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The Fall in the Value of the Indonesian Rupiah — DéjàVu 1998?

September 25, 2018 in Economics

By Steve H. Hanke

Since that August interview, the poor rupiah has been put into
the emerging market meat grinder. It has reached depths not seen
since 1998. But, are the causes of the fall of the rupiah the same
as they were in 1997-1998? In a word, “no.”

For one thing, Indonesia’s broad money (M2) was growing at
an excessive annual rate of 25.35% in 1997. Today, it’s
growing at a modest 6.4%. Just how modest?

To answer that question, I employ a monetary approach to
national income determination for a diagnosis. As Milton Friedman
put it in his 1987 New Palgrave Dictionary of Economics
entry, “Quantity Theory of Money” (QTM), “The
conclusion (of the QTM) is that substantial changes in prices or
nominal income are almost always the result of changes in the
nominal supply of money.” The income form of the QTM states
that: MV=Py, where M is the money supply, V is the Velocity of
money, P is the price level, and y is real GDP (national
income).

Let’s use the QTM to make some bench calculations to
determine what the “golden growth” rate (read: optional
rate) is for the money supply. This is the rate of broad money
growth that would allow the Bank Indonesia (BI) to hit its
inflation target. According to my calculations, the average percent
real GDP growth from the time that the President of Indonesia Joko
Widodo “Jokowi” took office in November 2014 through
July 2018 was 5.05%. The average change in the velocity of money
was 1.76%. Using these values and the BI’s average inflation
target of 3.88%, I calculated Indonesia’s “golden
growth” rate for Total Money to be 7.17%.

Calculations:

Golden growth rate = Inflation target + Average real GDP growth
- Average percent change in velocity

Golden growth rate = 3.88% + 5.05% – 1.76% = 7.17%

The actual average rate of growth in the money supply during the
Jokowi years (7.22%) is very close to the golden growth rate of
7.17%. The BI has been on target. Not surprisingly, the realized
inflation rate has been very close to the BI’s inflation
target, too.

So, what’s the problem? Why are Indonesians so uneasy
about the rupiah? There are three reasons. The first is the fact
that Indonesians remember the Asian Financial crisis and have
little confidence in the floating rupiah. Secondly, they have
little confidence in Jokowi’s ability to deliver much needed
economic reforms. Indeed, even though Jokowi has presented big
infrastructure plans, all have proceeded at a snail’s pace.
Thirdly, instead of remaining calm, the Jokowi administration hit
the panic button when the rupiah was attacked in late summer. The
administration said things that were nonsense, namely that it was
going to “save the rupiah” at all costs and that it was
not going to raise interest rates. These incompatible statements
gave markets the impression that the administration didn’t
know what it was doing.

So, the recent plunge of the rupiah represents a collapse in
confidence. And, as John Maynard Keynes stated in The
General Theory: “The state of confidence, as they
term it, is a matter to which practical men always pay the closest
and most anxious attention.” Once lost, confidence is hard to
regain. So, as I said in August, even though the monetary
fundamentals in Indonesia are quite good, the rupiah will end the
year on a weak note.

Steve H. Hanke

In 1998, thanks to President Bill Clinton and the IMF, the
Indonesian rupiah collapsed, and inflation surged.

I know every act in this play because I had a front row seat as
then-President Suharto’s Special Counselor. A brief account of this
sorry saga is contained in Forbes. In a nutshell, to stabilize the
rupiah and stop inflation in its tracks, I proposed, and Suharto
accepted, a currency board system for Indonesia. This would have
made the rupiah a clone of the greenback.

The prospect of a currency board unleashed a ruthless
counter-attack from the White House and the IMF. Both knew the
currency board would work, and that Bill Clinton would be stuck
with Suharto. The message to Suharto from both Clinton and Michel
Camdessus, Managing Director of the IMF, was the same: If you
proceed with Prof. Hanke’s currency board, Indonesia will not
receive the $43 billion bailout. In the end, Suharto abandoned the
currency board idea, and the Asian Financial Crisis ousted him.

Since my Forbes column of July 6th, 2017, White House documents that confirm my
observations have been released. In anticipation of the
Presidential elections in Indonesia in April of 2019, the documents
were released ahead of schedule.

Shortly after the White House documents were released,
journalists and a film crew arrived at my Johns Hopkins office to
film part of a documentary. One question that kept coming up
during the filming dealt with where I thought the rupiah was going.
Obviously, there was a great deal of angst in Indonesia about the
rupiah’s weakness. At the time, I simply said that the rupiah would
be weaker at the end of the year than it was then (in early
August). Given the trend of the rupiah-dollar exchange rate, that
was a safe bet (see the chart below). Little did I know how fast
the rupiah would sink. Yes, in Indonesia, everything seems to be
sinking, even Jakarta—the
fastest sinking city in the world.

Since that August interview, the poor rupiah has been put into
the emerging market meat grinder. It has reached depths not seen
since 1998. But, are the causes of the fall of the rupiah the same
as they were in 1997-1998? In a word, “no.”

For one thing, Indonesia’s broad money (M2) was growing at
an excessive annual rate of 25.35% in 1997. Today, it’s
growing at a modest 6.4%. Just how modest?

To answer that question, I employ a monetary approach to
national income determination for a diagnosis. As Milton Friedman
put it in his 1987 New Palgrave Dictionary of Economics
entry, “Quantity …read more

Source: OP-EDS

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