Saturday, February 16, 2008

Competing currencies: putting the Central Bank out of business.

The Inflation in Sri Lanka is now at about 20%, and the Central Bank expects the figures to remain at 16% to 20% at least for the first half of 2008. It’s getting so unprecedented now, that it’s receiving some attention from international monetary experts. Over in the U.S. too they have problems with their currencies, the Dollar is loosing value against other currencies at record levels.

So the question is when certain currencies under performs say the SL Rupee or the Zimbabwean Dollar, why wouldn’t the market choose other currency instead? (Economists call this dollarization – replacing a countries currency with currency from another country – e.g. US Dollars) While the Central Bank may have the monopoly authority to print money in Sri Lanka, what stops the market from choosing foreign currencies? Why wouldn’t for example, retailers in Colombo declare, they “now accept Euros, Dollars and Pounds for transactions" and consumers follow suit. After all, most retailers support multiple types of credit cards and modes of payment, why not different currencies? It’s a question I put to FussBudget of LBO, who’s possibly one of the few Sri Lankan economists who’s taking the issue of Inflation head on. Here’s his response:

Deane,
Good one ! It is legal tender laws that bar you from accepting for payment or keeping foreign currency with you. You are barred from even keeping dollars with you. These exchange control rules were a little relaxed last year. But still you have to deal in Sri Lanka currency and keeping large quantities of foreign currency is still illegal.

Foreign exchange is subject to exchange control as well as customs laws here, and the govt could not only confiscate them and land you in jail but also fine you 300 percent.

By allowing NRFC accounts Sri Lanka slightly relaxed the monopoly on savings in local currency some time ago.

When people keep dollar notes, keep travellers cheques without changing and NRFC accounts it chips away at the note issuing monopoly of a government. (Notes - reserve money - deposits - M2). The liking for foreign currency and the distrust of the local currency is due to the loose monetary policy of the central bank.

However with tighter monetary policy since 1995, when the Central Bank changed from a pure inflationary money printer to something that at least tried to keep inflation in check we have seen a slight change in the situation and confidence increasing in the local currency.

As you know at one time the US banned citizens from holding gold through legal tender laws.

Deane, your friend Ron Paul is asking for competitive currencies inside the US. In the US though gold is no longer illegal to hold, it is still taxed when traded. This makes it less easy to challenge the dollar monopoly.

At the moment we have a 100 percent reserve backed currency. That means if govt wants, they can dollarize Sri Lanka tomorrow and eliminate high inflation.

While the Euro is obviously the best currency to dollarize to keep inflation as low as possible, for purposes of exports it may be better to dollarize with US dollars to prevent a big shock to the industrial sector.

As you know a currency board is also the same as dollarizing in a practical sense - except that we will have notes of a different colour.

If you followed Yugoslavia, there was dollarization with the German mark, when hyperinflation struck. Then you had the situation of currency boards, Euro union etc.
Here the debate about monetary reform has been muted until now. With Steve Hanke also getting into the picture now the 60 years of deception practised by the central bank on the poor of this country is also getting chipped away. [Link to comment. The Links, emphasis in the quote are mine]
Well, whad’ya know, I’m a criminal. Hopefully none of the custom’s chaps read this blog. I have from recently actually kept some of my savings in foreign currencies instead of Rupees.

I knew there was probably a truck-load of regulation preventing a market-led dollarization from ever happening (in any country, really) but I didn't know the exact provisions in Sri Lanka.

FussBudget’s (who’s real identity I do not know) reference to Ron Paul is an exchange we had before and a few days ago Ron Paul – whom I backed for U.S. president – made a speech in the house floor asking congress to consider the concept of “competing currencies” . Here is a relevant excerpt:

At this country's founding, there was no government controlled national currency. While the Constitution established the Congressional power of minting coins, it was not until 1792 that the US Mint was formally established. In the meantime, Americans made do with foreign silver and gold coins. Even after the Mint's operations got underway, foreign coins continued to circulate within the United States, and did so for several decades.

On the desk in my office I have a sign that says: “Don't steal – the government hates competition.” Indeed, any power a government arrogates to itself, it is loathe to give back to the people. Just as we have gone from a constitutionally-instituted national defense consisting of a limited army and navy bolstered by militias and letters of marque and reprisal, we have moved from a system of competing currencies to a government-instituted banking cartel that monopolizes the issuance of currency. In order to introduce a system of competing currencies, there are three steps that must be taken to produce a legal climate favorable to competition. [link] (Emphasis mine)
None of this will probably happen for a very long time. But I’m glad the debate has started.

8 comments:

pinkboxinggloves said...

Something that is happening now is the emergence of regional "currencies" like this example in Germany. It's something like Disneydollars which can be used as currency in Disney Theme Parks and Disney stores.

I too, have some cash stacked away in GBP, which seems to be one of the stable currencies out there. This does provide something in the lines of SDR.

But I think rare metals such as Gold / Platinum will be the best "savings account" which we can use now.

Deane said...

Disney Dollar, nice. :) We should have a Colombo Dollar.

A Better example is probably the Liberty Dollar , which was a fully silver-backed currency. Unfortunately The company who was making the LD was raided recently and shut down by FBI/US Secret service.

The same company was making the Ron Paul Dollar some time ago.

The Story is here on Youtube.

(http://www.youtube.com/watch?v=qmNIdbl8cyk&feature=related)
(http://www.youtube.com/watch?v=4_sSipUrBG0&feature=related)

Paul, and the people from the Austrian School of Economics (among others) are backers of the idea of commodity backed-currencies, like gold. So Central Banks (i should say governments, really) cant just print money when they want them out of paper. US had a gold standard earlier, and thanks in part to the Ron Paul run it has received some attention of late, Alan Greenspan the former Fed chief is on record saying that US benefited under an international gold standard. (http://www.youtube.com/watch?v=ZjMQG3qUFKo)

Yes, keeping money in gold is probably a great investment, but it's just difficult i suppose to convert to currency when you need it. I should seriously do the numbers on whether it's actually more profitable to keep all of most of my savings in Euros. I think it is.

Andy said...

Great stuff, Deane.

I visited the links on youtube, in your comment. The person being interviewed made a valid point.

If i can exchange my Radio with your DVD player, why cant i do the same with silver. (or something close)

Are you serious about the Colombo Dollar?

Anonymous said...

I'm a Sri Lankan economist, working outside the country. You say the debate has started, but i don't see any debate outside of LBO and some places on the Internet.

If you take a look at the Sri Lankan newspapers, there's hardly any debate.

Why don't you guys start writing for the local newspapers?

Deane said...

Thanks both.

hmm I don't know, i suppose a Colombo-Dollar could work. :) checkout something called the digital gold currency I think it could be workable. i think.

Anon, Yes i wish there was more mainstream media focus on these issues. Me-writing for media, i don't think so. But you should. :)

Anonymous said...

Hi deane,
The debate has definitely started in the newspapers. Last Monday the island published an article from central bank Economic Research Department defending their monetary program.

They are beginning to feel the heat obviously. Whether or not the Central Bank's monopoly on currency is reducing, the central bank's former monopoly on monetary policy thinking certainly has crumbled and people in this country is slowly but surely realizing that inflation is a monetary phenomenon.

Here is the link.
http://www.island.lk/2008/02/19/features6.html

It is quite shocking to see how poor the central bank's grasp of monetary policy is as is shown by this article. But that is not really surprising. If they knew how the system really worked, this country would not be having 20 percent inflation.

Deane said...

Thanks anon. Good to see it has started, I believe there was something on Harsha de Silva's show on Biz1st(?). I couldn't catch it.

Yeah.. on the bright side, he's not arguing "It's Oil"

Deane said...

oh wait.. he kind of is..