Attention as to the local economic affairs has recently been focused on the current foreign exchange problem. Despite differences of opinion among experts on how to improve the situation, there is a common criticism on the existing exchange system and dealings in foreign exchange. The various suggestions made may be summarized as follows:
(1) The current exchange rate of N. T. for the U. S. Dollar should be readjusted.
(2) The current control system should be relaxed, either totally or partially.
Are these suggestions right as to their respective workability in relation to the economic development of ? It is a question that deserves serious consideration. We are here concerned with the first point only.
Those who contend that the exchange rate should be readjusted protest against the overvaluation of our exchange. To them, the current exchange rate is likely to curtail our export on the one hand and, on the other, to bring about the difference between the exchange rate and the free market price of the U. S. Dollar here, which constitutes a loss to exporters in general. So far, most of the exportation has been subsidized by the Government to the advantage of exporters and some importation such as the import of cultural equipment for the newly-founded missionary university has been permitted to be settled at 20 to 1. It is unnecessary, they suggest, to maintain the existing quotation equivalent to the certificate price. N.T.$15.65 for one U. S. Dollar. Moreover, owing to the fact that importers in general are subject to a 20% Defense Tax and that some of them who are not entitled to have claim to exchange settlement must pay 25% commission to obtain certificates from those who are entitled to have and willing to yield, so what they pay for the exchange settlement should be so calculated as to add 20% Defense Tax plus 25% commission to the original price of the certificate. In total, the cost of the settlement would amount to about N.T.$23 instead of N.T.$15.65. On the basis of the above-stated facts, the exchange rate should be lowered to a figure nearer to the free market price of one U.S. Dollar to approximating N.T.$27 presently.
Normally speaking, the export problem is a complex of which the exchange rate, in some cases, may be regarded as a component part. With reference to our existing rate, what makes us feel the overvaluation of N. T. in terms of the U. S. Dollar is apparently the dearer free market price of the U. S. Dollar and the recent down-swing of the external market. Either of the two phenomena would indicate that the N. T. has been over-valuated. The argument of these critics is obviously based upon the so-called Theory of Purchasing Power Parity.
To ascertain whether our current exchange has been over-valuated or not, we have first to discuss briefly the actual applicability of the Parity Theory.
II
The Parity Theory holds that a rate of exchange between two countries will approximate the ratio between their general price levels. The same may be expressed in terms of the external purchasing power conforming to the internal purchasing power of the two currencies. A rudimentary form of the theory was held as early as 1802 by Henry Thornton, a member of Parliament and a Director of the Bank of England. Later on, the same view was taken by John Wheatley, David Ricardo and Alfred Marshall. In 1918, this conception was developed into the Parity Theory by G. Cassel. It is not hard to explain the cause for the development of the theory. The Napoleonic Wars and the War of 1914-1918 resembled each other in that a number of belligerent countries had inconvertible currencies, inflated to various dimensions. The only difference was that, in the former case, the inflationary effect upon the foreign exchanges became manifest during the war, while, in the latter, the war itself witnessed the official control of foreign exchange, and not until after this was relaxed, did the full effect of currency depreciation make itself felt on the foreign exchanges. The exchanges became disorganized, rates shifting from day to day in a manner out of keeping with previous experience. In both cases, economists sought theoretical explanation of the question how foreign exchanges were regulated under inconvertible money conditions.
From this historical background, we may come to an understanding that if the theory is sound its applicability is premised on two conditions: first, the existence of inflated in convertible money and, second of a free exchange system. But the theory itself is not a satisfactory one, because it lays stress on the concept of the general price level. So if such a level cannot reflect exactly the actual changes of the market, then the theory would hardly hold water. If the price of commodities cannot become an independent factor affecting the exchange rates, then the theory would be unable to prove the causal relationship it stands for. It can hardly escape this dilemma.
III
Blind to the controlled exchange system now prevailing, students of the Parity Theory here further condemn the mistake of calculation in applying the principle to the case under investigation. Their judgment that the N. T. exchange has been over-valuated does not logically depend upon a comparison between the general price levels of the United States and Taiwan, but on the change in the free market price of the U. S. Dollar here. Whether such price should be looked upon as the natural rate or the market rate of exchange, none of them can say with certainty. If it were the natural rate, it could serve, it is granted, as a means to measure the appreciation or depreciation of N. T. exchange. As a rule, the natural rate, as differentiated from the market rate, is independent of the influence of changes in the supply and demand of the market. But that price is actually affected by market fluctuations. In , the only rate that can be reckoned as the market rate is the one indicated by the certificate price. Under the exchange control system, together with the government-owned enterprises, the supply of U. S. Dollar exchange is at the disposal of the government, while the demand far it is subject to official control. Furthermore, since the provision of commercial procurement by the counterpart fund, the equilibrium of the balance of trade has been doubly secured. So, even though there is a rate commonly taken as the market rate, we have no fear of its fluctuation. Being neither the natural nor the market rate, the free market price of the U. S. Dollar is a very unusual phenomenon having little relationship to the balance of trade. The existence of such a price and its fluctuation must be explained by other causes. For instance, according to official reports in November, 1950, the export settlement amounted to US$12,236,636.95 while the import settlement amounted to US$8,137,856.22, the excess in our favor being, in round numbers, US$4,000,000. Normally speaking, the free market price of the U. S. Dollar should have been lowered, or at least remained unaltered. 9n the contrary, we did see, in the same month, the sudden upsurge of the free market price of the U. S. Dollar. Since then, the tendency has not changed. We are here not concerned with the causes of the fluctuation of that price. Suffice it to say that the appearance of such fluctuation does not show the over-valuation of our exchange, but the maladjustment of the exchange scrimp system as well as the existence of highly speculative activities in the U. S. Dollar.
Let us push our argument a little further by taking for granted that the fluctuation of the U. S. Dollar has been due to over-valuation. Then is it possible to get rid of or to lessen the fluctuation by readjusting the official quotation or the certificate price nearer to the U. S. Dollar price? An instance may be cited as an answer. In April, 1951, when the U. S. Dollar was around N.T.$17, in order to stabilize it, the competent authorities tried to readjust the certificate price down to N.T.$15.65. But no sooner was the readjustment made than the U. S. Dollar lumped to N.T.$20. Past experience tells us that the official quotation always fails to keep pace with the advance of the free market price. Even though we attempt to lower the quotation below the free market price, it would be hopeless to control the latter. This again explains the lack of connection between the price fluctuation and any alleged over-valuation.
To argue for the over-valuation of the N. T. currency on the ground of lower external price level is not without theoretical merit. In his "Tract" and "Treatise," J. M. Keynes tried to verify the Parity Theory by arguing that if the price levels that were taken into account were those of commodities entering into international trade, then the theory was "little more than a truism." Those commodities are the exports from different countries, and external price represents, exactly the price of exports. But our students of the Parity Theory only look at the downward tendency of the external market. They never compare the external price with the price of our exports, and then jump to the conclusion that the N. T. exchange has been over-valuated. Out of the general price level of Taiwai, the export price index is far lower than the import price index. Therefore, to estimate the rate of our exchange by the ratio of the external price to our export price, instead of our general price, cannot be expected to produce the same results. Even if, through such a method of calculation, we still find that our rate is too high, it still does not prove that the curtailment of our export has been due to over-valuation of the N. T. exchange. For the existing international situation is so complicated that the external price is subject to a varied range of noneconomic influences, and the production problem of Taiwan itself is not a simple one. We have to find out why our exports cannot be quoted at competitive prices on the external market. Is our technique of production up to the international standard? Is the administration of our enterprises in accordance with economical principles? Unless we are assured that our conditions of production measure up to the latest tests of efficiency, there is no room for the argument that the exchange rate should be held responsible for the difficulties of our export. So even though the Keynesian theory itself is correct. we have to gird ourselves against the danger of putting shoes on the wrong feet.
I have tried to show that neither the free market price of the U.S. Dollar nor the external price level can prove the over-valuation of our exchange, but not that there is not the least indication of over-valuation at all. When a currency reaches the condition of inflation, internally it is depreciated and there would be no exception externally. This is a truism. But the questions we have to bear in mind are: (1) Is our exchange still over-valuated after the rate have been readjusted, for the past few years, from five to one down to the current certificate; price level (plus the Defense Tax or subsidies)? (2) Provided that the present rate is still too high, should it be further readjusted for the sake of our exports?
IV
Regarding the first question, our main difficulty lies in the lack of a basis upon which the value of our currency can be fixed. Generally speaking, the value of a paper money, according to some authorities, lies in its purchasing power. But, in whatever case, there is a definite basis for fixing the initial value of a currency. For instance, notwithstanding the fact that the Pound Sterling and the Dollar Currency are both paper money and even unconvertible, the basis of their value is derived from the Gold Pound and the Gold Dollar respectively. In the gold standard epoch, the reason why a Pound contained gold metal weighing 113.0016 grains and a Dollar weighing 23.22 grains was due to the metallic content of a silver Pound and a silver Dollar in terms of the ratio between silver and gold. And from the ratio between the gold metallic content of the Pound and the Dollar, the exchange between the two was fixed at the rate of 1:4.8665. When the Pound is depreciated, it results in the ratio being shifted downward to 1:2.80. This fact the currency theory cannot deny. It has to take for granted that when the gold price in terms of a currency is at par, the price level is in unity. i.e., equal to 1. Then with the relative changes in the quantity of currency and in price, the fluctuation of the purchasing power of the currency is calculated. When the price level is greater then 1, the currency is thus depreciated; when less than 1, appreciated, or over-valuated. The same is true of the exchange rate. Suppose, at the time when the Pound is able to maintain a ratio of 1:4.8665 with the Dollar exchange, its rate equals 1. The Pound exchange become depreciated, if the rate is less than 1. This "1" is the standard with which we measure the extend to which a currency is depreciated.
The New Taiwan currency is so "new" that it lacks any conventional basis as its standard of account. It is not the offshoot of our national currency, because, by the time of the monetary reform, the national currency was on the verge of collapse. Nor can it be based on the currency of before the Restoration because the old money was attached to the Japanese yen. So, for our exchange with the U.S. Dollar, there is lacking a definite norm of valuation. The regulations laid down by the Money Reform Bill did not make clear the basis of calculation for foreign exchange purposes. We do not know why, internally, the gold price in terms of N. T. was fixed at N.T.$280 and, externally, one U.S. Dollar at N.T.$5. Discounted at gold price, our exchange was obviously over-valuated because, with the official gold price of $35 per ounce in the United States, the rate of our exchange should have been 8:1, or with the market price of gold in the United States at $50 per ounce, the rate should have been 5.6:1. We have therefore good reason to say what viewed in the light of the Regulations Governing the Issuance of the New Taiwan currency our exchange was then over-valuated. Now let us see how much the over-valuation was in mid-June, 1949.
In principle, although our currency is not based on a gold standard, we still can reduce its value to gold price, not only because the latter is relatively stable, but also because gold is still the basis of the international money market and, at the same time, the U.S. Dollar is on the gold standard. In estimating the value of our money in terms of gold price, we should refer to the following factors: (1) Hongkong gold price and (2) the cost of gold production in . As regards the first factor, owing to the scarcity of gold, precaution should be taken against its possible outflow to Hongkong if our price is lower than the prevailing Hongkong price. In June, 1949, the Horigkong price of pure gold cost H.K.$346 (discounted in terms of the price of Hongkong gold bar which contains 0.945 metallic quality) which, in terms of N. T., should be N. T. $325 per ounce. In the same period, the price per ounce of pure gold in was N.T.$283 (discounted in terms of 0.991 bullion), much lower than the former. Actually, the cost of production per ounce of pure gold produced in in the same period was N.T.$281. Adding 20% normal remuneration, the price per ounce should nave been N.T.$337.20, just a little higher than the Hongkong price. Discounted at the American official price of gold, the then rate of exchange should have been 9.7:1. Now with this rate as the basis, as a consequence of N. T: inflation, how much should the exchange be depreciated today? To answer this, one may ask how much is the N. T. inflated now. Some maintain that our currency has not been inflated on the ground that the quantity of trade and output has increased in proportion to the increase in note issue. But, if the equations laid down by the Quantitative Theory are correct, then, in this case, the price level would not be raised some six times, according to official reports, the level in the currency reform period in 1949. The rise of commodity price may be explained by means of real causes, such as changes in the demand and supply of the market. But the price movement consequent upon such causes would present a curve smoother than the movement resulting from monetary cause. Furthermore, if we make a comparison between the trade and production indices with mid-June, 1949 as base, then the indication of inflation is at once apparent. According to the general price index, the inflation should be about six times. But this figure is inaccurate. In reality, no method can make such calculations accurate. First, the general price index itself is not always reliable. Secondly, it is impossible to estimate the personal hoardings out of the total quantity of money. Thirdly, owing to the unpopularity of bill transactions in , the amount of the bill transactions of banks fails to reflect exactly the actual quantity of trade. Fourthly, more important is the impossibility of calculating the amount of money necessary for regular circulation on the market in any period of time. So, from the quantitative aspect, it is difficult for us to ascertain the degree of inflation. The same difficulty is met in the calculation of exchange depreciation. Anyhow, we may be able to find out the degree of depreciation by the same method as used for estimating the value of our currency. We may use the current gold price in to assess the wisdom of our exchange rate. At present the cost of gold production here is, on die average, N. T. $800 per ounce. Adding 20% normal remuneration, the price per ounce of I pure gold is N. T. $1,000. Then the current rate of exchange should be N.T.$28.6, i.e., three times as the rate in the currency reform period. If the original ratio 5:1 was not over-valuated, we may say that, at the current certificate price, our exchange, too, is not over-valuated, because three times five is equal to 15. This is the reason why, as I have said above, the over-valuation is not effected at the current rate, but was made at the beginning of the currency reform.
V
As for the second question, should we readjust our present rate, even though it is too high, for the sake of our exports? The answer will depend upon the influence of depreciation on our foreign trade and internal price.
In regard to our foreign trade, we may begin our discussion from the four elasticities postulated by Professor Joan Robinson, namely: (1) the foreign elasticity of demand for exports, (2) the foreige elasticity of supply of imports, (3) the home elasticity of demand for imports, (4) the home elasticity of supply of exports.
Let us recapitulate briefly what Professor Robinson has argued as to the relation of depreciation to the four elasticities. On the export side, we are convinced that a fall in the exchange rate tends to increase the value of exports in terms of the home currency. But the increase will be smaller or greater as the foreign elasticity of demand is smaller or greater, there will be no increase in the volume of exports and consequently no increase in their value if the foreign demand is constant. On the other hand, if the elasticity of home supply is lacking, the volume of exports does not alter. Their foreign price is unchanged and their value in terms of the home currency will increase in proportion to the fall in the exchange rate. If home supply is elastic and the home price is constant, the foreign price will fall in proportion to the fall of the exchange rate. Therefore the increase in the volume of exports and thus in their home price and the fall in their foreign price will both be smaller or greater as the elasticity of the home supply is smaller or greater. So, if both the elasticity of the foreign demand and the elasticity of the home supply are great, the fall in the exchange rate will tend to increase the volume of exports so as to stimulate production. If the foreign demand is inelastic and the home supply has greater elasticity, the consequence of depreciation will not raise the volume of exports, but will tend to bring about over-production of such commodities. A greater elasticity of foreign 4iemand and a smaller elasticity of home supply will bring about a small increase in the volume of exports, and their foreign price will fall to a less degree than the fall in the exchange rate.
On the import side, the value of imports in terms of the home, currency will increase or diminish according as the elasticity of home demand is less or greater than unity. When home demand has less than unity elasticity, the value of imports will rise higher and, when it has greater than unity elasticity, will fall lower, the greater is the elasticity of foreign supply.
A smaller or greater increase in the value of imports due to depreciation will be greater or smaller as the elasticity of home demand is smaller or greater.
Now in the case of , the supply of exports has but small elasticity because most of our exports are raw or processed agricultural products. Moreover, on the external market, they have to meet with a greater amount of competitive goods, such as Cuban sugar and Japanese tea, so the elasticity of foreign demand for our exports is very great. Under such conditions, a fall in the exchange rate may contribute to maintenance of competitive prices with our competitors, but the increase in the volume of exports will still be very limited. On the other hand, our imports are mostly goods necessary for our production or consumption and for which we can find no sudstitute on the internal market. So the elasticity of our demand is very small. As may be expected under the circumstances, the depreciation will tend to raise the price of imports greater than the fall in the exchange rate. In such a case, the effect of depreciation upon imports is unlikely to be favorable, and the benefit accruing to the balance of trade from the increased value of exports may be cancelled out, or even outdistanced by an increased value of imports.
The argument is incomplete without reference to the internal repercussions to depreciation. First, the dearer imported capital goods will raise the cost of home production, the production of exports not excluded, so that the Prices of all home-produced goods will correspondingly rise. Secondly, the imported consumer's goods will become dearer resulting in greater expenditure of our national income. In this regard, one may contend that, as the price of imports has already been fixed at the free market price of the U. S. Dollar, the readjustment of the exchange rate will not result in any further rise in the value of the imports. But, unless we can be assured that the readjustment will not bring about a further rise the free market price of the U. S. Dollar, it will be hopeless to attempt to arrest the upward tendency. Thirdly, the rationing price of arrivals under the provision of the American economic aid will rise in proportion to the readjustment. This will further raise the cost of production and the price of output. Under such circum stances, our export will not be able to retain in the long run the advantage of depreciation. Eventually, we shall be in a very awkward situation in dealing with the vicious circle of the exchange rate and the internal price, especially under the remaining influence of the recent inflation. The above argument compels the conclusion that the existing exchange rate, though too high, should not be readjusted.
VI
Now, let us discuss the central point of the problem. We have to ask how the curtailment of our export has been brought about. Nineteen fifty, the period before and after the outbreak of the Korean conflict, was marked by a higher price level on the external market, our export was in good condition, although the exchange rate was fixed at 10:1. Our difficulties arose in the latter half of 1951. As a rule, during the downward tendency of the external market, the exporting countries usually take to a depreciation policy. But internally, they endeavor, from time to time, to improve the technique of production and management in order to produce, at the cheapest cost, goods of the best quality. But, in the existing conditions of production, most of our output has been uneconomically produced. For instance, the sugar enterprise has recently carried out a drastic action of dismissing some 6,000 men without reducing its production. This proves that this enterprise, prior to that drastic action did suffer from over-employment, which fact accounted for the undue wage-cost. Besides, they have so far to pay other uneconomical expenses due to higher freight charges and dearer fertilizers and sacking, undue port charges and so on. This amount would account for some N. T. $200,000,000. The same is the case for other industries. Let us suppose that, by removing those undue expenses from the total cost we can reduce 25% of the cost of sugar production and the price of sugar correspondingly, it will contribute to the competitive price of our sugar on the international market at the current exchange rate.
As for the free market price of the U.S. Dollar, the existence of which has constituted a loss to exports, we have to investigate carefully the causes of its fluctuation and, accordingly, to adopt adequate measures for doing away with it. Then all the secondary influences on export will correspondingly fall away.
We are aware of the danger of inflation. We should not fail to understand that appreciation is one of the means to check inflation. We cannot say that since our currency has been in flatted, our exchange should be depreciated. Such a conception would not only delay the solution of our export problem, but also endanger the future of the economy. So before we could be assured that inflation would no longer be there and that existing productive conditions and the exchange system would be satisfactorily improved, it would hardly be possible to solve our problem by merely readjusting the exchange rate.