"It is always very difficult to strike the right balance, particularly in exchange rate management, between withholding key information for the purpose of retaining some constructive ambiguity on the one hand, and transparency that theoretically enhances efficiency and credibility on the other.

... the free market does not always give priority to public interest. It is indeed advisable to keep something up our sleeves, whether it is key information or the right to change the rules of the game."

A market is nothing but a collection of buyers and sellers. Each agent makes decisions as to what to buy/sell, in what quantity and at what price. If a buyer finds the right product at the right price in the right amount, they buy it from a seller who has the right product at the right price at the right amount. It is simple and ingenious. My Yam has made a common mistake. A market is not an entity in itself. It has no morals. It never acts in the public interest. This was the key insight of Adam Smith:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

What Mr. Yam means is the free market does not always go how the HKMA would like it. That's a very different thing. He's not alone. Any time you hear or read someone bleating about the evils of "the market" and how it acts contrary to "public interest", be clear what both those terms really mean.

On the subject of dysfunctional markets...

Jake rightly explains that while Saint Alan Greenspan can get away with constructive ambiguity, the HKMA is in a very different position. Hong Kong's monetary policy is exceedingly simple: you get 7.8 Hong Kong dollars for every US dollar, or vice versa. It's robotic, it's well understood, it's credible and it works. It was setup in response to the debacle that was Hong Kong's monetary history. Thanks to some inventive policies it survived the 1997 Asia crisis, although it resulted in 7 years of deflation as a consequence (if your currency can't devalue, your prices have to fall).

Jake also notes in general the 1997 Asia crisis was survived, rather than dealt with:

...government policy muddles once again threaten to unsettle monetary affairs in Asia. The last time they did so the result was the Asian financial crisis of 1997. On that occasion it was exchange rate rigging in Thailand that set things off. At present it is fuel price subsidies in Indonesia that have come unstuck because of higher oil prices. This has led to rupiah interest rates soaring and the rupiah plunging.

The sad history of Asian central banks since 1997 has been one of first blaming others for their troubles and then resorting to the same old pre-1997 game of rigging their US dollar exchange rates without adopting a formal and transparent mechanism such as we have in the peg. The US dollar may have fallen dramatically against major currencies over the past three years but you would not know it to look at the exchange rate history of most Asian currencies over that period.

We have certainly had constructive ambiguity at work here but not St Alan's sort. All that Asian central bankers have done to stave off a repeat of the 1997 experience is starve their domestic economies of capital investment by building up massive foreign reserves in the hope that this will scare off the speculator.

Perhaps they will succeed on this occasion but, if they are determined still to rig their currencies, there is only one good way of ensuring that Indonesia's troubles go no further than Indonesia. It is to do what we did in 1997 by having a formal fixed currency system in place and sticking to the rules it imposed on us in a transparent manner that served the public interest.

* _{I should note, the title has absolutely nothing to do with this post. But it's a good one. Thanks, Tom.}

Other reading

Sun-bin translates more on Joseph Yam and the RMB basket.