Picture: hedgeye.com

Milton Friedman, a Nobel Prize winner in economics, illustrated the economic crisis as the guitar string: when we strum the guitar strings down, the strings will bounce right away. Unfortunately, this recession theory does not work in the current world economy because the recovery is so slow. In addition, since the global financial crisis (GFC) in late 2008, world economy becomes very uncertain.

It is already more than six years after GFC occurred but many central banks are still doing unpredictable monetary policy. In the first three months in 2015, there were more than 20 central banks, i.e. including the European Central Banks (ECB) representing 19 nations, stimulated the economy by implementing various expansionary monetary policies. Several giant emerging markets, such as India, Russia, Mexico, Turkey, and Indonesia, have cut interest rates as well as developed countries, namely Australia, Canada, Denmark, and Sweden, leaving the US (and possibly the UK) as the countries to raise its policy rates in 2015.

Moreover, China has reduced bank reserve requirement to tackle economic slowdown by unleashing the liquidity. China also decreases the down payment requirement from 60 percent to 40 percent to boost property sector.

Even, surprisingly in January 2015 Switzerland abandoned the peg of its currency after they pegged Franc to the Euro since September 2011 due to significant appreciation. Similarly, Singapore also reduced the slope of the Singapore Dollar Nominal Effective Exchange Rate (S$ NEER) Policy band to slow the pace of its currency appreciation against Singapore’s trading partners.

Actually, one of the goals of these expansionary monetary policies is to depreciate their currency. In particular, many developed countries are currently facing binding monetary and fiscal policy (e.g. zero interest rates and huge budget deficit). The only way to stimulate the economy is by boosting exports. Therefore, many countries tried to weaken their currencies in which can help their exports to be more competitive than other countries. Eventually, it leads to a “currency war”, a term introduce by Guido Mantega, the finance minister of Brazil. In 2010, Mantega complained the US’ quantitative easing (QE) policy because this policy weakened the US dollar causing other countries lose their export competitiveness.

Obviously, all currencies cannot depreciate at the same time. Currency war is like a “zero-sum game”: a situation in which each country’s gain (or loss) is exactly balanced by the other countries losses (or gains). For instance, due to the Fed’s QE in 2008-2012, on one hand, the US economy has recovered (i.e. stronger labour markets, more job creations or lower unemployment, wage recovery, etc.) but, on the other hand, this policy led to high inflation, currency appreciation, lower of export competitiveness, and spike in asset prices in emerging markets.

However, the current situation is extremely different compared to 2008-2012 period. After more than six year, the Fed has ended the largest financial stimulus program in the US history (QE) and plans to tighten monetary policy by increasing its interest rate in 2015. As a consequence, most currencies depreciate against the US dollar. The dollar rocketed to its strongest point in the last few years. In contrast, other large economies, such as Europe, China and many other emerging markets, slow down. China still struggles to tackle their internal problems, Europe faces economic stagnation and deflation, whereas emerging markets are threatened by capital outflows. Our global economy seems to begin a new chapter.

This uncertain global economy could enormously damage emerging markets economy. Since the Fed announced to prepare a contractionary monetary policy by raising the Fed rate, the emerging markets, including Indonesia, become very volatile. Before this announcement (2009-2012), emerging markets were flooded by $4.5 trillion of gross capital inflows, around half of global capital flows.

However, due to the US and some advanced economies recovery, investors are likely to diversify their portfolios causing capital outflows in emerging markets, including Indonesia. As a consequence, rupiah depreciates gradually since 2013 and reaches Rp13,000 per US dollar since early March 2015.

Do we still remember the impact of significant rupiah depreciation in 1998 on the Indonesian economy? It brought Indonesia into a severe crisis. At that time, rupiah greatly depreciated from about Rp2,600 per US dollar to over Rp14,000 per US dollar causing massive debts default (non-performing loan) and broken banking and financial system which were led to economic and social crisis.

To prevent (or at least reduce) more capital outflows, Indonesia should maintain its policy rate until the global economy becomes more certain and stable. In particular, Indonesia should highly pay attention on the Fed rate and other major trading partners policies. Temporary interventions in foreign-exchange (forex) market are also necessary to stabilise the rupiah at certain level. Otherwise, Indonesia could be hit again by a monetary crisis.