Why a Currency Board?
Dr Goh Keng Swee
Extract from: Prudence at the Helm: Board of Commissioners of Currency Singapore 1967–1992
12 June 1992
Singapore finds herself in the unique position of being the only independent state to issue its currency under the Currency Board System (CBS). The CBS is, in every sense of the word, a colonial relic. When the sun never sets on the British Empire, the currencies of British colonies were issued under the CBS. This provided for 100% backing of the note issue in overseas reserves, namely Sterling deposits in London. This allowed the automatic conversion of the local currency into the British pound.
The CBS served both sides reasonably well. Since the 19th century up to about 1929, the pound Sterling was the pre-eminent world currency. Colonies had stable currencies, meaning that the rampant inflation observed today in many ex-colonies did not occur. The British enjoyed substantial inflows of capital from their Empire and this helped to make London the world’s leading financial centre. To be fair to the British, it should be said that the independent Dominions — Australia, Canada, South Africa and New Zealand — also kept their overseas reserves in London at that time when they were free to keep them elsewhere.
In the post-War years, rapid decolonisation took place. In every instance the newly independent state established a Central Bank with note-issuing powers. The requirement of 100% backing in overseas assets was abolished. Singapore stood out as the sole exception. We retained the CBS and when the Monetary Authority of Singapore (MAS) was set up in 1970, it performed all the functions of a Central Bank except for note-issuing powers. How and why did we preserve such a strange anachronism in this age of electronic finance? The decision to proceed along these exceptional lines was a collective decision of the Cabinet. Each member reached this decision in his own way and I will explain mine.
When I was studying economics at Raffles College in pre-War days, the Keynesian revolution broke out with the publication of John Keynes’ The General Theory of Employment, Interest and Money. Today, critics, including Sir John Hicks, are agreed that it was a badly written work and made for difficult reading. I can attest to the latter. As an undergraduate, I read the book from cover to cover no fewer than three times, some chapters even more. What puzzled me most was that Keynes measured variables and aggregates, such as National Income and Money Supply, in terms of what he called “Wage Units”. I asked my professor what this meant and why Keynes did this, but could not get a satisfactory reply. Nor did the literature of the day prove more helpful.
Years later, the truth dawned on me. The Keynesian remedy for curing unemployment — the burning issue of the day left behind by the Great Depression years — involved a serious risk of inflation. Of course, Keynes knew this. The remedy he recommended took the form of expansion of bank credit through central bank policies to finance government expenditure. This extra spending will create additional demand for goods and services, thereby reducing unemployment. But if economic variables are measured in wage units, inflation would be factored out as wages will rise in keeping with price increases. If variables such as the consumer price index or interest rates and aggregates like money supply, were measured in wage units, their increases would be reduced to the extent to which wages rise.
There is a further difficulty to contend with. The Keynesian system is a closed one, that is, it takes no account of foreign trade. This is admissible in theory, but in practice, since all modern states engage in foreign trade, a Keynesian stimulus will lead eventually to balance of payments deficits if governments do not exercise restraint in time. A part of the increased incomes people receive will be spent on imports and when exports do not increase in proportion, a trade deficit will occur. In the immediate post-War years, Keynesian economics won widespread acceptance in both academic and government circles in Britain and the United States. Confidence increased in the ability of governments to maintain full employment and stable economic growth through Central Bank credit policies and government fiscal (budgetary) policies. However, by the mid-1960s, certain stubborn difficulties appeared and refused to go away. In Britain, this took the form of balance of payments troubles which led to the devaluation of the pound in November 1967.
America experienced troubles in a different form. Because all major world currencies fixed their par values in terms of the US dollar and the US dollar was pegged to gold at US$35 per ounce, America could not devalue the dollar except by raising the price of gold. This the government was unwilling to do for political reasons. Eventually, what happened was an increase in inflationary pressure in the US and a decline in confidence over the convertibility of the US dollar into gold at US$35 per ounce because of increasing US dollar balances accumulated overseas as a result of trade deficits. In the end, gold convertibility of the US dollar was suspended in August 1971 and, shortly thereafter, the regime of floating currencies came into being. World currencies continue to float till this day.
My Cabinet colleagues took careful note of these dramatic events as they unfolded on the world’s financial scene. None of us believed that Keynesian economic policies could serve as Singapore’s guide to economic well-being. Our economy was and is both small and open. Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster. There was no effective way of exchange control in an open trading economy like ours to deal with inevitable balance of payments troubles.
Another contributing factor was the world outlook of my colleagues — the old guard as they are now called. We all grew up under difficult conditions and did not believe anybody owed Singapore a living. The way to a better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the workplace. Diligence, education and skills will create wealth, not Central Bank credit.
Hence, we were not impressed by claims — excessive as they turned out to be — that governments could bring about prosperity through spending. It did not surprise us that the Anglo-Saxon countries which adopted such policies got into trouble. We also noted that the Germans and Japanese did not believe they could “spend their way to prosperity”, as the phrase went. Like Singaporeans, they set store on diligence, education and skills.
Against this background of leadership thinking, it is hardly surprising that the CBS was preserved with its legal requirement to back the currency note issue with at least 100% of overseas assets. Actually, these assets stand at 110% because it is only after this level has been reached that the earnings of overseas assets can be transferred to the government’s Consolidated Account. Cabinet’s collective purpose in retaining the CBS was threefold. First, to inform the financial world that our objective was to maintain a strong convertible Singapore Dollar. This remains the best protection against inflation. When nearly two-thirds of our citizens’ expenditure is spent on imported goods, a strong Singapore Dollar helps to keep consumer prices down.
The second purpose was to inform our citizens that if they wanted more and better services, they must pay for these through taxes and fees. There is no free lunch here. Third, we wanted to indicate to academics, both local and foreign, that what is fashionable in the West is not necessarily good for Singapore. A perceptive mind is needed to distinguish the peripheral from the fundamental, transient fads from permanent values.
It is also not surprising that when MAS was set up, the Chairman was by law the Finance Minister. World Bank experts advised us against this. Since MAS was effectively a Central Bank, the Chairman should be an independent person with sufficient authority to resist a Finance Minister’s request for money to finance a budget deficit. The World Bank believed that putting the Finance Minister in charge would be like asking a cat to look after fish. But Singapore has always worked on the principle that government expenditure on education, defence, social and economic services, etc., must be paid for out of government revenues — taxes and fees. It is the Finance Minister’s prime duty to balance the budget and, if possible, accumulate a surplus for the rainy day. Successive Finance Ministers have been doing just this. They do not need an independent Central Bank Governor to persuade them not to run budget deficits. The World Bank’s anxieties were misplaced.
What would happen if a future government, returned by a complacent electorate, were to do what the World Bank feared? Democratically elected governments the world over are exposed to the temptation of winning votes through promising better and cheaper services and at the same time lower taxes. This has happened not only in rich countries but also in poor developing countries. Rich countries have the resources to get by for a few years by borrowing on the international markets, but in poor countries, punishment comes quickly in a cruel way — high rates of inflation, economic decline and political instability. These three factors reinforce each other in a way which makes escape from misery difficult.
In Singapore, an irresponsible government does not need a Central Bank to finance lavish spending as a means to win popularity. We have substantial overseas reserves which can serve this purpose. However, the recent constitutional amendment contains a provision for an elected President to block this dangerous method of vote-catching. But if the electorate, misled by soft-headed opinion makers, persists in wanting the good life without working for it, constitutional safeguards cannot stop foolish behaviour for all times. What will happen if the electorate chooses this option is that after a brief period of high living, Singapore will spiral downwards and eventually become another miserable developing country.
In conclusion, I want to correct any impression this article may have given that I think poorly of Keynes as an economist. I do not. He is the greatest economist the world has produced this century. He introduced a new way of looking at an economic system, in a different way from the classical greats such as Adam Smith, David Ricardo and Alfred Marshall. The classicals saw the system as one consisting of producers and consumers, each making his own decision as a producer or a consumer. They studied how a free market harmonises their interests. Keynes looked at how the system functions as a whole. Keynes gave birth to a discipline we now call macroeconomics.
Another Cambridge economist, Richard Stone, worked out a method whereby the macro-system can be divided into sectors and sub-sectors, examined how these sectors were related to each other and explained how their transactions could be measured. His landmark work led to the establishment of the United Nations System of National Accounting. This is the way modern states estimate the level and composition of their annual Gross National Products (GNPs). The combination of Keynesian theory (now better understood after the lessons of the 1960s) and National Accounting gives governments a practical way of evaluating economic performance. In this way, modern states are able to manage their economies much better than they did in the pre-War years.
The Great Depression which started in 1929 was the result of grave mismanagement by governments and Central Banks of Europe and America. It was in response to the wrong policies of that period that Keynes created his new system of economic analysis. If one has to fault Keynes on any point, it would be the title of his book. This should have been The Special Theory of Employment, Interest and Money. His prescriptions were intended to address the special circumstances created by the Great Depression. By calling it a General Theory, he led lesser minds than his into believing that his prescriptions could be applied under all circumstances, with unhappy consequences, as we have noted.