ECONOMYNEXT – The steep salary hikes of Sri Lanka’s central bank after the inflation the agency itself created, has drawn public and legislators’ ire, but the deeper problem is that it is yet another sign of the lack of accountability in the new monetary law.

Some legislators are upset that the Parliament’s control of public finances has been usurped by the ‘independent’ central bank.

But Sri Lanka’s central bank has a history of topping up pensions also to cover for inflation  – whether low or high  – while giving low interest loans for staff.

This is questionable because unlike other SOEs, the central bank itself is responsible for cutting rates, blowing a hole in the balance of payments, driving up inflation and later interest rates to stabilize the currency.

The practice of transferring billions to defined-benefit pension staff funds when inflation and interest rates are down, can perhaps be excused as a reward for not triggering monetary instability.

But when steep salary hikes are given when inflation rises, the act insulates the staff of the agency from its own policy errors and makes the very people who de-stabilized the nation, to be rewarded for their actions.

This runs counter to the principle of accountability.

If a ceiling on the annual salary hikes is placed on the central bank along the lines of the inflation target – not its achievement – may be the agency would be incentivized to give low inflation.

That is why in price regulation, other SOEs with monopoly powers are given price increases based on a benchmark.

However, that is a second-class solution and distracts from solving the underlying problem of not having a single anchor monetary regime that can be practically operated and excessive discretion that comes from a high inflation target.

Lawyers and Activists

Sri Lanka’s lawyers and public interest activists took several macro-economists who injected money to cut rates to court as well as their politicians who endorsed the action (or were misled depending on how it is viewed) and got a historic judgement against them.

This should serve as a warning to macroeconomists who cut rates or otherwise inject liquidity and trigger forex shortages and currency crises.

The actions of the lawyers and activists and the historic judgement show that this country is no longer what it was in the 1970s or the 1980s.

Macro-economists cannot get away with the same actions they did in the 1970s, though they have managed to mislead the legislature into passing a new monetary law of the inflationists, for the inflationists and by the inflationists.

Inflationist macro-economists all over the world are adept at blaming all and sundry for the consequence of their obsession with rate cuts and the belief that easy credit forms a path to prosperity instead of providing a stable monetary foundation for people to live.

It is no accident that Lee Kwan Yew was a lawyer and he understood monetary systems as well as classical economists did.

Both lawyers and classical economists use deductive reasoning.

‘Data driven’ macro-economists today depend on mindless statistics and dismiss anything that does not fit their world view as ‘outliers’.

Even data driven macro-economists should reflect on why currency crises were created with a 5 percent inflation target after the end of the war, eventually driving the country into default, and whether they should continue to take cover under such a high target.

Accountability

The so-called ‘accountability’ provisions of Sri Lanka’s new law, can only be described as a joke and goes to show that it was a self-serving piece of legislation that allowed the agency to de-stabilize the nation and get away with it.

If the central bank misses the inflation target the governor or the monetary policy board does not get sacked.

A central bank’s monetary law has to be a constitution that restrains its actions and forces the agency which has been given a monopoly in money not to de-stabilize the nation.

It should not be a tool to give absolute discretion as the current law has done through ‘independence’, and a high inflation target.

Australia’s Central Bank Governor Philip Lowe last year lost his job – his term was not renewed – following high inflation and rate hikes after money was printed for ‘stimulus’.

He was under pressure for giving what was called forward guidance – promising not to raise rates till around 2024 and getting people to borrow – and suddenly doing so when inflation went up.

Ordinary people understand that kind of thing better than the fact that monetary stimulus or potential output targeting or indeed the policy rate itself which is mis-used for goals other than stability, is the fundamental problem.

A low inflation target is essentially a legal restraint on the mis-use of central bank’s liquidity tools.

How does a central bank get money for salaries?

The central bank earns money to pay salaries essentially from seigniorage, that is profits from the note issue.

If there is high inflation, the central bank makes more money from its Treasury bills portfolio, which it usually acquires in the process of cutting rates and de-stabilizing the nation.

This column has advocated a currency board, rather than dollarization, so that profits from the note issue remain in this country.

But the profits from the note issue are small compared to the losses to generations and the social unrest the agency creates in the process of issuing rupees.

By engaging in third world central banking and borrowing through swaps and the Asian Clearing Union to intervene in forex markets and print money to maintain its policy rate, the central bank made large losses on its forex operations in the current rate crises.

Dollarization is just as good a fix as a currency board, that will bring stability and block the ability of inflationists and the IMF to engage in macro-economic policy.

The benefits from dollarization, which will put a permanent brake on macro-economist’s powers to de-stabilize the nation and drive away part of the population, will be far greater than the lost profits from the note issue.

The macro-economists’ claim that a currency board cannot be set up without full reserve backing is false as a currency board is simply a means of eliminating the bureaucratically decided policy rate.

As in a floating exchange rate, currency boards do not actually use reserves (because money printing is outlawed) for imports or any other purpose. That is why reserves do not fall steeply in currency board regimes and the exchange rate remains fixed.

However, it is less easy to convince the public that a country cannot be dollarized or currency competition cannot be introduced.

In Argentina macro-economists and other inflationists successfully scared off that unfortunate man Javier Milei from dollarizing the country though several other countries in the region itself from Panama to Ecuador to El Salvador have done it.

He is now trying to relax economic controls without restraining the central bank first and the fate of JR Jayewardene or worse, awaits him.

The problems in Argentina show how difficult it is to defeat the inflationist macro-economists and the current ideology of interventionism that dogs a discipline that continues to be called ‘economics’.

Economic Freedom

Instead of just arguing about salaries of central bankers – even though it may well be a valid point from the view of parliamentary control of public finances – a better strategy will be to end the money monopoly of the agency and reduce its ability to destabilize the country in the future.

The current money monopoly was created by the British in 1884 when the Ceylon Currency Board was set up.

Before the currency board two Chartered Banks issued money.

The Madras Bank’s rupees did not depreciate, unlike that of the Oriental Bank Corporation (corrected), which depreciated steeply when it closed its doors in is now called ‘floating’.

Before the Bank Charter Act Sri Lanka had free banking as well as currency competition.

The false claims made by central bankers and other macro-economists today that the exchange rate has something to do with the real economy could not be made so easily in the earlier ages in countries without a money monopoly.

When one currency is stable and another currency depreciates in within the same country, one cannot get away with blaming budget deficits or current account deficits. The problem with excess credit in the note-issuing bank is clearly spotted.

Exchange controls can be eliminated after the powers to create monetary instability are taken away, and economic freedoms restored.

That is why countries like Estonia, Lithuania, Latvia, UAE, Singapore and Hong Kong where macro-economists were defeated in a crisis, figure on the top of the list of countries with economic freedom rankings.

By calling monetary instability ‘macro-economic instability’ Western post-1920s inflationists have managed to deflect the blame away from themselves, and prevented the problem from being ever solved.

If the legal tender monopoly is taken away from macro-economists, the people will have freedom to use other types of currencies.  

The central bank’s ability to depreciate the currency and blame its victims will diminish as foreign currencies progressively push out rupees as the circulating medium.

Salaries are low in Sri Lanka and people leave for jobs in currency-board-style regimes in the Middle East in Saudi Arabia, UAE or Qatar, due to the central bank destroying the rupee and denying monetary stability for this country to grow and create jobs, with unworkable operating frameworks and high inflation targets.

It must be noted that under current central bank Governor Nandalal Weerasinghe, the rupee has appreciated and not depreciated.

It is not an accident but purely due to the monetary policy followed by the agency under him.

The currency appreciation has prevented further burdens falling on the people, including through energy prices, but that is not widely understood.

Upending Economics

Ironically, it was the British Currency School in the classical tradition, that created the money monopoly of the Bank of England, though with very good intentions.

The Bank Charter Act was an attempt to impose restraint on note-issue banking from outside.

However, with the fixed policy rate, the opposite happened after the First World War and the US Fed invented open market operations.

Sri Lanka’s monetary law in particular and the operational frameworks of IMF-dependent reserve-collecting central banks with outright purchases of domestic assets in general, have been developed as if Ricardo, Hume, Cantillon and Adam Smith never existed.

It is a testament to the success of the ideology of Anglophone universities and perhaps the IMF, that such note-issuing banks continue to exist and spurious claims like exchange rates are ‘market determined’ are widely believed.

That the exchange rate is the outcome of the success or otherwise of the monetary anchor pursued by the central bank through its operational framework is no longer widely known.

If Robert Torrens, or Ricardo or Hume were alive today and heard what was being peddled as ‘economics’ in their name, or through Sri Lanka’s IMF backed monetary law, they would be shocked to the core.

They would be surprised to know that people who claim to be ‘economists’ are in fact following the doctrine of John Law, who was among the most well-known persons who proposed the bureaucratic interest rates enforced by printed money or what is now called the policy rate.