Seoul Advised to Overhaul Foreign Exchange System
By Cho Jin-seo
Staff Reporter
A number of government officials and economists agree that the effects of widely-fluctuating foreign exchange rates have been the most vulnerable part of the Korean economy, as seen in the crises of 1997-1998 and 2008-2009. But few have the courage of Shin Jang-sup to stand up and say that the current system is wrong.
The professor at the National University of Singapore says South Korea should drop its free-floating system of dollar-oriented currency exchange, and go back to a state-managed currency band system based on a basket of multiple foreign currencies, which was used here until 1997. His call is gaining backers in and out of Korea after the recent economic crisis, albeit slowly.
"The government has to send a message that the market is not always right, that it can sometimes get things wrong, and that when it does get it wrong, the state won't stay still," he told The Korea Times. "A large part of the foreign exchange market is composed of speculative money. So, shifting to a basket-band regime is like setting a betting limit in a casino."
South Korea currently has $273 billion in foreign exchange reserves, the sixth largest in the world after China, Japan, Russia, Taiwan and India. Under the current free-market system, the government has to have a large volume of foreign currency in reserve, and use it to "defend" its currency when it gets too volatile in the market - selling or buying against the market's momentum, often at a loss.
There is no official measurement of how much the Korean government has lost by trading against the market's movement during the crisis, but traders do attest that the clumsy interventions of non-profit-oriented governments in the foreign exchange market often bring easy money to profit-oriented speculators.
Why Get Ripped Off?
A senior foreign exchange trader of Deutsch Bank told an Oxford University lecture last year that his team romped to big profit by trading on the Korean won and Turkish lira during the crisis, betting against their governments. “Why do we xxxx with them? Because they are xxxxable,” he told, using the f word.
The ineffectiveness of the currency-defense system using reserve dollars, Shin says, is because market forces are simply too big for a single state to cope with - about $4 trillion change hands every day on the global foreign exchange market, dwarfing the reserves of not only Korea but also China.
A good example of the state's powerlessness is Black Wednesday - when the U.K. government fought against George Soros and other speculative foreign exchange traders in September 1992. The hapless efforts eventually cost approximately 3.3 billion pounds of British taxpayer money, and awarded $1 billion in profit from short-selling to Soros.
What Shin calls for as a substitute is a currency basket-band system where the exchange rate of foreign currencies can fluctuate within a certain range set by the government, based on the compounded value of multiple foreign currencies such as the dollar, yen, euro and yuan. The government may or may not disclose the range, and can use several methods to encourage market players - mostly banks - to trade within the band. It has proven particularly useful for small and open economies, such as Singapore, where Shin is teaching.
"The foreign exchange regime should go hand in hand with capital control. Rapid cross-border flow of speculative money is not beneficial to the economy," he said, adding that imposing a liquidity ratio rule or minimum foreign reserve requirement on foreign and domestic banks can be viable measures to control capital flow.
Shin says he attained a practical approach to economics from his experience as a journalist at Maeil Economic Daily covering the finance ministry during the 1997 Asian crisis. He then earned his master's and doctoral degrees at Cambridge University.
Nobel Laureate Supports
Shin's message is also causing a ripple effect among top government officials, but their response has not always been favorable. Chin Dong-soo, the top financial regulator, said that going back to the basket-band system is a "retrograde policy" in the global context, though he agreed some actions are needed to fix the current regime. Infuriated by the remark, Shin recently started a blog and refuted that copying the free-floating systems of advanced economies does not necessarily mean improvement for Korea, where economic conditions are different.
Ironically, the greatest support for Shin's protectionist idea comes from the United States, the home ground of laissez-faire capitalism. Edward Prescott, the 2004 Nobel Prize winner in economics, says that Korea is already using a quasi-fixed-rate system, probably at a greater cost than using other state-managed systems. .
"Korea holds huge quantities of reserves and uses them to peg the value of the won. This is not a floating exchange rate system, which is a free market system," the professor at Arizona State University told The Korea Times in an e-mail. "You want enough reserves so that the chance of a currency run becomes virtually zero, but not more. Holding reserves is costly as they produce very low interest."
Shin also says that Korea should take a cautious approach to the upcoming Group of 20 summit in November, as the currency debate between the United States and China is getting fierce. The United States and some Western European countries have been urging China to appreciate its currency and in the end to float it on the free market, while China has been adamantly resisting the pressure.
"Korea doesn't need to take a side too early. Though in economic terms China has become the largest partner to Korea, it still depends heavily on America politically and militarily. It's like walking a tightrope," he said.