Learning from Mr. Dekan of Bank Indonesia Institute, Towards a Self-Reliant Indonesia
Tauhid Nur Azhar
This morning, my teacher, Mr. Janu Dewandaru, who is also a dean at the Bank Indonesia Institute, posted a concise summary of a presentation related to the global economic forecast for the coming period. Here is his summary:
The crisis in the Baltic region has led to an increase in transportation costs, which in turn has increased global inflation expectations. The response of central banks in advanced countries: maintaining high policy rates. The impact on developing countries: their exchange rates weaken (including the Rupiah)… leading to higher import prices and production costs… ultimately, inflation will rise. According to the Asian Development Bank (ADB), the impact of inflation will be felt by October. There is also a risk of corporate debt bubbles forming due to the weakening of exchange rates in developing countries.
I copied Mr. Janu’s writing verbatim, without adding or subtracting anything, including spelling and writing style. It’s a true copy-paste.
The real problem is a classic one, which has been discussed since Malthus’ time, and is always influenced by horizontal conflicts of interest that are easily sparked.
The supply and demand of resources will trigger a struggle for control over resources.
Transactions will be influenced by the power of a country or alliance in determining the direction of the game in a region or globally.
In a globally connected economy, geopolitics and regional crises have a significant impact on a country’s economic stability.
This morning, we will discuss the impact of these factors on three main economic indicators: exchange rates, inflation rates, and the Gini index.
Using economic theory and empirical examples, we will see how these external factors affect a country’s economy, region, and globally.
Since Master Janu is an influential figure in the central bank, which has authority in monetary matters, including exchange rates, let’s start with his area of expertise.
Exchange rates are highly sensitive to geopolitical events and regional crises. When a country experiences political instability or economic crisis, investors tend to withdraw their investments to seek safer assets.
This phenomenon is called “flight to safety” and often causes the depreciation of the country’s exchange rate.
A concrete example is the political crisis in Venezuela, which led to a sharp depreciation of the bolivar.
On the other hand, currencies of countries considered safe havens, such as the US dollar, Swiss franc, and Japanese yen, tend to strengthen during periods of global instability.
The question is, why is this the case?
Even anomalies caused by regional dynamics sometimes do not align with the theories that are often used as references.
According to the Purchasing Power Parity (PPP) theory, for example, exchange rates should reflect the difference in prices between countries. However, in practice, geopolitical factors often cause deviations from this theory.
Why?
Because there is another theory that is more oriented towards psychological aspects, namely the Expectations Theory.
The Expectations Theory states that exchange rates are influenced by market expectations of future economic and political conditions. And isn’t it true that observations and constructions of perceptions are highly susceptible to bias due to information manipulation and distortion?
Even the power of multi-directional thinking, including destructive thinking, can create expectations that change a situation, including the prerequisites for inflation to occur.
The Quantity Theory of Money, which states that inflation occurs when the money supply grows faster than economic output, in the context of current global geopolitics, seems to need to be expanded to include the impact of inflation expectations and production costs influenced by political instability and individual, communal, and global thinking patterns.
The concern about the rise of inflation and the change in central banks’ policies to play a controlling role through interest rate modulation is a necessity that needs to be addressed because it will happen.
Many aspects and elements are involved in regional and global economic volatility. Wars and obstacles to energy sources, such as the Russia-Ukraine war, and pandemics that have plagued the world for over two years, have a significant contributing effect.
To understand the global economic constellation related to microeconomic fate, which is more pragmatic and has an impact on family-level control, we must understand the chain of processes involved in determining global economic status.
Whether it’s from the real sector, monetary sector, or fiscal policy, which is the authority in each country’s domain.
What stimulus instruments will be used? What contraction or relaxation effects are expected? Can fiscal instruments such as tariff exemptions and tax holidays help mitigate the impact of rising raw material prices?
Where the repression of raw material prices will have a systemic impact on industrial competitiveness, which will experience a significant increase in production costs, right?
So, if we refer to the Political Economy Theory, which explains how a country’s political conditions and policies affect the distribution of wealth and income, it is reasonable that political instability and economic crises often force governments to take measures that, although necessary for macroeconomic stability, can worsen income inequality.
The correction is usually done through social assistance and job creation programs. Redistributive budgeting taken from foreign exchange reserves will show a nation’s resilience in ensuring the welfare of its citizens.
Foreign exchange reserves, or foreign exchange reserves, are foreign currency holdings by central banks and monetary authorities.
Foreign exchange reserves can be in the form of cash, gold, securities, and financial derivatives. The currencies in foreign exchange reserves are usually recognized by many countries and are valid internationally, such as the euro, US dollar, yen, and pound sterling.
These foreign exchange reserves can be used to finance balance of payments imbalances, maintain exchange rate stability, and support obligations.
In Indonesia, Bank Indonesia (BI) is responsible for maintaining foreign exchange reserves to achieve a sufficient amount to implement monetary policy agreed upon by the government and legislative bodies as representatives of the people’s sovereignty.
Without a visionary policy to substitute dependence on raw materials, as is currently happening in many sectors, including critical industries such as pharmaceuticals, will give birth to a low level of economic resilience in our beloved country.
Including the independence of our currency, which has so far followed the global system established unilaterally in the early stages by linking guarantees to gold.
Referring to the calculations of economist Tareq El Diwany, the growth of global gold production has been unable to keep up with the amount in circulation plus the potential for quantitative easing due to the mechanism of debt and interest. This phenomenon is known as fractional reserve banking.
Where did the concept of gold guarantees for currency exchange rates come from?
History records the Bretton Woods Agreement, which was made in 1944 in New Hampshire, USA.
This agreement was made to create monetary stability in the international arena through the stability of exchange rates of major currencies in the world. To achieve this, the United States, as the initiating party, set a benchmark on the price of gold before World War II, around $35 per ounce of gold.
This price was based on the Gold Reserve Act of 1934. With the agreement on the value of the dollar and related currencies, it can be said that gold acted as an anchor to strengthen the international currency in circulation.
But there was a global dynamic that eventually gave birth to the concept of fiat money. Fiat money is a type of money whose value and use are determined by the government and not backed by physical commodities like gold or silver.
The value of fiat money comes from the trust and confidence of the people that it can be used as a legitimate payment instrument.
Fiat money does not have intrinsic value related to physical commodities. Its value is entirely based on the trust of the people in the government that issues it.
Fiat money is established by the government as a legitimate payment instrument through national laws.
The government is also responsible for controlling the money supply through monetary policy from the central bank.
The value of fiat money, of course, fluctuates and is dynamic, depending on economic conditions, monetary policy, and public trust in a country’s economic stability.
Fiat money, which was initiated by US President Richard Nixon in 1971, gives flexibility to central banks to control the money supply and monetary policy to stabilize the economy.
For example, central banks can print new money or implement quantitative easing to overcome recession.
Any problems in the monetary anatomy will be attempted to be corrected through various fiscal instruments aimed at ensuring government stability, including the concept of welfare distribution marked by an increase in purchasing power parity and improvement in the Gini index.
Innovation related to currency independence can start with regional cooperation related to currency exchange rates, as done by the European Union with its Euro. We in Asia, and ASEAN in particular, can do the same. Not with a common currency, but rather by starting with a shared payment system based on digital instruments through QRIS and CBDC (central bank digital currency) and utilizing sovereign wealth fund instruments in the form of intrinsic value guarantees from potential natural resources such as carbon absorption, clean water, air, renewable energy sources, and other pre-exploitation natural resources.
Digital money can be hybrid, as it can be issued by central banks, while still having intrinsic value that can become a bargaining chip to increase bargaining power against partner countries in terms of raw material procurement and other substitute products.
Hopefully, this morning’s idea can spark concrete ideas that can be born from Mr. Janu and his faculty members, who are brilliant Indonesians.
