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After European now Asian Monetary Union?

When US Federal Reserve chairman Alan Greenspan speaks, markets worldwide listen - though, perhaps, they've gotten a bit weary of the chairman's pronouncements recently. But when it comes to longer-term economic policy issues, we have long preferred to listen to Robert A Mundell, the 1999 Nobel laureate in economics and archetypal anti-Keynesian. So, we listened - closely - when Mundell spoke at Bangkok's Chulalongkorn University the other day at a conference on monetary and currency systems. What he said seemed at best premature, and in part went entirely against the grain of editorial opinion expressed in these pages over the past few years - in other words, it was precisely what one needs to hear every once in a while to jog one's mind and not get smug and complacent in one's views.

The "Asean plus three" (the 10 members of the Association of Southeast Asian Nations plus China, Japan, and Korea) "should look to the European Union as a model for closer integration of monetary policy, trade and eventually, currency integration," said Mundell. That (trade integration excepted), as our frequent readers will know, is a proposal we have not favored. It follows in the groove of former Japanese international finance chief Eisuke Sakakibara's 1997 Asian Monetary Fund proposal and has from the get-go seemed to us the equivalent of a mutual bail-out society to avoid structural financial and economic reform. But it got more disconcerting: Mundell came to the defense of Malaysian Prime Minister Mahathir's capital controls imposed in September 1998, noting that Malaysia, which at the time had fixed the ringgit to the US dollar, had "come out best from the [Asian] crisis", while other countries, such as Indonesia, had seen their economies ravaged by exchange rate volatility under floating systems introduced at the urging of the International Monetary Fund. "The IMF [has] sponsored monetary disintegration by insisting on flexible exchange rates," Mundell charged.

Happily, among Mundell's claims there's at least one that's readily tested against reality, that Malaysia has "come out best from the [Asian] crisis" - and that one's just plain wrong. Korea grew nearly twice as fast as Malaysia in 1999 and continued to grow faster in 2000, and at present, growth in both countries is slowing rapidly and at about the same rate due to collapse in external demand for semiconductor products. Moreover, few would argue that Indonesia's economy was ravaged by exchange rate volatility; rather, rupiah volatility was a consequence of political instability.

But let's back-track for a moment and explain why we hold Mundell in the highest regard.

Thirty years ago when the Bretton Woods gold-based fixed exchange rate system collapsed, he was the first economist to predict the dire consequences that ensued: high inflation and unemployment as clueless central bankers, deprived of a policy yardstick, gave in to political demands for deficit spending and rapid monetary expansion. With the US and world economies in a wretched state by 1980 and Keynesian economists at sea on how to solve the problem of stagflation, Mundell turned the Keynesian demand model upside down and argued that only hard money and low taxes would restore sound growth. To its credit, the incoming US Reagan administration took the advice. Inflation quickly fell and supply-side tax cuts led to new capital formation, new jobs, and the resumption of economic growth. US governments have by and large followed Mundellian economics ever since and fared well with it. Others - in Europe and Asia - haven't, to their peoples' and economies' detriment.

Also in the early 1970s, as he forecast the developments of the dismal decade, Mundell (in his seminal work "Monetary Theory") authored the idea of optimal currency areas, proposed common currencies for Europe, the Americas and Asia, and argued for rapid integration of global markets for the free flow of capital, goods and services. European monetary union, of course, now exists and the Americas are being dollarized. His Bangkok proposal that "it's the right time to start thinking" about greater monetary policy integration in East Asia with the end of a single currency in view thus hardly comes out of nowhere.

The precondition, naturally, is freer trade within East Asia, reduction of investment barriers and movement toward common fiscal policy targets. Will this fly? Is it desirable even? It is, we should think, but only to the extent that monetary devices such as swap agreements and regional monetary funds are not devised merely as protective cover for unreformed national economies. European Monetary Union provides a cautionary tale: to date, all the expected efficiencies notwithstanding, the euro has been a disappointment - precisely because the regulatory and fiscal reforms Mundell regards as critical to sound and sustainable economic growth have not been implemented in the euro-zone.

So, yes, it IS time to start thinking about Asian monetary union, but it is even higher time for the implementation of Mundellian reform policies which must precede and are the only guarantee for beneficial effects of greater monetary integration. We commend Mundell for forcefully having put an Asian Monetary Union on the agenda - and if he took a closer look at Malaysia, he might even agree with our more negative assessment of developments there and forego holding it up as a shining example.

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