Rupiah Rasputin: A currency board won't solve Indonesia's woes

SYNOPSIS: Profile of Austrian school economist Steve Hanke: currency board fanatic, self-promoter, crank

The Rasputin of the rupiah. That captures how some IMF and U.S. Treasury officials regarded an obscure Johns Hopkins professor named Steven Hanke when they first learned a few months back that Indonesia's President Suharto had suddenly fallen under his sway. At times Suharto, you'll recall, seemed ready to renege on promises of economic reform, and to gamble everything instead on his new guru's favorite panacea: a "currency board" that would use Indonesia's foreign-exchange reserves to back its money supply, in principle pegging the rupiah permanently to the U.S. dollar. It took massive pressure, including a personal call from Bill Clinton, to persuade Suharto to back off.

Is Hanke simply a quack peddler of economic nonsense who somehow wormed his way into presidential favor? Well, yes and no. Yes, in the sense that he is, at the very least, a self-promoter whose image as a successful country doctor has been pumped up by resume inflation. Hanke began his career in economics as an expert in, of all things, municipal water supply. His office and main appointment at Johns Hopkins are in the department of geographical and environmental engineering, not economics. Since the 1980s he has written mainly for conservative house organs like the Cato Journal rather than professional journals (he's also a columnist for FORTUNE competitor Forbes). According to many press reports, Hanke has played an important role in the establishment of other, successful currency boards--for example, the Wall Street Journal editorial page claimed he "advised Argentina on linking its peso to the dollar," and Hanke likes to describe himself as an adviser to former Argentine Finance Minister Domingo Cavallo. Cavallo himself tells a different story, though. He claims Hanke first became involved three years after the board was established, when he volunteered his services as a publicist.

But no, the case for a currency board for Indonesia isn't nonsense, although it is probably a bad idea right now. The most prominent example of a successful currency board is in fact Argentina, which since 1991 has backed every peso in circulation by a dollar of foreign-exchange reserves. This means Argentina has no control over its money supply, which at times can be a real problem: In 1995 it nearly led to a banking crisis--only averted thanks to emergency loans from the World Bank and the IMF. But Argentine officials regard the loss of policy discretion as a necessary sacrifice because the country has such a grim history of using inflation to finance runaway budget deficits. Given Argentina's price stability and relative prosperity in the 1990s, it is hard to argue with their judgment.

Could a currency board work the same magic in Indonesia? Probably not. The main thing such a board does is reassure investors that the government will not inflate away their wealth. But what worries investors about Indonesia is that many of the country's banks and corporations could go bust, or even that the whole country could descend into chaos. For these concerns a currency board is irrelevant, or worse: Creating a board means committing a lot of foreign exchange to backing the currency, making those dollars unavailable to pay for imports or debt service. The one group that would find a currency board particularly attractive is members of Suharto's circle, who conceivably might want to move a few billion dollars out of the country at a favorable exchange rate.

In short, the appeal of Hanke's plan is very similar to that of supply-side economics in the U.S. in the 1980s: It offers something for nothing, with the policies needed to produce that magic just happening to directly promote the financial interests of the plan's supporters. Seems like deja voodoo all over again.

Originally published, 4.13.98