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Wednesday May 18th, 2022

Sri Lanka monetary instability blamed on lack of industrialization

KOREAN TROUBLE: Despite the overhaul of a Latin America style central bank built by US money doctor Arthur Bloomfield, Korea continued to have BOP trouble and high rates (which triggered subsidized credit) until the mid 1980s reforms.

ECONOMYNEXT – Sri Lanka’s recurring monetary instability is due to lack of industrialization and not money printing or budget deficits, Howard Nicholas, an economist said, though the hot favourite now is lack of tourism revenues.

Others have blamed Sri Lanka’s monetary troubles on trade deficits (the usual suspect), oil, vehicles (another usual suspect), low productivity, exiting rupee bond holders (after 2015 in particular).

Throughout the 1990s controlling budget deficits were given as a ‘panacea’ for all economic ills but the country continued to have current account deficits and currency troubles, Nicholas who is from the International Institute of Social Studies (ISS), Erasmus University Rotterdam said.

Budget deficits was blamed for crowding out private investment by the International Monetary Fund and others he said.

“The reason was the lack of industrialization,” he told a business forum in Colombo organized by the Ceylon Chamber of Commerce.

Industrialization had happened in the late 1980s under President Premadasa, he said.

In Sri Lanka there were lot of opposition to money printing.

But Nicholas said the idea was no longer ‘fashionable’.

However he said unlike Modern Monetary Theory advocates he did not believe that money printing and deficit spending could be continued all the time.

The industrialization was the answer to end balance of payments troubles and industrialized countries such as in East Asia for example have current account surpluses he said.

“Vietnam went aggressively for industrialization in 2010 and they never had a balance of payment problems,” Howard claimed.

As the US housing bubble collapsed in 2008/9 Vietnam engaged in a stimulus attempt cutting rates and triggered a currency crisis.

The dong collapsed from around 16,000 to around 21,000 dong by the end of the debacle.

By 2011 overnight rates were topping 14 percent as the State Bank of Vietnam desperately defended the collapsing dong amid an unsustainable boom.

After the currency crisis Vietnam was left with massive bad loans from the mal-investment made during the boom, partly fuelled by the US Greenspan-Bernanke housing bubble in the 15,000-16,000 dong peg period.

The SBV has since been using the exchange rate as an inflation anchor for low inflation and stability and trying to dispel the US led Mercantilist myth that its currency is ‘undervalued’.

Vietnam has so far resisted IMF and US pressure to move into ‘flexible inflation targeting’ a highly discretionary regime with virtually no rules, which had devastated Sri Lanka in recent years.


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Vietnam’s stability and growth, both in domestic non-tradable and export activities started gain traction after SBV reforms after 1989, when its bank credit operations were separated into commercial banks to stop central bank re-financing, analyst familiar with Vietnam say.

Some of the banks such as Viettin bank (Vietnam Joint Stock Commercial Bank for Industry and Trade) unlike in China are now privatized and listed on the stock market as part of reforms envisaged under the US-Vietnam bilateral trade agreement, which led to a series of deep reforms.

A third spurt including large scale shifting of Korean firms like Samsung as identified by top policymakers in the country started after Vietnam entered the WTO in 2006.

Soon after the economy re-opened in 1986 the currency collapsed as central bank re-financed credit expanded and the economy imploded as the currency collapsed, triggering a new wave of boat people and an uprising in the highlands.

The first SBV reforms were almost similar to Peoples Bank of China reforms under Deng Xiaoping in 1978. However partly due to state enterprises finance the Renminbi continued to have problems until the late 1980s, until it was fixed in 1993 as a firm external anchor.

Nicholas said in Sri Lanka now people are complaining of money printing, but Japan was printing money and did not have inflation.

However Japan also had high inflation when it was printing money with a pegged exchange rate, until the currency was fixed at 360 by US banker Joseph Dodge under Amerian occupation, as inflation hit triple digits and food shortages were worse than the the war, analysts have shown.

Korea, the poster child for state backed industrialization also had severe currency crises, inflation and high interest rates to defend the currency, subsidized credit and government guarantees for foreign loans until the Bank of Korea was successfully reformed in the in the mid-1980s.

Korea’s First Republic collapsed along with currency under a US-built central bank designed by Arthur Bloomfield, a Fed official like John Exter, who built Sri Lanka’s Latin America style central bank.

However Bank of Korea (in its second re-incarnation) was reformed around a dozen times and periods of exchange rate stability of at least two Fed cycles at a time.

The Korean won appreciated for the first time in the 1987.

Meanwhile Howard said currency stability usuall came after industrialization and Sri Lanka should not to put the “cart before the horse”.

But countries like Singapore and Hong Kong and to a great extent Malaysia (until 2006) had currency stability and low interest rates due to orthodox currency boards or currency-board-like systems long before they were industrialized.

Un-fashionable ideas

Like Ceylon before the US-built central bank, their currencies were stable decades before they became industrialized, data show.

Singapore made its “Colonial” currency board the foundation of its economic program.

“When nearly two-thirds of our citizens’ expenditure is spent on imported goods, a strong Singapore Dollar helps to keep consumer prices down,” Singapore’s economic architect and Lew Kwan Yew’s top minister said explaining the decision.

“The second purpose was to inform our citizens that if they wanted more and better services, they must pay for these through taxes and fees. There is no free lunch here.

“Third, we wanted to indicated to academics, both local and foreign; that what is fashionable in the West is not necessarily good for Singapore. A perceptive mind is needed to distinguish the peripheral form the fundamental, transient fads from permanent values.”

“We also noted that the Germans and Japanese did not believe they could “spend their way to prosperity”, as the phrase went. Like Singaporeans, they set store on diligence, education and skills.:


Why Singapore chose a currency board over a central bank

One of the most industrialized countries in the world Germany also had currency troubles and defaulted until the Deutsche Bundesbank was built by Ordoliberals and Joseph Dodge.

Central Banks generally get a free pass for policy errors with monetary instability in the form of inflation, credit bubbles (and balance of payments troubles if is pegged), being blamed on cost-push, commodity prices, imports, overvalued currencies (REER), trade deficits and current account deficits.

The latest free pass to reserve currency central banks is ‘transient inflation’ and ‘supply chain’ problems.

Over the past year Sri Lanka has blamed currency troubles on the lack of tourism revenues.

Classical economists have pointed out that budget deficits which transfer private spending power to the government cannot create any additional demand unless accommodated by the central bank to reduce crowding out. (Colombo/Dec06/2021)

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