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Running Amok

"Amok" is one of the few Indonesian words used in English. Its etymology dates back to 1665, when the meaning in the Malay language was "a murderous or violently uncontrollable frenzy that occurs chiefly among Malays." Indonesia, in the desperate midst of an economic crisis and approaching a controversial political election, is once again defining the term.

Indonesia's currency crisis, the spiraling inflation, and the accompanying steep rise in the prices of basic commodities, have led to a series of riots by ethnic Malays against ethnic Chinese shop owners, whom the crowds accuse of price gouging. Chinese make up about four percent of Indonesia's population, yet control about 70 percent of the economy. Many Chinese are taking whatever measures they can: sending their savings abroad, making emergency escape plans, and painting "Islam" and "Muslim" on their doors to keep rioters at bay.

The riots have claimed five lives and hundreds of serious injuries, and caused millions of dollars of property damage. Ten churches have been burned. Three hundred have been arrested. It is the worst violence Indonesia has experienced in 30 years. Obviously, a bunch of folks are running amok.

But the rioters are not alone. On Feb. 16, Indonesian police warned they would shoot rioters on sight. "Why not? That is right, shoot on sight," said Try Sutrisno, current Vice President and official police spokesman, to reporters in East Java. So the military did, killing two men dead, and shooting three others. Central Java military chief Major General Mardiyanto defended the shootings, by saying "if the rioters try to hurt my men, I will not tolerate it."

The Suharto government is using a classic policy tool to handle the crisis: denial. Sutrisno, whose term as VP is going to expire in March, denied that crime and rioting would increase with the growing unemployment rate, saying that police had not found any link between crime and unemployment. General Wiranto, the former army chief-of-staff, said "National stability is going ahead well. There have only been a few places where stability and the restoration of the economy have been disturbed. That's natural. Every nation has its problems." While it may be "natural" for some nations to enjoy daily riots, there is certainly cause for alarm when the fourth largest nation in the world is running amok.

Suharto, whose nation is struggling under the weight of strict new guidelines imposed by the IMF in return for $50 million of emergency loans, is currently entertaining some ideas to increase the economic stability of the nation. But in searching for a quick fix, he is seizing upon the wrong solution. He met on Friday the 13th with Steven Hanke, an economist from Johns Hopkins University who has been a leading advocate of currency boards. The New York Times quoted Hanke as saying after the meeting that the Indonesian leader was committed to going ahead with the plan and would continue to discuss it with the IMF.

A currency board, which has been relatively effective in Hong Kong and Argentina, would peg the Indonesian rupiah to the dollar at a fixed exchange rate. In order to make the currency board regime credible, the government must hold reserves of foreign currency equal (at the fixed rate) to at least 100 percent of the total domestic currency level. As the Economist explained in a Nov. 1, 1997, article, "Unlike a conventional central bank, which can print money at will, a currency board issues domestic notes and coins only when there are foreign-exchange reserves to back it."

Some supporters of currency boards point to the experience of Hong Kong, whose exchange rate is pegged at HK$7.80 to the U.S. dollar. Although some analysts believe that last year's crash of the Hang Seng index in Hong Kong was the spark of the Asian crisis in the first place, Hong Kong has actually escaped the brunt of the financial crisis unharmed. The IMF said that Hong Kong's commitment to its linked exchange rate system had "provided an important anchor for economic stability."

But Hong Kong is very different from Indonesia. First of all, the currency board was introduced in 1983, during a time of relative prosperity and confidence. Radical changes to Indonesia's system now could shake jittery investors even more, as was underlined by the 11 percent drop in the stock market on the day of Hanke's visit.

Second, Hong Kong's foreign reserves stand at $85 billion, more than four times the amount they need to keep the system credible. And the Hong Kong dollar is backed in turn by China's reserves, which push the figure up to nine times the amount. Such giant foreign reserves guarantee confidence in the stability of the system, and thus entice investors looking for a stable environment. Indonesia, by comparison, has less than $19 billion in foreign reserves. Martin Feldstein, Professor of Economics at Harvard University and President of the National Bureau of Economic Research, said in the March/April 1998 issue of Foreign Affairs, "A clear lesson of 1997 was that countries with large reserves could not be successfully attacked by financial markets." Hong Kong has these reserves; Indonesia does not.

Third, Hong Kong's financial markets are well regulated. They are open and transparent, and governed by predictable rule of law. This, as the Economist points out, puts Hong Kong in a good position to deal with the higher interest rates that may be necessary to defend the currency board. Indonesia shares none of the above advantages.

One further disadvantage to an Indonesian currency board is that if inflation in Indonesia remains higher than in the pegged currency (and given America's current low inflation and Indonesia's sky-high rates, this is a certain), then the rupiah will be overvalued at the official exchange rate. This might create a two-tier currency market in which the average Indonesian suffers, as he receives money that the government tells him is worth a month of groceries, yet he can only buy a week's worth of food with it. Hanke's proposed rate is reportedly around 5,500 to the dollar, which is almost twice as strong as its current real rate, which would bring these problems to bear almost instantly. Other (more technical) problems also loom on the horizon.

Under a currency board, the government theoretically gives up control of monetary policy to the country whose peg is used. While taking control of economic policy out of the hands of Indonesia may sound like a good idea in theory, the IMF will have nothing to do with the idea. Michel Camdessus, the IMF's managing director, threatened Suharto with a cutoff of the bailout funds if Suharto proceeds with the currency board. Camdessus cited the above problems, especially the low foreign reserves, and said of the currency board, "we are of the strong view that this moment has not yet come in Indonesia." Other regional economists agree. "The real issue in Indonesia is how do we really progress, move forward on these issues, and I don't think they can be solved just by a different exchange rate mechanism," said Eugene Chung, chief Asian investment strategist at SBC Warburg.

Why is Suharto suddenly so keen on the currency board? The IMF regime would impose strict conditions on Indonesia that would deconstruct a great deal of the business enterprises built up by Suharto's clan. Suharto, faced with choosing between his family and his country, may be drifting to the former. If a respectable economist will tell him that he need not submit to the IMF's draconian policies and he can still save the economy, he is likely to listen to most any theory, no matter how illogical.

The New York Times reports that two of Suharto's children were responsible for helping Hanke win access to Suharto, and they are encouraging the idea. Marshall Mays, chief strategist at Nikko Securities, said "It's hugely popular with the crowd in charge right now because they have a hope they can hold onto their goodies, where if they have to give up monopolies, do the right thing and restructure the system, they would suffer."

Suharto must do the right thing. He must go along with the IMF's restructuring plan, and forego the idea of a currency board for the time being. There may be a good time for it at some point in the future, but not now. Suharto, however, is not known for taking advice he doesn't like. Upon learning of the riots, some apparently fomented by local political opponents, Suharto ordered the military to take "stern action" to deal with his opponents and rioters.

Additionally, the markets have been rebelling against strong hints from Jakarta that Suharto will nominate Bacharuddin Jusuf Habibe as his next Vice President. Because of Suharto's age, his VP (in the past, largely an honorary post) is important this time. But Habibe, known for his profligate spending on quixotic projects like nuclear power plants and a domestically produced commercial airliner, is deeply unpopular among managers who want a more conservative and thrifty government. Although Habibe, basically a competent technocrat who perhaps doesn't get the credit he deserves, might be the best choice to run the nation after Suharto, the stock markets want nothing to do with him.

Rioters run amok, destroying businesses. The police run amok, shooting the rioters. The government runs amok, pushing an ill-advised economic panacea doomed to failure. And the markets run amok, jumping up and down at the slightest hints from Jakarta.

The Indonesians need to stop running amok, and start running a country.

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