Wednesday, November 10, 2010

Call for a Fixed Currency Peg for the Philippines

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Countries that were most affected by the 1997 ...Image via Wikipedia
Countries that were most affected by the 1987 Financial Crisis
Let me quote from Cesar Purisima: "I will not recommend competitive revaluation. We should allow the market to determine the exchange rate. Our role is to smoothen these adjustments."

Now is a very good opportunity to challenge G20's effort to preserve the failed global financial system by preserving the floating exchange rate regime (putting US in a very good export position at the expense of our OFWs and exporters). We must call on the Aquino administration for the return of a fixed exchange rate, probably pegged at P50=US$1 in order to protect our migrant workers and what little is left of our export industriesincluding the Business Process Outsourcing (BPO) industry.

The G20 does not want this (maybe some members, but not the US-allied countries). The Aquino government, despite its token protestations, does not want this because it puts us in a good position for "debt prepayment". But OFWs will be with us on this. Well-meaning economists, even those in the neoclassical frame (but they may remain silent so as not to alienate the mainstream), will accede and even support us on this matter. By fixing the exchange rate, we also permanently remove a strong excuse for debt prepayment and force the government to use it reserves for capital build-up and technology transfer.

It is time to fight fire with fire. If the US will continue with its "quantitative easing (QE)" (the Federal Reserve already printed, out of nowhere, $600 billion to buy securities from the the US Treasury) and unilaterally decide on the foreign exchange markets, then we should protect our currency from the market. This is what China and Malaysia did during the 1997 Asian Financial crisis and had been a factor for its survival and development.

The time is ripe for this call.

Below is an article on the impact of QE on the Philippines and government response:

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Estong said...

Hi James, many countries (foremost is China) have adopted the strategic use of their currency to grow, but at the same time, brings instability to the (global) flows system. The currency peg @50 (in effect devaluing-the-peso) proposal has one problem and that is its inflationary. The OFW/$-earning segment of our population may seem to benefit at first, but prices will get back at them - and everyone. And what about the larger our non-$ dependent populace. They stand to gain nothing from the devaluation, and have inflation to bear.

-(estong 'to) wala lang akong magawa hehe

SYNTHESiST said...

I agree with Estong that it is inflationary...

Firstly, from innovation perspective, the fixed exchange rate of US$50:1 is just a transfer payment (without productivity improvement) that will quickly bankrupt the reserves. As the problem is the weakness of the US$ rather than the strength of the peso and, proportionately, we will lose our shirt before are puny reserves can make a dent, I suggest a better and low cost solution to the rest of the Filipinos who live in the country. Why not encourage the OFWs to negotiate their salaries in Pesos or, easier for the other party but more difficult for POEA to monitor, in their local currency, Norwegian Kronor, Saudi Rial, etc. if traded by oour BSP, as all these are strengthening against the US$, too! All this needs is an administrative order.

Secondly, announcing a fixed rate of exchange will invite the speculators to bet that we cannot hold the line. Frankly, our US$56B in reserves will be quickly used up defending the indefensible. Without fixing the rate, a better way is to implement some form of capital controls - that the Chinese do - to insulate the country and discourage speculative carry traders say a holding period for portfolio investments of six months before any outward remittance of principal and profits is allowed.

The exchange rate is too blunt an instrument to respond to a situation that we cannot control. If we intend to save our topline for 9million OFWs, imagine the bottom line for the 90M Filipinos who will have to suffer with your proposal. We need more creativity as problem is complex with unintended consequences.

SYNTHESiST said...

Revision to the first paragraph: I agree with Estong that it is inflationary... to which I return at the bottom. There are two other reasons I do not think announcing a Php50:US$1 is a good idea.

SYNTHESiST said...

To simplify our contention that your proposal is inflationary, it is the equivalent of saying:

Let us increase the price of gasoline by 17.8% (50.00/42.50).

Of course you will respond then we implement price controls.

Then oil products will disappear from the stations ones inventories run out.

Then the government will import to provide supply ... at a loss of course. This is one mechanism that results into the reserves running out.

The scene will repeat for rice that is dependent on imported fertilizer, electric power from bunker fuel, etc.

James Miraflor said...

Hi Estong and Marvin!

Before, I respond, let me just clarify and refine my proposal a bit. First, it is not meant to be a permanent policy. Well, to be general, no policy should ever be permanent. As for the problem that called for the proposal for fixed currency peg, the more desirable solution would really be capital controls, or in BSP’s parlance, “capital management techniques” (which belies euphemistic tendencies, but that is the subject for another day). I agree with Marvin on that one. More specifically, I am for what University of Denver Ilene Gabrel describe as “graduated, transparent, vulnerability-activated capital controls.” To quote Gabrel, these “capital controls are activated whenever information about the economy indicates that controls are necessary to prevent nascent macroeconomic fragilities from culminating in serious difficulties or even in a crisis”. The system employs “trip wires”, or measures that warn both policymakers and investors that the economy is nearing a level of risk (e.g. currency collapse, capital flight, emergence of high-risk financing strategies, etc.), and “speed bumps”, which acts so as to reduce this risk.

One of the recent examples of capital regulation was employed by Malaysia, which it did in 1994, refusing to give in to the increased private capital inflows just before the Asian Financial Crisis. They restricted the maintenance of domestic-currency-denominated deposits and borrowings by foreign banks, controlled foreign exchange exposure of domestic banks and large firms, and prohibited foreign sale if domestic money market securities with less than a year maturity. Just to get ahead of ourselves a bit, part of the package is to establish, in 1998, a fixed domestic currency rate.

But there are no such controls now, and it would require complex legislation that may be difficult to pass. A more expedient, ambulatory response is to fix the currency peg.

Second, there are actually two ways of maintaining a fixed currency peg. One is through the strategy of “monetary sterilization” in which the central bank attempts to counteract the effects of a changing monetary base through via open market operations in the forex market. This is what Central Bank did in 1990s to control the exchange rate in a recently liberalized Philippines. As we know, it led to Central Bank’s collapse and the birth of BSP and a new central bank chapter.

The other, and less popular is simply through illegalizing the exchange of currency at any other rate. This is what China did, and it did so very effectively. This may create a black market for foreign exchange, but just as counterfeiting can be prevented, this can be prevented too. And because the peg is higher than the prevailing market rates, OFWs will have no incentive to engage in the black market. Only those who will have the incentive to do so would be the traders, who profit from it, and the banks, which will not act on the impetus.

My proposal would be a combination of both. Illegalizing currency exchange at any other rate, and some limited open market intervention to further neutralize any black market intervention. As we will see later, this will resolve the problem of inflation and even the high prices of imports.

Continued on the next post.

James Miraflor said...

Just to summarize, the proposal would be a fixed currency peg (through illegalizing trade at any other rate and limited open market intervention) coupled with efforts to build capital control. But I’ll add one more clarification, that my proposal does not cover other major currencies such as Yen, Euro, Yuan, or even Won. This will be put at use later.

How does my proposal address the problem of inflation?

Theoretically, there would be no inflation as far as domestically produced products are concerned. Why? Because in the first place, we are not going to print more pesos than what BSP is currently printing. The government is simply mandating that people can no longer trade pesos to dollar (note that) at any other rate.

The problem comes with imports. Looking at the trade data (, bulk of our imports are actually food (7.57%) especially rice (1.99%), industrial chemicals (10.2%), telecommunications equipment (15.73%). This will likely have higher prices. But as you know, even during the time when peso to dollar is 50 or near 50, these products still enjoy markets. For the rice, we have NFA to subsidize prices so import prices will not impact consumers as much.

If these sectors will be hit by inflation, then I see this more as an opportunity than a curse. Getting from Michael Todaro’s (a development economist) notion of changing factor prices so as to favor a certain economic structure, this is actually form of changing factor prices to favor domestic production to importation – a more sustainable solution to begin with even from an innovation perspective. This goes with agriculture and hi-tech industries. For mobile phone production, Cherry Mobile and My|Phone are having a good start. The next step would be to shift from OEM to OBM as fast as they can through internally substituting imports from China. For oil imports, I have a more substantive post here:

And it’s not as if we are compromising all our trading partners. We are just targeting one, the United States. Exchange rate with Japan, South Korea and China will still be floated, and this is also a good incentive for the government and Filipino firms to shift away from the debt-ridden US market.

But would there really be inflation to begin with? That has to be empirically established by having a pilot test of my proposal. But I seriously doubt there would be inflation. Prices and wages are sticky (in the Keynesian outlook) due to legislated rules and monopsonic characteristics of the commodity market. If there are inflationary pressures, this would likely be absorbed by the sellers and not the buyers, preventing its occurrence in the first place. And even if we assume there will be price movements, then production can actually reconfigure itself to respond through import substitution (yes, this is unavoidable) because of pressure from the changing factor prices.

In the long run, as soon as we already built a strong domestic industry and market, a fixed currency exchange rate will eventually be obsolete. In fact, it may even impede technological transfer and ingress/egress of essential goods. But that is in the long run. Right now, benefits outweigh costs.

It is time to establish a fixed currency peg.

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