Defending the dollar

Some University of Asia and Pacific economists want to boost the value of the US dollar:

UA & P Economist says the government must stop boosting peso

THE Arroyo government should take steps to prevent a bigger trade deficit this year by weakening the local currency through more dollar reserves, according to the economists of the University of Asia and the Pacific (UA&P). "The trade deficit will be much larger this year because of the (strong) peso," said Dr. Victor Abola, strategic economics program director of the University of Asia and the Pacific (UA&P), at Wednesday's press briefing. He described the impact of the Bangko Sentral's move in allowing the peso to gather more strength as a "double whammy." He added: "What the BSP (Bangko Sentral ng Pilipinas) is doing is making the OFWs finance the trade gap and at the same time, make industries uncompetitive," Abola said. "Oil prices are going down. You can't allow the peso to strengthen more." To allow the country to withstand the negative effects of the erratic flow of portfolio investments, Abola said the government should intervene by buying dollars to mop up the excess in the financial market.Dr. Emilio Antonio, Abola's UA&P colleague, said that to erase a substantial portion of the deficit this year, the peso should be allowed to go down to as low as P75 to a dollar. However, if the foreign exchange is maintained on the average at P55 to a dollar, the imbalance is likely to reach $8.5 billion. Abola also dismissed fears of perceived government intervention on the foreign exchange, saying, "There is no such thing as a freely floating exchange rate." ... Both urged the government to increase its GIR equivalent to six to 12 months instead of following the conventional standard of three months, which has become obsolete because of the speed of financial transactions.

Well first of all the title is wrong - the government is not "boosting the peso." It is simply doing nothing - allowing the value of the dollar to slide, in peso terms. (Oh for a more perceptive economics journalism in this country!)

I am entirely sympathetic to Vic Abola's argument. It provides a sobering counterweight to syncophant "analysis" on the government side claiming that a strengthening peso is entirely good news. There is some appeal to targeting a weaker peso.

However in principle I skeptical about any kind of policy towards targeting exchange rates. And the fact that India and China are doing it, does not mean it is the right policy. It is indeed possible to minimize intervention in foreign exchange markets. Just because a landlord must monitor the care of his property, does not entitle him to snoop and sneak at whim into the tenant's residence and forbid all manner of use.

There is some legitimacy to the argument of stockpiling a surplus in order to battle speculation. The problem though is whether anyone really knows what "speculation" is. No, "big" trade deficits are not necessarily a sign of speculation. A trade deficit simply means that foreigners are willing to sell more goods to the Philippines (in peso terms) than they are willing to buy from the Philippines. This is an intertemporal (comparison of time periods) decision. Their excess pesos are kept in some form - perhaps in cash, or peso-denominated assets. Think of it as a household with a credit card. The household sells labor services to the outside world. It purchases goods from the outside world. By means of the credit card, the household can buy more goods than it sells in any given month. The outside world is willing to hold onto the excess in return for an interest charge. Maintaining a zero deficit is something like cleaning up your monthly bill everytime - it sounds responsible, but there is a hidden cost somewhere, say the household may be holding off purchasing a new car or constructing a house.

It may well be that big trade deficits now are needed, say to purchase durable equipment. In that case a strong peso would be quite helpful indeed.

My advice to the BSP would be: stick to the basics, which is a low and stable inflation rate. Anything besides that is a distraction at best and a fount of instability at worst.