days also defies logical explanation. There are few reasons to believe that Korea’s economy is worse than that of the United States. Korea’s economic situation may have worsened to some extent but it can’t be so bad that the won has depreciated by more than 10 percent against the dollar and could be forced to lose more.

Market believers assert that companies must boost competitiveness and hedge in case the exchange rate doesn’t move to the tune of the actual economy. However, few companies can change their competitiveness freely in accordance with changes in the exchange rate. It costs a lot to hedge against foreign exchange risk. A free trade agreement between Korea and the United States might lower tariffs but it won’t compensate hedging costs. Washington also uses weak or strong dollar policy. We must not give up our sovereignty due to market dogma.

The government needs to prepare a system to control capital in case of an emergency. It should consider introducing the currency basket system. The international financial sector has negative views on control over capital. However, in a seminar held in Bangkok, Thailand in 2007, Hubert Neiss, the IMF’s former director for Asia Pacific affairs, said that well-defined emergency capital controls are necessary. His view has probably changed watching that system at work in Malaysia.

One of the merits of a basket system is that it costs little to maintain the exchange rate. Under a floating foreign exchange system, when the government intervenes in the market it needs to buy or sell currencies in the foreign exchange market. That might cause great loss. Meanwhile, under a basket system, the government can announce the exchange rate. If the announced exchange rate is much different from the market exchange rate, speculation can take place. If so, the government can release foreign exchange reserves to fight speculators. A basket system can be an important strategy for the country because China employs such a system.

In the early 1990s, when Korea gave up the basket system, China was not a major factor to consider. The United States and Japan asked Korea to adopt a floating exchange rate system and Korea didn’t have a good reason to refuse. However, struck between the United States, Japan and China, Korea needs a system to respond actively to a variety of changes. There is no golden rule for a foreign exchange system. We should think about what suits us best. For instance, Singapore has a basket system and the country has become an international financial center.

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

by Shin Jang-sup