MEMORANDUM
Date:
To:
From:
Re: |
6/17/98
Dr. David Chappell
Amanda M. McDaniel
Debate on Currency Boards |
Definition:
A currency board is a means of insuring that the home currency remains
linked to an "anchor" currency at a fixed rate. This "anchor" currency
is the reserve for the region. The amount of reserve currency the
board controls is equivalent to the amount in circulation in the country.
The currency board automatically adjusts relative to market change.
Argument For Currency Boards:
With the recent stabilization of the Hong Kong dollar as well as the
success in Argentina, some feel that currency boards are proving their
strength and effectiveness.
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Currency boards have no monetary policy. Due to the fixed
exchange rate, there can be no discrepancy between it and the nation's
monetary policies.
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Currency boards prevent a balance-of-payments crisis.
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Currency boards automatically adjust. This causes the prospect
of currency crises to be less.
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Currency boards restore faith in the country's domestic currency.
Regions are pegged to other countries with strong and stable currencies,
thus making the consumers at home feel more confident in their purchasing
power.
Argument Against Currency Boards:
Some people feel that currency boards are both unnecessary and ineffective.
They argue that countries should focus on stable economies through smart
monetary and fiscal policies.
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Currency boards do not prevent speculative attacks on currency.
Since currencies are pegged to a fixed reserve, interest rates rise if
an attack occurs to maintain that link. Meanwhile, bankruptcy occurs
leading to recessions.
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Currency boards lead to instability in banking. High
interest rates can cause bankruptcy and force loans to be recalled, leading
to the destruction of firms and industries.
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Currency boards are closely related to fixed exchange rates.
Fixed exchange rates were causes in the Mexican peso crisis and the current
Asian crisis. Like currency boards, they represent a lack of flexibility
in an ever changing market.
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Currency boards do not prevent real appreciations and they do not insure
competitiveness. In Asia, for example, the peg to the United
States dollar caused large capital inflows and the expectation of low exchange
rate risk.
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Currency boards can collapse, they are not as sturdy as believed.
If the currency is attacked, people will flock to the foreign reserve and
abandon their domestic assets, causing it to deplete.
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Currency boards prevent the use of monetary policies which regulate
the government's budgetary deficits.
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Currency boards cannot participate in open markets which regulate the
region's money supply.
Insights:
There is no doubt that the argument against currency boards is strong,
however, there is something to be said for the recent survival of Hong
Kong and Argentina. Hong Kong is one of the few nations in Asia to
survive the crisis because it had a true fixed exchange rate.
It let the market determine the board's actions and even in times with
the stock market was falling as much as 27%, they stuck by it.
Although not a perfect solution, I think that currency boards are necessary
for nations that need a stronger currency to rely on. It allows them
to develop confidence in their own currency which leads to growth and expansion.
This in turn helps other regions, including the United States because it
gives us a healthy trading partner that can afford to be competitive.
Citations:
Hanke, Steve H. "Auto Pilot for Hong Kong." Wall Street
Journal 29 October 97. http://www.hanke
Judy, Richard W. "Currency Boards: An Idea Whose Time Has Come?"
http://www.judy
Melloan, George. "Look at Whose Money Survived the Crisis Weeks."
Wall Street Journal 4 November 97. http://www.melloan
Roubini, Nouriel. "The Case Against Currency Boards: Debunking
10 Myths about the Benefits of Currency Boards." http://www.roubini
"What a Currency Board Is." http://www.currency