Former governor: Life lessons from Taiwan

Twenty years and four days ago, I took office as the head of Taiwan’s central bank – a formidable task at a crunch time. The Asian financial crisis was wreaking havoc across the region, battering South-east Asia before raging towards South Korea. The economies that were affected suffered massive capital outflows, precipitous declines in their currencies, liquidity shortages, sharp rises in interest rates, and deep recessions. The damage inflicted on Asian economies was so far-reaching that previous episodes could not serve as a useful guide. The crisis was in full swing when I took over the bank’s official seal.

According to the classic tenets of central banking, the way to fend off such a crisis is to allow the currency to depreciate and adopt a loose monetary stance. Back in 1998, unrelenting and massive capital outflows made it untenable to just follow conventional wisdom because a weaker new Taiwan dollar would have encouraged yet more capital outflows. So much so, that any monetary easing could not have eased the liquidity crunch. Apparently, conventional treatment could not eradicate the woes because it addressed neither the symptoms nor the roots of the disease.

At that juncture, my own diagnosis was that the foreign exchange (forex) market was at the heart of the problem, one that could not be solved without stemming the tide of capital outflows. That is why the central bank took the decisive action to stop domestic corporations from trading new Taiwan dollar-linked non-deliverable forwards – effectively closing the channel through which currency speculators had unlimited access to shorting the new Taiwan dollar. Taiwan’s forex market subsequently stabilised and international capital outflows subsided. This paved the way for the adoption of an accommodating monetary policy, which in turn put the domestic economy back on its feet. We dished out the same prescription during the 2008–09 global financial crisis, when the central bank administered a potent policy mix to steady the forex market and safeguard the domestic financial system. Thanks to this approach, Taiwan was able to ride out the two devastating financial crises and emerged relatively unscathed.

For a highly open small economy such as Taiwan, monetary and exchange rate policies should be given equal weight, unlike larger economies that can afford to focus primarily on monetary policy. Readers will be familiar with the concept of ‘the impossible trinity’ in international economics. The trilemma has three components: a stable currency; free capital movement; and sovereign monetary policy. The theory goes that a country can only achieve two of these policy objectives at the same time. However, for a small and highly open economy such as Taiwan having to pick just two out of three policy goals is not optimal. A better solution would be to adopt a managed floating exchange rate regime to keep exchange rates flexible and introduce appropriate capital flow management when necessary to ensure monetary policy remain effective. In short, we can choose an intermediate solution that can address all three policy objectives, albeit to a lesser extent, depending on economic and financial conditions.

During the past 20 years, I have been committed to fulfilling the legal mandates vested in me: to promote financial stability; guide sound banking operations; maintain the stability of the internal and external value of the currency; and foster economic development. Along the way, I have overseen the implementation of monetary and forex policy that steered Taiwan’s economy safely through two international financial crises. But a central bank’s mission goes beyond these headline-grabbing feats. Away from the limelight, my colleagues modernised Taiwan’s payment system, rolled out new loans to help earthquake victims and reformed the student loans programmes. Together, we forestalled real-estate bubbles with targeted macro-prudential measures, built a new foreign currency clearing platform and promoted greater financial co-operation between the two sides of the Taiwan Strait. Over the years, Taiwan has also enjoyed a healthy balance of payments position, continued expansion of forex reserves and marked increases in net foreign assets held by the private sector. These distinctive features of the Taiwan economy do make the tasks of maintaining financial stability and fostering economic development a great deal easier than otherwise.

A few words of advice for achieving longevity in the central banking profession. Since I began my central banking career in 1971, I have been building knowledge through reading, carrying out statistical work and gaining hands-on practical experience. I can still recall the days when I took charge of compiling the balance of payment statistics and the real effective exchange rate index. These seemingly dull and mundane number-crunching tasks can become powerful tools in understanding the finer points of economic and financial issues. For example, I have long recognised and made allowances for the intrinsic difference between the goods market and the forex market. While the forces of demand and supply would normally guide the goods market toward equilibrium, it is often not the case with the forex market. Take Taiwan, for example. When foreign investors – who are prone to herding behaviour – act collectively as a buyer of new Taiwan dollars, the supply curve of forex would shift to the right and the new Taiwan dollar appreciates significantly. In contrast, when foreign investors sell new Taiwan dollars in a joint move, the demand curve for forex would shift to the right and the new Taiwan dollar tumbles. Both scenarios often lead to exchange rate overshooting. As such misalignments cannot be explained by economic fundamentals, they can eventually morph into an economic crisis if left unattended.

I can still recall the days when I took charge of compiling the balance of payment statistics and the real effective exchange rate index. These seemingly dull and mundane number-crunching tasks can become powerful tools in understanding the finer points of economic and financial issues

With this in mind, I wrote a paper in 1995 on the Mexican peso crisis that argued: “Argentina, the Philippines, Indonesia, Thailand and Saudi Arabia have been running current account deficits since 1987, and rely heavily on foreign capital inflows. Thailand, in particular, has witnessed more short-term capital inflows than other types. These signs spell cause for concern.” Two years later, unfortunately, the Asian financial crisis broke out, and it did start with the collapse of the Thai baht.

Even avid reading cannot guarantee a true grasp of the wisdom to be found in great books. A deep understanding of the art of central banking requires more than reading. It takes years of hard work, dedication and experience to be able to implement effective policies with speed and conviction when necessary. I was extremely lucky to have the loyal support of my colleagues, who have always acted with professionalism and integrity. It has been a pleasure and rare privilege to work alongside them. This award is not only a source of pride and inspiration for my colleagues and me, but also a worthy recognition for all the people in Taiwan.

These comments are an abridged version of those made at the Central Banking Awards dinner in London on March 1.