Wall Street Journal February 23, 1998U.S. Professor Jousts With IMF Over Fixing Indonesia's Economy
By BOB DAVIS and JAY SOLOMON
Staff Reporters of THE WALL STREET JOURNAL
JAKARTA, Indonesia -- Steve H. Hanke, economic missionary, may be losing his grip on his most prominent convert ever, President Suharto. If so, that comes only after extraordinary pressure from leaders of the world's richest countries.
A couple of months ago, Mr. Hanke was an obscure Johns Hopkins University professor who flooded indifferent reporters with notes and news releases on his work. Then, suddenly, he became a top economic adviser and sometime spokesman for President Suharto, who is intrigued by Mr. Hanke's ideas for monetary reform. As the world's fourth-most-populous country struggles with a battered currency, a wrecked economy and civil unrest, the U.S. economist is squired around Jakarta by an entourage of the nation's elite. A former cabinet minister calls him Mr. Suharto's dukun -- a Javanese medicine man.
For several weeks, Mr. Hanke bested the elite economists of the International Monetary Fund and the U.S. Treasury, who consider him a crank and fervently oppose his prescriptions for Indonesia. They were caught by surprise when he turned up at Mr. Suharto's side. When Mr. Hanke got a Feb. 2 audience with the president, a top Treasury official found out only when a reporter mentioned it two days later.
Then, the global economic establishment launched a massive counterstrike. IMF Managing Director Michel Camdessus threatened to suspend the $43 billion IMF-led bailout if Indonesia pursued Mr. Hanke's plan. President Clinton telephoned Mr. Suharto on Friday, for the second time in a week, to lobby against Mr. Hanke's advice. Leaders of Germany and Japan weighed in, as did finance ministers from leading industrial nations at a weekend meeting in London.
The campaign now is showing signs of success. A top Indonesian monetary official said over the weekend that the government has suspended plans to implement Mr. Hanke's ideas. Treasury Secretary Robert Rubin said that would be "a constructive step" and announced that he is dispatching an envoy to Jakarta to clarify the situation.
Even so, Mr. Suharto hasn't pushed aside the American economist, who on Friday night was on a television station controlled by one of the president's sons to promote his plan. Some analysts in Jakarta believe that Mr. Suharto will never formally renounce Mr. Hanke for fear of losing face. They suggest that the American will simply disappear from Jakarta as suddenly as he appeared. His hotel says he is booked to stay in town at least through the end of the week.
So who is Steve Hanke? A self-described "farm boy from Iowa," he earned his doctorate at the University of Colorado, taught for a time at the University of California at Berkeley and worked as a natural-resources economist for the White House Council of Economic Advisers early in the Reagan administration. "He was only there one year," says former council member William Niskanen. "He was not asked to stay." For the past several years, the 55-year-old professor has written a column for Forbes magazine.
In the early 1990s, Mr. Hanke became intrigued by "currency boards," under which a country fixes its currency to a strong foreign currency, eliminating its central bank's ability to change the money supply or adjust interest rates. Such boards have worked well elsewhere to restore market confidence and combat inflation. Nobel Prize-winning economist Merton Miller praises Mr. Hanke as "the leading expert" on currency boards.
He is also their single most dogged advocate and says he played a role in establishing currency boards in Argentina, Bulgaria, Estonia and Lithuania. Some question the degree of Mr. Hanke's contribution, though. "He was invited by [Finance Minister Domingo] Cavallo to advertise the success of the Argentinian currency board," says economist Guillermo Calvo, a Latin American specialist and former IMF staffer. "I don't mean he wouldn't have been a good adviser. But he was only called in at the end, and he didn't play any instrumental role in setting up the planning in Argentina."
Another Hat
Mr. Hanke isn't just an academic. He is also vice chairman of a U.S. subsidiary of Friedberg Mercantile Group, a Toronto money manager and currency trader. Friedberg says it made major profits trading Asian currencies in the 1997 fourth quarter, some of which came from selling Indonesia's rupiah short -- that is, betting it would decline. "The Asian crisis theme remains, in our opinion, a profitable source of trading opportunities," the company said in its fourth-quarter report.
Albert Friedberg, its director and general partner, says Mr. Hanke doesn't pick investments but operates as a kind of salesman for the firm. "He'll go to Argentina and see Cavallo, and when he's there, he'll help try to get clients for us," Mr. Friedberg says. "The pension funds listen to him more because he's an adviser to Cavallo." Friedberg's Internet site (http://www.friedberg.com/) promoting its Argentina mutual fund pictures Mr. Hanke and identifies him as president of the company that manages the fund and an "active consultant" to Argentine President Carlos Saul Menem.
When Mr. Hanke's clients place an order with Friedberg Mercantile, Mr. Friedberg says, Mr. Hanke gets a commission. Most years, those payments total "somewhat less than six figures."
Mr. Friedberg says Mr. Hanke has called him once so far from Jakarta to discuss "technical issues" and complained that his phone might be bugged. Mr. Hanke hasn't arranged any business in Indonesia. But his boss remains hopeful. "We have zero position in the rupiah now," Mr. Friedberg says. "I'm waiting for this thing [the currency board] to happen. Then every hedge fund in America will want to buy the rupiah. Do I expect him to call me when he leaves Suharto's office and say, "It will be signed in three hours'? It would be nice, but I don't think so. He's never been in a position to do so before."
Mr. Hanke didn't submit to an interview or answer questions faxed to him in Jakarta for this article. His wife, who accompanied him to Indonesia, said he didn't want to answer The Wall Street Journal's questions. In an earlier interview with the Journal, Mr. Hanke said he refuses payment for his government advisory work. "It would not look good as an adviser if I'm also getting paid," he said.
A onetime collaborator and fellow currency-board advocate, Kurt Schuler, a Virginia economic consultant, says Mr. Hanke discloses his business interests to clients. "He doesn't use the multiple roles in a way that would generate a conflict of interest," Mr. Schuler says.
What Boards Do
A country that adopts a currency board puts its monetary policy on autopilot. It is as if Alan Greenspan were replaced by a personal computer -- and not a fancy one. When dollars flow in, the board issues more domestic currency and interest rates fall; when dollars flow out, interest rates rise. The government sits back and watches, even if interest rates skyrocket and a recession ensues.
When they work, currency boards have several advantages: They arrest any tendencies in an economy toward inflation or budget deficits. They prevent misguided politicians from adopting foolish macroeconomic policies. They assure citizens and foreign investors that the domestic currency can always be exchanged for dollars (or some other strong currency). And, by creating confidence, they promote trade, investment and economic growth.
But even some fans of currency boards -- first used by the British empire to make colonial administration more efficient -- question whether they are the right solution for Indonesia. It isn't coming out of an era of hyperinflation, as Argentina was when it successfully adopted a currency board. And unlike Hong Kong, another successful case, Indonesia doesn't have the robust banking system that such a board requires. A government that adopts a currency board also has to maintain huge foreign-currency reserves, and it has to be willing to bear whatever economic pain interest rates inflict. If the government buckles -- and currency traders are likely to test its will -- it may be left with a situation worse than before.
Mr. Hanke is "oversimplifying the requirements and downplaying the risks" of adopting a currency board, contends economist John Greenwood, who was awarded the Order of the British Empire for his work in creating Hong Kong's successful currency board.
In Indonesia, the case is complicated further by corruption and cronyism. A rupiah value fixed well above the early Monday morning 9,400 or so to the U.S. dollar -- about 5,500 to the dollar, Mr. Hanke is believed to favor -- would give the nation's wealthy elite, including Mr. Suharto's children and associates, a chance to trade their rupiah for dollars and deposit them overseas. If they did so, interest rates would climb and batter what is left of the economy.
No Problem
In talk after talk in Jakarta and Washington, Mr. Hanke has brushed aside the concerns. Money will flow into Indonesia, not out, he told a gathering of Indonesia's journalism union, thanks to new international confidence in the currency. Thus interest rates will move "down, not up." A currency board "is the least risky option for the Indonesian economy," he says.
As for corruption, a currency board "completely takes out the political element" from monetary policy, he explained in an earlier interview. "This is particularly why you'd want one in place."
Recently Mr. Hanke met with a group of Indonesia's top economic minds, led by Sumitro Djojohadikusumo, who, as a Suharto adviser, helped craft the long economic surge that preceded today's crisis. After listening to the group's criticisms of the currency-board idea for a short while, Mr. Hanke lost patience, says Mohammad Sadli, a former Suharto minister of mines and energy. "If you don't listen, I'll leave," Mr. Hanke said, according to Mr. Sadli. "He said that he had work to do and that [my criticisms] were simply nitpicking."
Former U.S. Ambassador to Indonesia Paul Wolfowitz says, "Hanke is basking in the moment of his glory, but the great fear is that his plan is just too radical to work." Mr. Wolfowitz heads the School of Advanced International Studies at Johns Hopkins; Mr. Hanke is a professor of applied economics at the university.
Explaining how Mr. Hanke's Indonesian role came about, his business colleague Mr. Friedberg says that early this month, Mr. Hanke told him simply, "The big man called." Off Mr. Hanke flew to Jakarta.
There, he is getting the royal treatment. A receptionist at the luxurious Shangri-La Hotel, where he is registered under the pseudonym Simon Holland, says his room is booked by PT Astra International, an Indonesian conglomerate whose chairman is Mohamad "Bob" Hasan -- Mr. Suharto's oldest golfing buddy. An Astra director, Rini Soewandi, accompanies Mr. Hanke on some of his rounds in Jakarta. Government officials say Mr. Hanke's first meeting with Mr. Suharto was organized by the president's eldest daughter, Siti Hardiyanti Rukmana.
At a time when Indonesia's economy was failing to respond to the bitter medicine the IMF had prescribed, such as budget discipline and the closing of failing banks, Mr. Hanke had a more optimistic message. Instead of focusing only on painful economic reforms that could take months to help, Mr. Hanke was saying he could get the country back on track in as little as three weeks.
Last week, he explained to 200 bankers at the Jakarta Financial Club how currency boards had been used successfully from early 20th-century Russia to Bulgaria today. He also mentioned that a solution to Indonesia's problem of $74 billion in private-sector debt had come to him over coffee. He offered no specifics but said the problem "can be taken care of in a week."
IMF officials, deeply skeptical of such advice, say they have been in three meetings with Mr. Hanke and concluded it isn't possible to budge him. In one meeting, Mr. Hanke sparred with IMF special envoy Prabhakar Narvekar, each trying to get the other to commit on paper to a plan. Neither did, say participants, because each feared the other would trash it during private meetings with the president.
Mr. Narvekar has had two meetings with Mr. Suharto. In the first, Mr. Suharto seemed taken with the Hanke plan, but during the second meeting, last Tuesday, the president indicated he was open to alternatives. By Mr. Clinton's call on Friday, Mr. Suharto had bowed further to pressure and said that the Hanke plan was only one of several he was considering. The IMF appears to have succeeded in its immediate goal: Get Mr. Suharto to put off a currency board for at least several months -- an eternity in the fast-moving Asian crisis -- while Indonesia cleans up the banking mess that the IMF believes is a major cause of the nation's problem.
Nevertheless, IMF officials complain that the Hanke controversy has distracted them and their Indonesian counterparts from moving ahead. One thing the IMF is currently trying to do is get Indonesia to make its food subsidies for the poor a clear part of its budget, rather than hide them through currency gimmicks that the financially savvy could exploit for profits. This week, the Fund also wants to tackle Indonesia's debt-repayment problems.
Officials in Jakarta already are pointing to progress made in recent days on some issues. On Friday, Japan announced that it would provide a $1 billion credit line for trade insurance for Japanese companies trading with Indonesian concerns. Tokyo also announced plans to help Indonesia deal with shortages of food and medicine, and Messrs. Clinton and Suharto discussed similar plans in their Friday telephone call. A nagging row preventing bankers and debtors from beginning to tackle private-sector debt may also be over, with all parties agreeing on David Brougham, a Hong Kong-based executive director of Britain's Standard Chartered PLC, to serve as chairman of the bankers' steering committee.
Even the dogged Mr. Hanke admits to some doubts about whether his ideas will be adopted in Indonesia. He told reporters on Thursday that "speed is of the essence" in creating a currency board. Asked if Mr. Suharto was going to heed this advice, the American economic missionary responded: "You'll have to ask the president. I'm just his adviser."
-- David Wessel in Washington contributed to this article.Copyright © 1998 Dow Jones & Company, Inc. All Rights Reserved.
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