An Echelon Media Company
Tuesday May 30th, 2023

Why Singapore chose a currency board over a central bank

From a speech by Goh Keng Swee, former Finance Minister of Singapore

When the sun never set on the British Empire, the currencies of the British Colonies were issued under the CBS. This provided for 100 per cent 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 — Australian, 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 per cent backing in overseas assets was abolished. Singapore stood out as the sole exception.

Retaining the Currency Board

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 this own way and I will explain mine.

When I as 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 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 serious risk of inflation.

Of course Keynes knew this. The remedy recommended took the form of expansion of bank credit through Central Bank policies to finance government expenditure. The 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 and aggregates like Money Supply were measured in wage units, their increases would be reduced to the extent to which wages rise.

Balance of payments trouble from Keynesian Stimulus

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 government 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) polices.

However by the mid 1960s, certain stubborn difficulties appeared and refused to go away. In Britain, this took the form of balance of payment 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 at US $ 35 per ounce because of increased 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.

Printing money is a disaster for small open economies

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 the 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 work place. 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 government 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 per cent of overseas assets.

Actually, these assets stand at 110 per cent 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.

Strong currency is best defence against inflation

First, to inform the financial world that our objective was to maintain a strong convertible Singaporean 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 form the fundamental, transient fads from permanent values.

It is also not surprising that when the Monetary Authority of Singapore (MAS) was set up, the Chairman was by law the Finance Minister. World Bank experts advised us against this since 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 a rainy day.

Successive Finance Minister 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 though promising better and cheaper services and at the same time lower taxes.

Central Banks bring misery to poor countries

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 systems 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 whole. Keynes gave birth to a discipline we now call macro-economics.

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 world led to the establishment of the United National 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 and the lessons of the 1960s) and National Accounting give 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.

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Sri Lanka rupee at 296.75/297.25 to dollar at open, bond yields steady

ECONOMYNEXT – Sri Lanka’s rupee opened at 297 /297.50 against the US dollar in the spot market on Monday, while bond yields were steady, dealers said.

The rupee closed at 296.75 /297.25 to the US dollar on Monday after opening around 296.50 /297.50 rupees.

A bond maturing on 01.09.2027 was quoted at 26.50/75 percent steady from Friday’s close at 26.50/65 percent.

Sri Lanka’s rupee is appreciating amid negative private credit which has reduced outflows after the central bank hiked rates and stopped printing money. (Colombo/ May 29/2023)

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Sri Lanka rupee appreciation squeezes exporters

ECONOMYNEXT – Sri Lanka’s recent appreciation is starting to squeeze apparel exporters as their domestic costs including wages and energy, were hiked over recent months, when the rupee fell steeply, an industry official said.

Companies had raised salaries and emoluments at rates averaging 25 percent for workers while transport costs have also gone up but not has come down, Yohan Lawrence Director General of the Join Apparel Association Forum said.

Apparel factories in particular also provide transport and some meals for workers.

Electricity prices have also been hiked, based on the rupee which was weaker. A tariff cut is expected from June after the rupee appreciated and imported fuel prices fell.

Sri Lanka’s rupee collapsed in 2022 from 200 to 360 to the US dollar as interest rates were suppressed with liquidity injections and a failed attempt was made to float the rupee with surrender requirement in place.

From the second half of 2022, with higher interest rates and negative private credit, the central bank has avoided printing money under conditions which are generally accepted to be difficult, and is broadly running deflationary open market operations, triggering a balance of payments surplus and putting the rupee under upward pressure.

Central bank net credit to government which was 3,302 billion rupees in September in 2022, was down to 3,209 billion rupees by March 2023, part of which was due to rollovers, analysts say.

Market pricing of fuel and electricity by the Ministry of Energy and also spending controls and tax hikes buy have also helped contain domestic credit.

Sri Lanka also has mandatory conversion rules, imposed on exporters, which is a concern for exporters.

“We believe rupee should be at its natural level, but with forced conversions you won’t get the correct picture,” Lawrence said.

Sri Lanka has to release a plan to remove import controls, exchange controls and other restrictions imposed in the period where policy rates were suppressed with liquidity injections (so-called multiple currency practices and capital flow measures) by June under the IMF program.

Apparel exporters have also seen orders fall amid tighter conditions in Western markets.

The central bank has to peg (intervene actively in forex markets and create money) to meet reserve targets under an IMF program and cannot free float (avoid creating money through international operations) the rupee.

The newly created money has generally been absorbed in an overnight liquidity shortage.

There have also been foreign purchases of rupee Treasuries. Amid a contraction in credit, the inflows also do not turn into imports fast as the money if the money is spent.

By making purchases a little below what is allowed by the contraction in domestic credit, the rupee can be allowed to appreciate, analysts say.

The central bank has so far allowed the rupee to appreciate to around 300 to the US dollar from 360 levels under a transparent guidance peg up to February.

Except after the 2008/2009 currency crisis, Sri Lanka’s central bank has not previously allowed to the rupee to appreciate under IMF programs where the first year in particular sees balance of payments surpluses, before private credit and domestic investments picks up again.

One of the considerations used by third world central banks are Real Effective Exchange Rate indices.

The REER of the Sri Lanka rupee based on a basket of currencies calculated by the central bank was 61.12 points in February before the rupee was allowed to appreciate by lifting a surrender rule.

In March the index went up to 69.55 points, but remained steeply below 100. Real effective exchange rates are calculated also taking into account inflation in counterpart trading nations.

Sri Lanka’s inflation index had hardly risen since September amid rupee gains. Falling food prices can help contain pressure for further wage hikes, analysts say. (Colombo/May30/2023)

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Sri Lanka forum to discuss central bank independence vs sound money

ECONOMYNEXT – Central bank independence and sound money will be under discussion at a public event organized by the Sri Lanka chapter of the Bastiat Society today, May 30, as island is recovering from the worst episode of monetary instability since independence.

The forum will feature Lawrence H White, Professor of Economics at George Mason University in the US, and W A Wijewardene, former Deputy Central Bank Governor, of the Central Bank of Sri Lanka.

“The discussion will compare the current system against alternative systems and explore the relationship between such banking systems and sound money,” the organizers said.

White specializes in the theory and history of banking and money. He is the author of “The Clash of Economic Ideas” (2012), “The Theory of Monetary Institutions” (1999), “Free Banking in Britain” (2nd ed., 1995), and “Competition and Currency” (1989).

Wijewardene has been speaking on central bank independence in Sri Lanka long before it became a topic of wider discussion, but also on accountability.

In April, a Central Bank Independence and Other Matters, which includes a collection of his orations on the subject over the years as well a recent development was published.

The discussion comes as independent central banks in the West have created the worst inflation since the 1970s and early 1980s and are apparently unaccountable to parliaments and the public.

The early 1980s also saw the first wave of external debt crises in so-called soft-pegged countries in Latin America and Eastern Europe in particular as the US and UK tightened policy to end the Great Inflation.

The discussion will be held at 7.00 pm at the Lakmahal Community Library and those interested can register online, the organizers said. (Colombo/May30/2023)

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