by Steve Hanke
For academics, the term “troubled currency” might be a term of art. But for people who are faced with such a currency, they know a troubled currency when they see one. Today, this is the case for millions of people around the world — most notably in Iran, North Korea, Argentina, Venezuela, Egypt and Syria.
A troubled currency is one in which users have lost confidence. When users no longer think a currency will retain its purchasing power, they attempt to dump it for a stable foreign currency (or commodities). As the demand for the troubled currency evaporates, its value vis-á-vis stable foreign currencies collapses, and prices for goods and services sold in the troubled currency soar. As this process develops, expectations about the currency’s ability to retain its purchasing power deteriorate, and a doom loop ensues. At the extreme, doom loops can culminate in hyperinflation — an inflation rate of over 50% per month. This, however, is rare. Indeed, there have only been 56 cases of hyperinflation.
Troubled Currencies in History — The Indonesian Rupiah
The Asian financial crisis of the late 1990s gave rise to several troubled currencies. The Indonesian rupiah was one currency that entered such a doom loop. On August 14, 1997, shortly after the collapse of the Thai baht, Indonesia floated the rupiah — on ill-conceived instructions from the International Monetary Fund (IMF).
Contrary to the IMF’s expectations, the rupiah did not float on a sea of tranquility. Its value plunged from 2,700 rupiahs per U.S. dollar at the time of the float to lows of nearly 16,000 rupiahs per U.S. dollar in 1998. Indonesia was caught up in the maelstrom of the Asian crisis. By late January 1998, President Suharto realized that the IMF medicine was not working and sought a second opinion. I was invited to offer that opinion and began to operate as Suharto’s Special Counselor. I proposed replacing Indonesia’s troubled rupiah with a stable rupiah anchored to an orthodox currency board system. On the day that news hit the street, the rupiah appreciated by 28% against the U.S. dollar (see the accompanying chart).