Sri Lanka is suffering the worst currency crisis in the history of its central bank, with the rupee halved in value, children suffering malnutrition, elevated interest rates, sovereign default and the banking system also taking a beating.
In an island where rule-based monetary policy is viewed with disdain by policymakers and depreciation, mistargeting of interest rates and flexible or discretionary policy is revered, it is opportune to consider what the creator of the central bank said in hindsight.
John Exter created the central bank abolishing a Singapore and Hong Kong-style hard peg at the request of the then Ceylon government giving a long list of reasons why a central bank was more appropriate. The supposed drawbacks of currency boards now claimed by present-day economists – despite the malnutrition of little kids and outmigration – were also detailed in the report.
The Exter Report contained the standard US propaganda used to break the Sterling Area. “The decision of the Governor of Ceylon to establish a central bank was a decision with far-reaching implications for the people of Ceylon,” the report began.
“One implication already stands out very clearly; in taking steps to establish an independent monetary system to be administered by a central bank the government has demonstrated unmistakably its intention to achieve genuine economic freedom as a corollary of the political freedom achieved a year and a half ago.”
The lofty ideal of ‘Economic Freedom’ however did not last long. A brand new exchange control law came in 1952 and in 1969 an import control law. “This type of system therefore is a mark of colonialism,” he added for good measure, which may have been lapped up gleefully by the newly independent nation, little knowing that the public would soon be enslaved by draconian exchange controls, import controls and the import-substituting robber barons.
“For a developing economy it has a number of serious disadvantages,” the report continued.
“The role of the Currency Board must remain purely passive; it cannot influence the money supply in any way and thus relieve the pressure to which rapid swings in the balance of payments may at times subject the economy.”
This claim is oft repeated. “A 100% system, this a ‘fair weather system”, he also claimed falsely. A currency board’s value comes not in a fair weather system but in protection from the worst type of economic storm possible.
The currency board had already protected Sri Lanka during the Great Depression and two World Wars, from which both Singapore and Thailand suffered as central bank money was circulated by the Japanese. “Under such a system banks are vulnerable, for, without a Central Bank, they have nowhere to turn for help in case of need,” he added.
While this criticism is partially true, Hong Kong and Singapore had easily solved the problem with overnight liquidity without a fixed policy rate. Also, it is quite easy to set up a separate bailout fund with currency board profits if need be.
In practice, however, banks in currency board territories tended to be prudent and manage with deposit funds without access to extensive CB window facilities and largely avoid failure due to the inability to overtrade. To be fair in 1949 that was the prevailing Keynesian, Latin American dogma. Sri Lanka’s central bank was built on a blueprint devised for Latin America by Robert Triffin. The US was intent on getting as many countries as possible to join its dollar-pegged Bretton Woods system.
However, a few years later Bretton Woods itself was under pressure. In 1968 – a year before Sri Lanka enacted the Import and Export Control Law – to further rob economic freedoms and also established parallel exchange rates, Exter visited Sri Lanka.
In the publication Central Bank of Sri Lanka in Retrospect, a lecture he delivered at the Institute of Chartered Accountants is detailed. By this time Exter had predicted the collapse of the soft pegs and had started collecting gold eagle coins according to an interview given to Lawrence Sanders the founder of the Liberty Dollar.
He was quoted as saying that creating excess credit by the central bank was ‘bound to cause inflation, the balance of payments difficulties and generally unstable conditions.” Mr Exter said Ceylon could benefit greatly from the example set b several small countries in the area such as Malaysia, Singapore and Thailand.
“Hong Kong was the most remarkable economy in the world – its population had risen from 800,000 to four million in the past 20 years or so and yet there was no unemployment, wages had risen in the sixties by 75% while prices were kept at a low level. There were no exchange or trade controls of any significance in these small ‘city states’ that exported almost as much by value as India, a nation of over 500 million.
“The thing about Hong Kong and Singapore was there were no Central Bank-like institutions and monetary policy was determined by what he called market conditions. There was no organization which could disturb the stable dynamism of the economy by introducing control by resorting to deficit financing.” He also criticized the monetary policies of the US.
The thing about Hong Kong and Singapore was there were no Central Bank-like institutions and monetary policy was determined by what he called market conditions. There was no organization which could disturb the stable dynamism of the economy by introducing control by resorting to deficit financing
While Exter had changed his views, it was too late for Sri Lanka. Sri Lanka’s open economy was closed and the roots of two uprisings in the North and the South were to be laid shortly after. Neither Washington-based pundits nor Sri Lanka has changed their views even now. The country is still in the grip of Latin America style interventionism with depreciation thrown in as a bonus.
The thing about Hong Kong and Singapore was there were no Central Bank-like institutions and monetary policy was determined by what he called market conditions. There was no organization which could disturb the stable dynamism of the economy by introducing control by resorting to deficit financing