The impact of globalization is felt all over the world. Sometimes the effect of globalization forces can be dramatic and sometimes subtle. While globalization can be very difficult to track and study there are tools that can help an economist to get an idea of what is happening when it comes to international trade. This is none other than the exchange rate which is linked to currency exchange. While every nation has its own currency its value fluctuates every second, every minute, everyday. Comparing the value of one’s currency to another is called the exchange rate. In a free market the exchange rate is determined by the interaction of buyer and sellers but in the 1990s the unregulated market created a major problem for Asian currencies and this has resulted in the Asian financial crisis. In the aftermath many are calling for exchange rate control. There is a good reason why control is needed but at the same time one has to remember that a capitalistic market is characterised by freedom and not government interference.
Macroeconomics
Globalization is the reason why economists and investors should study macroeconomics. Although the impact of globalization was already felt even before the turn of the 20th century, in recent decades the forces of globalization have intensified due to radical improvements in technology both in communication and in transportation. While globalization can be also understood as good businesses seeking to expand overseas the effect can be so complicated and very difficult to quantify. For example, “…globalization has forced us to incorporate multinational ownership and location of production – an acquired comparative advantage not based on natural resources (Kroon, 2007: 217). In the past one look at a geopolitical nation and it was very easy to assess its military and economic might.
In the not so distant past, an analyst would simply look at the location of a particular government, the natural resources that is within its control as well as the manpower that it commands and one will have a fairly accurate assessment of the said nation’s ability to wage war and defend itself from external attacks. In the Age of Industrialisation that same thing can be said of corporations. An analyst can go to its headquarters, study the natural resources that can be exploited as well as the human resources that will facilitate the extraction of resources as well as managed it; then one can also have a fair assessment of its power and influence. Today, a casual observation is not enough because a company’s headquarters can be in Arkansas in the United States and yet have business establishments exploiting human and non-human resources in countries like China, Vietnam, Philippines and India. One way of being able to keep on top of the global economic situation is through the expert use of exchange control.
Exchange Control
There must be exchange control because currency exchange can create subtle as well as sudden changes in the national economy. In order to clearly illustrate this it is helpful to find out the advantages of an appreciation in the currency. First of all, there would be cheaper imports. UK businessmen and UK residents will be able to purchase goods at a much lower rate. When they travel overseas they will experience more purchasing power because of the high pound (Riley, 2006: par. 1). In the local scene, the producer who imports raw materials as well as component parts will also benefit from the strength of the pound. This is also true for UK companies that import technology.
A strong exchange rate will also result in lower inflation. Since it is cheaper to import then residents and businessmen can buy alternative products overseas. This means that if a car that is manufactured locally is very expensive then importers can buy Japanese cars for instance which are much cheaper compared to the exchange rates of the Japanese yen and pound. This will force local manufacturers facing stiff competition in the international market to lower the prices of goods and hence lower the inflation rate. The next consequence that will come as a result of lower inflation is lower interest rates. This means that people will have access to cheaper money and this will result in higher consumer and capital spending (Riley, 2006: par. 3). The reverse will be true if exchange rate is weaker.
Currency exchange and exchange rates are very important especially after World War II when the gold standard was no longer used as a tool to regulate trade between two countries (Krugman & Obstfeld, 2003: 512). An increase in exchange rate can be beneficial or not depending on the perspective of the one doing business. The exporters would like the real exchange rate to fall while the importer would like the exchange rate to rise. These changes are determined by demand and supply as well as the interaction of buyers and sellers (Kroon, 2007: 218). This is the essence of a free market, the absence of government interference. But in the 1990s the Asian financial crisis came like a Tsunami caused great havoc in the financing sector and laid waste many corporations.
The Asian Financial Crisis
There are many economists who cannot hide their disdain for exchange controls. This is especially true for those who are die-hard advocates of the free market. In fairness to them, there are more examples of economies that were destroyed because of government intervention in comparison to the free markets in operation in highly industrialised countries. But if exchange control is being considered then there is only one justification and one commentator was able to put it succinctly by saying that exchange control is a weapon used in economic warfare (Schumpeter, 1986: 323). The goal is total victory creating an advantage where none existed. From the perspective of national leaders and their finance ministers this is a tempting offer but most of the time this is not the standard practice. But everything changed after the Asian financial crisis.
The financial crisis that hit Asia was brought about by many factors but the most critical is the fact that some currencies were overvalued. An overvalued currency has its advantages but if speculators and other investors will get hold of the idea that this particular currency is overvalued they can initiate an “attack” which will force the government to defend the currency with high interest rates and if this fails then the currency will collapse (Montiel, 2003: 415). There are two countries in Asia that were able to weather the storm and these are Singapore and China. But before going further it would be better to revisit the countries that were badly hit by the said crisis.
According to experts Japan started it all when in May of 1997 it hinted that it will raise interest rates to defend the yen (Nanto, 1998: par. 6). Investors and speculators smelled blood and they began to unload Southeast Asian currencies (Nanto, 1998: par. 6). Apparently, speculators made the decision that since the more established Japanese market is in trouble then it will not take long for weaker economies to fall. It can be argued that in many instances this was a self-fulfilling prophecy, meaning that their negative perception fuelled their fears and hastened the collapse of many Asian currencies.
The three hardest hit Asian economies were Indonesia, Korea, and Thailand (ADB, 1999: 1). The primary reason according to experts is the “…shortage of foreign exchange that has caused the value of currencies and equities in Thailand, Indonesia, South Korea and other Asian countries to fall dramatically” (Nanto, 1998: par. 1). The reason is overvaluation; there was a time when their respective economies were perceived as robust. In just a short period of time investors and speculators learned that this is not the case. Yet, even if this is true no one could have predicted that the Asian financial crisis will turn out that way – affecting not only the region but even the United States of America (Nanto, 1998: par. 1). The slide could have been prevented if these countries found a way to depreciate their currency (Montiel, 2003: 415). The IMF is expected to come in to create stability in the region but its policies and interventions fell short. For each government, the step would be to increase the interest rate in order to stop the haemorrhaging of money. If these steps were followed then the negative impact of the Asian financial crisis would have been mitigated, but this was not the case.
In order to understand the Asian financial crisis from the point of view of policymakers it is important to study two survivors – Singapore and China. In the case of Singapore the authorities recognised early and accepted the fact that there was going to be a recession. Using this knowledge in combination with the fact that Singaporean officials are well aware of the true state of their economy they made deliberate steps to slowly depreciate its Singapore dollars against the US dollar to maintain its competitiveness (Jin, 1998: par. 3). This move was brilliant from the perspective of later analysts because Singapore was able to communicate to the outside world that their currency is not overvalued. This means that speculators will not be tempted to initiate an attack by selling Singapore dollars.
While many will consider this a brilliant move by Singapore officials, this is simply part of the story. The government of Singapore decided to reach a level of excellence by initiating financial reforms as well as cost-cutting measures to increase their competitiveness (Jin, 2000: par. 2). Some of its Asian neighbours were contented to seek help from the IMF. For instance the IMF was more than willing to provide $3.9 billion as part of the support package for Thailand. In the same year Indonesia had no choice but to ask help. The IMF responded by announcing the availability of a $40 billion stabilization package for Indonesia (Nanto, 1998: par. 6). It is understandable why Indonesia, Thailand and South Korea were forced to ask for help. On the other hand these countries should have considered the long term effect of their actions. It is easy to see that investor’s confidence is high when it comes to Singapore and low when it comes to other Asian countries. This negative perception is difficult to erase.
Aside from Singapore, China was also able to weather the storm and this was accomplished by using exchange control. Using stringent policies of China’s currency the RMB was not convertible for capital account transactions (Sharma, 2003: 269). Due to the partial convertibility of the RMB made it extremely difficult for speculators to take any short position against the RMB and this has spared the Chinese economy in the financial crisis of the 1990s (Sharma, 2003: 269). If only other Asian countries were more than willing to use “control” as demonstrated by the Chinese and “prudence” as demonstrated by the Singaporeans then they could significantly reduce the impact of the Asian financial crisis.
Conclusion
It can be argued that there are many ways to combat the Asian financial crisis aside from using exchange control. Singapore was able to show that timely adjustments in their policies as well as the commitment to implement cost-cutting measures allowed them to remain competitive. If other Asian countries were aware of the prudent decisions made by Singaporean leaders and add to it the deliberate moves made by the Chinese to prevent the outflow of money then the herd mentality of speculators could have been neutralised and its devastating effects minimised.
References
- Asian Development Bank. (1999) Policy Response to the Asian Financial Crisis: An Overview of the Debate and the Next Steps.
- Kroon, G. (2007) Macroeconomics the Easy Way. New York: Barron’s Educational Series, Inc.
- Krugman, P. & M. Obstfeld. (2003) International Economics. Pearson Education.
- Montiel, P. (2003) Macroeconomics in Emerging Markets. UK: Cambridge University Press.
- Sharma, S. (2003) The Asian Financial Crisis. UK: Manchester University Press.
- Schumpeter, A. et al. (1986) History of Economic Analysis. UK: Taylor & Francis.
- Jin, N. K. (2000) Coping with the Asian Financial Crisis: the Singapore Experience Southeast Asian Studies [online]
- Khor, M. (1998) Asia should impose foreign exchange controls, says Krugman.
- Nanto, D. (1998) The 1997-1998 Asian Financial Crisis.
- Riley, G. (2006) Microeconomics and the International Economy.