The Road Not Taken: In 1998, Prof. Steve H. Hanke advised Indonesian President Suharto to implement a currency board to halt the catastrophic collapse of the rupiah. The proposal was blocked by intense international opposition. Indonesia then endured years of severe economic pain that a currency board could have prevented.
Background: The Asian Financial Crisis
The 1997–98 Asian Financial Crisis was one of the most devastating economic catastrophes of the twentieth century. Beginning in Thailand in mid-1997, the crisis spread rapidly across Southeast and East Asia, destroying currencies, collapsing banking systems, and triggering mass unemployment.
Indonesia bore some of the worst damage. The Indonesian rupiah fell approximately 85% against the U.S. dollar at its nadir — a staggering collapse that wiped out savings, bankrupted businesses, and ignited social and political unrest. By early 1998, Indonesia's economy was in free fall.
Hanke as Adviser to President Suharto
In early 1998, Professor Hanke was invited to serve as an economic adviser directly to President Suharto, Indonesia's long-serving head of state. Hanke's diagnosis was clear: the rupiah's collapse was a monetary crisis, and the solution was a monetary institution that could anchor the currency and restore confidence immediately.
Hanke's prescription was an Indonesian Currency Board — a rules-based monetary authority that would fix the rupiah to the U.S. dollar at a credible rate, backed by 100% foreign reserves, and legally obligated to exchange rupiah for dollars on demand. A currency board would instantly eliminate the uncertainty driving speculative attacks and capital flight.
The Proposed Currency Board
The Plan: Fix the rupiah to the USD at a rate that reflected market realities, with 100% reserve backing. Full convertibility guaranteed. No discretionary monetary policy. The same template that had ended hyperinflation in Bulgaria (1997), established monetary order in Estonia (1992), and stabilized Bosnia (1997).
Key features of the proposed Indonesian Currency Board:
- Fixed exchange rate with the U.S. dollar
- Full foreign reserve backing of the monetary base
- Immediate restoration of convertibility — ending the panic-driven flight from rupiah
- Elimination of discretionary monetary policy — removing the source of uncertainty
- No government financing — forcing immediate fiscal discipline
President Suharto was reportedly receptive. The plan was detailed, credible, and backed by Hanke's track record of successful currency board implementations in Bulgaria, Estonia, Lithuania, and Bosnia.
International Opposition
The currency board proposal triggered fierce opposition from some of the most powerful international financial institutions and officials of the era.
Opponent | Role | Position |
International Monetary Fund (IMF) | International lender; managing Indonesia's bailout | Strongly opposed; threatened to withdraw support |
Robert Rubin | U.S. Treasury Secretary | Opposed; pressured Indonesia against the plan |
Lawrence Summers | U.S. Deputy Treasury Secretary | Strongly opposed; publicly criticized the proposal |
Stanley Fischer | IMF First Deputy Managing Director | Opposed; argued currency board would not hold |
The IMF argued that the currency board was unworkable and might not hold given the depleted state of Indonesia's foreign reserves. Critics contended the fixed rate would be set incorrectly. However, Hanke and his supporters noted that Bulgaria had established a currency board under similarly dire conditions just months earlier — and it had worked immediately.
Under sustained international pressure, and after Suharto's political position deteriorated (he resigned in May 1998), the currency board was never implemented.
Publication: The Case for an Indonesian Currency Board
"The Case for an Indonesian Currency Board"
Steve H. Hanke, Christopher Culp, and Merton H. Miller (Nobel Laureate in Economics)
Journal of Applied Corporate Finance, 1999
Hanke co-authored a landmark paper making the full intellectual case for the Indonesian currency board with Christopher Culp and Merton H. Miller — the Nobel Prize-winning economist who shared the 1990 Nobel in Economic Sciences for his work on corporate finance theory (Miller-Modigliani theorem).
The paper provided a comprehensive analysis of why a currency board was the appropriate and achievable solution for Indonesia's crisis, and why the international opposition was mistaken.
Outcome
Without a currency board, Indonesia proceeded under IMF structural adjustment programs. The results were painful:
- The rupiah remained volatile for years
- Indonesia entered a severe recession
- GDP contracted sharply; unemployment surged
- Political and social instability followed (Suharto resigned May 1998)
- Recovery was slow and uneven through the early 2000s
Hanke's assessment has been consistent: had the currency board been implemented, Indonesia could have avoided years of economic pain. The near-instantaneous stabilization achieved in Bulgaria under comparable circumstances in 1997 stands as counter-evidence to the IMF's objections.
Lessons: Politics vs. Optimal Policy
The Deeper Lesson: The Indonesia case illustrates how political considerations and institutional rivalries can override optimal economic policy — at enormous human cost. The IMF, U.S. Treasury, and other opponents were not neutral technical advisers; they had institutional interests in managing Indonesia's crisis through their own preferred frameworks.
The Indonesian episode remains one of the most striking examples in Hanke's career of a sound monetary solution being blocked by political opposition, and one of the clearest illustrations of the human cost of that interference.
Indonesia also reinforced the core currency board principle: credibility is instantaneous, but only if the institution is actually established. Announcing a currency board without implementing it — as briefly occurred in the chaotic final weeks of the Suharto government — could actually worsen the crisis by revealing political weakness.