Indonesia crisis lesson for Russia
by Steve Hanke
The Russian rouble ended 2014 in bad shape, and the problems are continuing. For most of last year, Russia faced the ratcheting up of economic sanctions. The latest stand-off over Ukraine, with the US and Russia appearing to move closer to a proxy battle backing protagonists in the disputed region of east Ukraine, sets the stage for further economic attrition.
Already in 2014, we saw a number of factors that combined to push the rouble into a free fall. The collapse of oil prices, the announcement on 10 November that the rouble would float, as well as confrontation in Ukraine created the conditions for the rouble to fall like a stone.
The rouble’s purchasing power was severely depleted while its volatility increased dramatically. It is not a pretty picture, but one that can be brought into focus by reflecting on the Indonesian financial crisis of 1997-98. The story of the Indonesian crisis, in which I played a role as President Suharto’s unpaid special counsellor, serves some useful lessons.
Much of this experience is relevant to Russia today. If Russia wants to avoid further rouble turmoil, further impoverishment of its citizens, and potential political upheavals, it should tether the rouble tightly to the dollar. That’s what I counselled Suharto to do in 1997, through the creation of an orthodox currency board in which the rupiah would be fully convertible into the dollar at a fixed exchange rate. This currency board system corresponds to the stance taken by the big oil producers in the Gulf. Despite the evident differences in geopolitics, Russia would be advised to consider a similar line.
There are clear parallels between Indonesia in 1997-98 and Russia in 2014-15. On 14 August 1997, shortly after the Thai baht collapsed on 2 July, Indonesia floated the rupiah. This prompted Stanley Fischer, deputy managing director of the International Monetary Fund, to proclaim that ‘the management of the IMF welcomes the timely decision of the Indonesian authorities. The floating of the rupiah, in combination with Indonesia’s strong fundamentals, supported by prudent fiscal and monetary policies, will allow its economy to continue its impressive economic performance of the last several years.
Contrary to the IMF’s expectations, the rupiah did not float on a sea of tranquility. It plunged from 2,700 rupiahs to the dollar to nearly 16,000 in 1998. By late January 1998, Suharto realised that the IMF medicine was not working and sought a second opinion, which I was invited to give, in the form of the currency board proposal. On the day that news hit the street, the rupiah soared by 28% against the dollar. These developments seemed to infuriate the US government and the IMF.
Ruthless attacks on the currency board idea and on myself ensued. Suharto was told in no uncertain terms – by both US president Bill Clinton and the managing director of the IMF, Michel Camdessus – that he would have to drop the currency board plan or forego $43bn in foreign assistance. He was aware that his days as president would be numbered if the rupiah was not stabilised. (Unfortunately for Suharto, he was forced to abandon the currency board idea, and, indeed, his days were numbered.)
Economists on bandwagon
Economists jumped on the bandwagon too. Every half-truth and non-truth imaginable was trotted out against the currency board idea. Those oft-repeated canards were outweighed by the support for an Indonesian currency board by four Nobel laureates: Gary Becker, Milton Friedman, Merton Miller and Robert Mundell.
Merton Miller understood the great game immediately. In his words, the Clinton administration’s objection to the currency board was ‘not that it wouldn’t work but that it would, and if it worked, they would be stuck with Suharto’. Much the same argument was articulated by Australia’s prime minister Paul Keating: ‘The US Treasury quite deliberately used the economic collapse as a means of bringing about the ouster of President Suharto’. Even Michel Camdessus could not find fault with these views. Upon his retirement, he proclaimed: ‘We created the conditions that obliged President Suharto to leave his job.
To depose Suharto, the IMF had to forge a public position of open hostility to currency boards. This deception was required to convince Suharto that he was acting heretically and that, if he continued, it would be costly. The IMF’s hostility required a quick about-turn. Less than a year before the Indonesian uproar, Bulgaria (where I was President Stoyanov’s advisor) had installed a currency board with the endorsement of the IMF, and Bosnia and Herzegovina (where I advised the government on currency board implementation) had followed suit under the mandate of the Dayton Peace Agreement, and with IMF support, in August 1997.
One element of IMF manipulation regarding the Indonesian episode involved the widelycirculated story asserting that I had proposed to set the rupiah’s exchange rate at an overvalued level so that Suharto and his cronies could loot the central bank’s reserves.
This take-the-money-and-run scenario was the lynchpin of the Clinton administration’s campaign against Suharto. It was intended to rally international political support against the currency board idea and in favour of ousting Suharto.
The overvaluation story was enshrined in the Wall Street Journal in February 1998, a piece of misinformation that was repeated in magazines and newspapers as well as in so-called scholarly books and journals. This convoluted story is worth telling because it shows that Russia, if it is wise, can handle its own travails in more effective ways than Indonesia nearly two decades ago.
Steve Hanke is professor of Applied Economics at Johns Hopkins University Back