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Central bank should go with flow

On Feb. 29, because of exporters' panic selling of US dollars at the start of trading, the foreign exchange market saw an intraday record high exchange rate for the NT dollar against the US dollar of 30.677. Yet the central bank intervened in the market toward the end of the session with a purchase of US$1 billion to US$1.5 billion, forcing the nation's currency to fall and eventually close at 30.95 to the US dollar.

The Taipei foreign exchange market and the Cosmos Foreign Exchange International Co alone had a turnover of US$3.498 billion, second only to the US$3.9 billion registered on Jan. 16 this year.

The move was generally considered as a government bid to offer exporters a window of opportunity to avoid risks. Also, as all domestic enterprises and banks were conducting asset evaluation and balancing accounts around the end of last month, such a move could reduce possible losses in currency exchanges for corporations. However, it is worth pondering whether such a policy is wise or not.

On the same day, given the ripple effect of the subprime mortgage crisis, the US saw a string of discouraging economic figures and enterprises' financial statements as the Dow Jones industrial average plunged more than 300 points. The three major US stock indexes all slid more than 2.5 percentage points.

A report published by four economists at this year's US Monetary Policy Forum sponsored by the University of Chicago Graduate School of Business and the Brandeis International Business School indicated that US subprime mortgage delinquencies and the credit squeeze of the past year would trigger US$400 billion in losses for the US financial system and knock 1.3 percentage points from economic growth this year.

This argument is in line with German Finance Minister Peer Steinbrueck's statement at the recent G7 meeting of finance ministers and bank governors in Tokyo that the G7 countries were worried that write-offs from the subprime crisis could reach US$400 billion. Hence the economists also expected that as the credit squeeze would have an impact on credit loan transactions, financial institutions could retreat from extending credit to the tune of about US$910 billion.

Besides, an economic report released by the US Federal Reserve Board earlier also suggested that as the real estate market falls and credit as well as the financial market remain unstable, prospects for the next few months would be bleak. Hence Federal Reserve Chairman Ben Bernanke expressed to Congress on Feb. 27 that even if prices continue to rise and worries over inflation surface, the US Federal Reserve will remain closely attuned to the risks confronting economic growth. The next day, the exchange rate of the US dollar versus the euro fell to US$1.51.

Thus, a combined analysis of the future of the US dollar still predicts further decline. The New Taiwan dollar will naturally rise in comparison. Besides, the optimistically anticipated economic transition after the presidential election will be like unleashing a tiger. As foreign capital floods into Taiwan, it will be increasingly difficult for the Central Bank to maintain low rates for the NT dollar.

The opportunity for a rise in the exchange rate must be seized; otherwise the losses will be enormous, as foreign currency from opportunists who wish to make an easy buck come in and then out again, taking advantage of the difference when the rise in exchange rates reach a certain point.

The lesson of 1987, when the rise of the NT dollar caused the central bank much damage, lingers in the memory. At the time, in order to maintain the exchange rate, the central bank released NT dollars against incoming US funds and maintained appropriate currency supplies through open market manipulation. However, as the slow rise of the NT dollar had already been anticipated, the central bank lost a significant sum in foreign exchange.

At the time, the NT dollar went from 38 to 25 to the US dollar. Many did not believe that Taiwan was capable of bringing the rate below 30. Others believed that a strong NT dollar would damage Taiwan's export industries. However, Taiwan's industries were spurred by the rise. While the strongest survived, more competitive strengths were fostered so that later the high-tech industries rose to new heights.

I believe that the central bank should go with the flow and it should especially estimate a possible new rate and establish it in one fell swoop. This would prevent the loss of the foreign exchange reserve as the rate slowly climbs. There should be intervention toward a reasonable exchange rate, with clear and thorough policy to reduce unnecessary fluctuation. The central bank should not try to use this occasion to teach opportunists a lesson -- but to dissuade them from attempting such behavior in the first place.

Lin Chien-fu is a professor of economics at National Taiwan University.

Translated by Ted Yang and Angela Hong
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