But these same exchange rate regimes were in place when the funds were flowing in, which suggests that they were not viewed as a serious structural flaw by investors at that time. Similarly, the underlying weaknesses in many Asian economies that so many observers (with the benefit of hindsight) now point to — ‘crony capitalism’, inadequate risk management, speculative lending to the property sector — were all present at the time when the funds were pouring into the region. Not only did these weaknesses fail to deter investors on the way in: the abundance of inward investment prior to the crisis tended to exacerbate the problems, rather than act as a corrective force on policies. More recently, we have witnessed what appears to be the start of a new wave of capital flowing back into the region, even though it is far from clear that these structural problems have been fully addressed. I think it is not going too far to say that these ‘hot’ capital flows not only failed to act in a way that policed policies effectively, but actually became a powerful destabilising force in their own right. The huge swings in interest rates and exchange rates that resulted from capital flight in this region did far-reaching damage to corporate, financial, and government sectors, which, in turn, reinforced the initial withdrawal of capital.
I might add here that the currency of Macau, the pataca, has been linked to the Hong Kong dollar since as long ago as 1977. But not all economies are in a position to meet the preconditions necessary for linked exchange rates to endure. In the aftermath of financial crisis in Asia and elsewhere, many economies are searching for new approaches to exchange rate management. The recent trend is clearly towards more flexible exchange rate mechanisms. We cannot ignore a smaller camp, though, that is opting for greater fixity of exchange rates, supported by more robust institutional structures than have sometimes been in place in the past. The integration of European monetary systems in the form of EMU is an obvious example. Similarly, a handful of economies have successfully adopted currency board systems similar to our own. We must recognise, however, that many economies do not currently have the preconditions to make such a regime work successfully. It seems inevitable that they will have to live for the time being with some sort of managed float. The disadvantages of this system are that the lack of a transparent anchor and of a clear commitment to some well-defined policy objective make credibility difficult to establish. These conditions invite over-shooting in financial markets, as speculators attempt to test the limits to which the authorities are willing to let the exchange rate move. How can the authorities anchor policies and expectations in such an environment?