Sri Lanka has gone through easy money booms, involving private credit surges financed by central bank credit to boost growth, and the resultant forex shortages, tightening of exchange and import controls too often since the central bank was set up in 1950.
That we cannot get away from the cycle of inflationary rate cuts, and cannot end exchange or trade controls, is a mute testimony to the false monetary doctrine that is dogging this country and the rest of the ‘third world’ that remains economically backward.
The IMF is good at imposing stabilization programmes, by rate spikes, but is unable to stop the next crisis, or poverty from currency collapses or drip-drip-drip depreciation due to the flawed regimes that encourage money printing for growth, now called potential output targeting.
Monetary Instability
Stabilization programmes do not really ‘stabilize the economy’ but involve slowing economic activities steeply to restore the lost confidence of a currency monopoly. A country can’t grow steadily without monetary stability.
Extensive dollarization and currency competition which reduces the ability of a central bank to conduct monetary policy (print money), can reduce the chances of a next currency or economic crisis, better than any IMF programme can.
Meaningful monetary reform, which eliminates potential output targeting (printing money for growth) and money and exchange conflicts inherent in a non-floating ‘flexible exchange rate’ which has been legalized in the new monetary law, can eliminate future crises and the need for stabilization programmes.
Whether it is drip-drip-depreciation or steep currency collapses, conditions are created in the country of their birth by the bad money central bank to make it impossible for millions to make ends meet and drive them out of their country of birth into currency board-like regimes in the Middle East or East Asia,the Maldives, or other low inflation single anchor clean floating, with higher real wages.
In the countries to which Sri Lankans leave their homes and go, central banking is restrained by tighter laws and depreciation is legally difficult or impossible for potentially inflationist economic bureaucrats or the IMF to engineer.
IMF rhetoric peddled to countries without a doctrine of sound money, that currencies depreciate due to ‘economic fundamentals’ which must be matched by a flexible exchange rate, have no effect on countries where there are legal restraints against money printing.
“Selling FX should be limited to disorderly market conditions and not prevent the exchange rate from moving in line with economic fundamentals,” the IMF told Sri Lanka in the December 2023, staff report.
All such Anglo-American inflationist talk disappears without a trace when faced with tight laws restraining bureaucratic rate cuts found in Dubai, Saudi Arabia, Qatar, Oman or indeed Hong Kong, which send money to the victim nation. The sad truth is that it is not ‘economic fundamentals’ that drive the value of a currency produced by a state-run central bank.
It works in the opposite direction, with the overproduced bad money of the SOE, which has been given a legal monopoly by misled politicians, driving countries into crisis and blasting economic fundamentals to smithereens.
Who Recovers First?
The consumers whose purchasing power recovers first, are the families of the people who have fled the country with the 5% or higher inflation targeting ‘flexible exchange rate’ central bank without a clean float.
In remittance-receiving countries which cannot create jobs – or the real wages of whatever jobs are generated are destroyed with a 5% inflation target and a depreciating flexible exchange rate – a significant part of the labour force has been driven out by previous monetary instability based on similar ‘impossible trinity’ IMF-backed monetary regimes.
Currency crises – especially in peacetime – do not appear out of the blue but are necessary outcomes of persistent beliefs in spurious monetary doctrines. Therefore, there is an existent community outside the country, whenever rate cuts trigger the latest crisis. There is an eco-system of job agencies, and a network of friends and family who will help get into these countries through legal and informal means.
Most clean floating countries usually have tight work permits and visas, making illegal entry more likely. In periods of extreme instability and deployment of macro-economic policy, there will also be boat people and people smuggling activities as well. It is a shame upon all Saltwater-Cambridge economists to see this happen in a country at peace, as their stimulus mania (specifically output targeting under flexible inflation targeting now), to see boat people.
Unlike wage earners in other sectors, remittance families get dollarized earnings from their family members outside, and their real incomes adjust. Sri Lanka’s Monetary Board or Monetary Policy Board cannot cut their wages to impoverish them since their wages are denominated in a currency issued by a better central bank or currency board-like regime, and not Sri Lanka rupees.
Farmers Also Recover
As long as there are no price controls – like those imposed on eggs leading to the closure of layer chicken farms – vegetable and grain prices go up with depreciation. Smallholder tea farmers, whose green leaf prices are linked to export prices will also see incomes go up to pre-crisis levels.
Food is generally an item that people will consume even when incomes fall, so farmers will tend to get pre-crisis incomes. This time farmers are also getting a boost from El Nino rains, this year, which is a silver lining. However next year conditions are less certain.
Tourist Sector
If there are no price floors – minimum room rates – to drive out tourists to other countries in East Asia, tourism is also a sector that recovers with dollar incomes. There is usually money to be paid as service charges or wages. Wages take time to adjust but may be faster than in other sectors. Those engaged in transport and operation of small hotels will be able to fill their hotels – unless there are minimum room rates.
The exodus of workers from the sector, where progressive taxes have also taken a hit on real wages, shows that the recovery in wages is below pre-crisis levels. However small hotel and restaurant owners will get pre-crisis incomes as long as occupancy is maintained. A part of their incomes, especially in larger hotels with debts, will go to settle bank loans.
Wage Earners
The hardest hit are wage earners in other sectors, which are the last to recover. Many small businesses, especially highly leveraged ones, will go down in the stabilization period when the real incomes of people fall and their sales also drop in proportion.
Among the wage earners, the higher income categories are the first to get used to the higher prices after depreciation and begin to spend. This time, progressive taxation had also taken a toll on the recovery through that path. However, in some of the larger companies, salaries have been raised to adjust for the higher income tax.
The last people whose income recovers will be other wage earners. It may take up to two years or more for prices to adjust to a currency fall. Typically, in bad-money-central-bank countries, by the time their wages recover, the currency would have depreciated some more, making workers either engage in strikes, bloating the ranks of unions or leave the country for other regions with greater monetary stability.
Even in the year that their salaries make a full real recovery, they are vulnerable to the seductive voices of economic charlatans of the right (nationalist) or the left, depending on who was responsible and who is carrying out the stabilization programme.
Construction
The construction sector will be one of the last to recover. The construction and capital goods sectors are the ones that gain the most from easy money (rate cuts from inflationary open market operations).
With outright purchases of bonds from the banking sector or term money injections, a flexible inflation and output targeting central bank or even a clean floating one will make it possible to finance projects that would never have been able to have real deposits available for credit.
Since output targeting money will end up as mal-investments, capital goods industries will take a hit when the bottom false out the market. The current troubles in China, and the US housing bubble, are also reflections of the same phenomenon.
Austrian economists very well explained the phenomenon. “The Austrian theory further shows that inflation is not the only unfortunate consequence of governmental expansion of the supply of money and credit,” explains US economist Murray Rothbard, a strong critic of the Federal Reserve’s policy errors. “This expansion distorts the structure of investment and production, causing excessive investment in unsound projects in the capital goods industries. This distortion is reflected in the well-known fact that, in every boom period, capital goods prices rise further than the prices of consumer goods.”
There are also bad loans amid the recession. “The recession periods of the business cycle then become inevitable, for the recession is the necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources from the capital goods to the consumer goods industries,” notes Rothbard.
Default
However, there are several threats to the cyclical recovery. Sri Lanka’s debt is being restructured and market access is expected to be restored after an ISB restructure if all goes well. Sri Lanka’s sovereign default has dealt a blow to confidence. Before the 2022 default, the debt repayment record did inspire some confidence. There is usually no shortage of bond buyers for defaulting countries like Argentina, especially when US rates are low.
Repeated defaults do not seem to have deterred lenders, since default has become fairly commonplace in the wake of post-1980s intensive currency crisis. It may well be the case in Sri Lanka. However, it is also likely that ISB holders and other lenders who give credit lines to banks will be faster off the mark in the next cycle.
Sri Lanka will be more vulnerable to external default as some of the lenders will remember, in 2022. Stock market investors will also remember how they were locked in and were unable to remit money out. Rupee bondholders also seem to be much more cautious now.
Sri Lanka’s recovery can also be slowed by reserve collections where part of the inflows are directed to the US or other reserve currency countries. However as long as there is monetary stability and liquidity is not injected to suppress rates and bust the currency, interest rates will and people’s lives will improve and the economy will grow as a result.
External Threat
A big threat may come from a US and Western economic disruption. Economist Steve Hanke who accurately predicted the Fed’s inflation based on money supply movements, among other indicators, has a steep recession that is ‘baked in the cake’ based on current broad money movements.
In the last few years, a big volume of money printed by the Fed went into government debt, not housing mortgages like in the 2008 crisis. People largely spent pandemic cheques, where the government was the borrower and not just private investors like in the Great Depression, when the fixed policy rate busted a country with a fairly benign situation even after World War I.
A default on US debt seems unthinkable, but the country’s credit is weaker than ever before. Confidence is fickle and can be lost in a hurry. The US political system is in disarray. The effects of the US and general Western disruption are already being seen in Sri Lanka’s export numbers, even though a recession is not official in those countries based on econometrics and definitions as yet.
An unusually bad disruption of the US and Western economies is possible whenever monetary ideologies deteriorate. Under Jerome Powell,
Multiple Mandate Threat
The biggest threat in Sri Lanka, as always is the ‘flexible exchange rate’ or depreciating soft-peg and potential output targeting. The inflationist monetary regime, currently peddled by the IMF to unfortunate countries without a doctrinal foundation in sound money can trigger an external crisis as soon as the economy recovers, as it had done before.
If the central bank can maintain monetary stability without printing money, a chance will be available for battered people to raise their heads. However, the prospects are dim. In monetary policy statements, there are mentions of potential output figures larger than life.
“The Board arrived at this decision following a careful analysis of the current and expected developments in the domestic and global economy, to achieve and maintain inflation at the targeted level of 5 per cent over the medium term, while enabling the economy to reach and stabilize at the potential level,” the last monetary policy statement said in the second sentence, rivalling Powell’s reference to employment, indicating that there is a very strong belief in a dual mandate and the effectiveness of macro-economic policy despite the carnage wrought in the past few years.
Stabilization periods are also fertile grounds for nationalism to rear its head. It has happened in many countries. Unfortunately, such ideologies rear their heads just as the economy starts to recover from the collapse as stability is provided by monetary authorities.