Crossroads (Toward Philippine economic and social progress)
Philippine Star, 15 July 2015


The current Greek economic crisis within the euro zone can be instructive for us in understanding our own monetary history since American colonial times. This is now what I will attempt to do. (I use italics whenever I refer to Greece.)

The fixed rate of exchange: Two pesos for one dollar.  From the beginning of its takeover of the Philippines in 1898, the US tried to maintain a fixed two to one ratio of the local peso currency to the dollar.

The peso was in wide use at that time. It was simply convenient to continue its adoption as basis for transactions involving trade and payments.

To attain monetary stability, the US colonial administration made a decisive change to stabilize the local currency by definitely linking it to the dollar through the gold standard.

The US dollar as a currency was then on the gold standard. This meant the dollar in circulation in the US was backed up by a specific value in terms of gold content which enabled the money’s value to be legal tender for domestic and international trade transactions.

American colonial rule progressed in the Philippines utilizing the monetary currency under the fixed ratio of two pesos to one dollar. In 1903, the Gold Standard Fund was set up to serve as a backup for the supply of transactions involving the peso. As it turned out, the strength of the US dollar backing up the peso was much more significant as an element that rendered stability to the peso as a currency.

This meant the peso was as good as the US dollar. The US colonial administration guaranteed the maintenance of the fixed ratio and facilitated its usage in payments and exchange. It was able to undertake its fiscal operations to run simply and smoothly.

The fixed peso to dollar parity could be likened to that of the euro currency of any member country in today’s European euro zone. The difference, of course, is the euro zone is a grouping of 19 countries and each member-country is independent with its own economic policies so long as these remain consistent with a policy of financial prudence required to remain in the euro zone system.

A euro in Greece is the same as in Germany, in France or in any other euro country. The euro has the same value and exchange rate among all the other 19 countries. Its exchange value within the member countries is fixed and uniform among all the members even as the euro itself could fluctuate in value relative to other world currencies.

A member country can free ride on the strength of the euro currency while it is weak on its own. This free-riding could obtain as long the country does not show extreme instability because of its condition. The strength of the euro would be provided by competitive economies within the zone.

For a long time, Greece enjoyed a free ride. When Greece followed a pattern of economic imprudence (with its high fiscal spending far exceeding its tax revenues, when its social programs could not be sustained with its tax collections), its demand for euro funds exceeded what it could produce as output and income at home.

That was possible as long as it could borrow to cover its extravagance. When it could no longer borrow or when the lenders stopped to lend it the money (most of whom were euro members themselves), then the free ride ended.

Philippine independence and monetary policy. Similarly, the Philippine economy could avail of the peso as if two pesos represented the equivalent value of a dollar. Under this fixed parity of two to one, the ebb and flow of economic activity followed the fluctuations (growth and depressions) that afflicted the US economy.

The passage of the Tydings-McDuffie law by the US Congress did not disrupt the value of the peso even though this law got passed during the Great Depression. The same monetary standard was used. Eventually, the country’s standard of living rose, facilitated by a stable exchange rate system that was sustained by prudent policies of continued development over the years.

(The Japanese occupation from 1942 to 1945 disrupted the economy and our monetary history. The new, managed currency under Japan meant uncontrolled printing of money that produced high inflation, serious economic disruption, and a breakdown of saving and investment. The fall of output and economic activity arising from the war and the occupation was severe. Output fell by as much as 60 percent of the level of GDP in 1940. (My estimates, based on a study of data.))

Aggressive policies of political independence and the exchange rate parity. For years as a colonial ward, consistent economic and fiscal policies provided a prop to the value of the peso-dollar rate.

Since American colonial fiscal policies were themselves prudent, there was no need or pressure to unleash a change in the parity of the peso to the dollar.

When we became independent in 1946, the new stage of political life led to aggressive efforts to promote industries and new investment projects, not to mention the need to satisfy pent-up consumption needs after the war.

All these produced an acceleration of expenditures not commensurate with the availability of tax and other non-inflationary financing. Despite the large inflows of foreign aid (US military spending and war damage payments), a large demand for imported goods put pressure on the peso-dollar exchange rate.

Even though we were committed to maintain the two to one peso-dollar exchange rate under the Philippine trade agreement with the US after independence, this ratio could not be held firm.

Within three years of adopting measures and projects as an independent country, the peso to dollar ratio was put under extreme pressures for change. By 1949 we had to impose import controls. A year later, we had to adopt more stringent exchange controls. We were definitely off the two to one peso-dollar exchange rate.

By this time, too, the Philippine central bank, established in 1949, was shaping monetary policy. Independence removed us from the tethers of a country with a strong currency. We had to manage our own.

We now had to face the risks and dangers of varying economic forces whenever we would make economic decisions that involve domestic spending, foreign trade, investments, and economic development