The Yanks And The Peg

Hantu Laut

Former Prime Minister Mahathir Mohammad dropped a hint that due to uncertainty in the world markets and rising costs of doing business in the domestic market the government should bring back the ringgit peg or otherwise known as fixed exchange rate.

The government should take heed and seriously consider this proposal in light of the high inflation and economic instability due to volatility in the world markets.

With the huge financial crisis in the US financial system requiring massive bailout, Malaysia's economy may not be spared the contagion of a US recession.

The financial crisis at Lehman Brothers,AIG and others financial malaise in the U.S can throw the US economy into serious trouble and hit the shores of other countries in matter of months.

The US government is now 80% equity holder of AIG through the bailout of US$85 billion to keep the company afloat.This is the first time in its history the US government had taken majority equity and management control of a private sector corporation.

In an even bigger mess is the sub-prime mortgage sector that put Freddie Mac and Fannie Mae into serious financial trouble.These two companies do business of factoring mortgages from banks and other financial institutions and currently hold guarantee of US$5.4 trillion of mortgages.In the past, US Government bailouts were only in the form of loan guarantee without any equity participation or involvement in management.

The US have copied our ISA to detain and imprison so-called terrorists without trail. Now they are copying Malaysian-styled bailouts.

In 1980 the US Congress approved a loan guarantee of US$1.5 billion to save Chrysler from bankruptcy which amount was considered big at that time.Chrysler paid back the loan few years ahead of time and the government actually made US$313 million profit in stock options.

Why peg? Pegging can take out certain uncertainties in the economy and bring some degree of stability.It can give a stable atmosphere to foreign investors.With a peg investors can know what their investment value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.

A pegged currency can also have its bad side.It can be difficult to maintain a peg in the long run.This fixed regime can often lead to severe financial crisis.If the government in its effort to maintain high value of the currency can no longer meet demands to convert the local currency into foreign currency at the pegged rate than the currency can become overvalued.There will be loss of confidence and investors may panic and there can be flight of capitals when investors converted the local currency into foreign currency before the currency is devalued against the peg.Such scenario can deplete the country's foreign reserve.

Such flight of capital can also happen in a floating regime which opposition leader Anwar Ibrahim claimed is happening to Malaysia due to mismanagement of the economy.It can be a bit of both, the unstable economy and political instability.

Pegging is often associated with countries that have unsophisticated capital markets and weak regulating institution.

In the 1997 Asian financial crisis Malaysia took an unprecedented and bold step to peg the ringgit while Thailand, in similar crisis, allowed the bhat to float.By the end of 1997 the bhat had lost 50% of its value.

In the 1997 crisis Mahathir much to the chagrin of former Finance Minister Anwar Ibrahim who wanted to adopt IMF sponsored bailout and financial reforms took an unconventional and bold step. He pegged the ringgit to put a stop to speculative currency trading and stabilise the currency.The properly managed peg helped Malaysia to recover faster than expected.

It goes to show that not only Mahathir was a better politician and need not shout his head off to be heard, he has shown that he was also a better finance minister and better economist than Anwar Ibrahim, who had been more than willing to accept the spoon-fed proposal from IMF.

The government of PM Abdullah Badawi should not completely ignore the advice of the former prime minister.The nation needs speedy reforms to create confidence in the economy.