ECONOMYNEXT – Sri Lanka’s gross overnight liquidity injections topped 400 billion rupees by mid December as money was printed to offset dollar sales by the central bank (sterilized interventions) and sell downs of a Treasuries stock held outright.
The estimated Treasury bill stock of the central bank had also topped 1.8 trillion rupees, based on available data.
The central bank started to sell down its disclosed Treasury bills stock held outright which peaked at 1,469 billion rupees due to failed bill auctions coming from an obsession to control interest rates, after price controls on Treasuries auctions were removed.
However the central bank was unable to sell down the bills permanently, as the credibility on an exchange rate peg was lost due to earlier money printing, which had made outflows exceed inflows (a balance of payments deficit) and the emergence of parallel markets due to partial convertibility.
Any convertibility provided (dollars exchanged for rupees to protect the exchange rate from printed money also called an ‘intervention’) leads to a liquidity shortage, which is then re-filled with printed money (sterilized) preventing a correction in rupee reserves of banks and the reserve money, triggering more credit and imports.
In November the central bank sold 310.64 million dollars to exchange for already existing money and has injected about 60 billion rupees to sterilize the intervention and maintain the 6.0 percent policy rate.
Sterilized interventions to maintain a policy rate is the key tool through which Latin America central banks destroy currencies and end up in debt default even when budgets are in surplus.
“Sterilized outflows was the key tool through which Argentina style central banks sought to resist the balance of payments,” explains EN’s economic columnist Bellwether.
“In the frenzy of Keynesian interventionism in the post-Depression era, this idea led to the wholesale collapse of gold standard central banks as economies recovered. Later sterilized forex sales led to the collapse of soft-pegged currencies in post independent nations creating social unrest.
“The same argument was used to break stable currency boards and move towards “active” versus “passive” balance of payments policy, with devastating consequences for those countries and the poor. These countries were doomed be emerging or Latin American basket cases forever.”
Goh Keng Swee, Singapore’s first finance minister who retained the currency board, said countries with such central banks were doomed to be ‘miserable developing countries.’
“..[W]e wanted to indicated to academics, both local and foreign; that what is fashionable in the West is not necessarily good for Singapore,” Goh said in a landmark speech.
“A perceptive mind is needed to distinguish the peripheral form the fundamental, transient fads from permanent values.”
The Monetary Authority of Singapore, which was later modified to appreciate the currency in the wake of bad Fed policy, blocks sterilized sales through a law requiring 100 percent foreign reserve backing for the monetary base and no policy rate.
The Singapore dollar which was 3.0 to the US dollar when the Bretton Woods collapsed appreciated to 1.2 to the US dollar with each inflationist policy errors of the Fed.
“These mistaken ideas were propagated by US academics like John Henry Williams (key currency advocate) and Arthur Bloomfield, a colleague of John Exter who found instances when gold standard central banks supposedly engaged in sterilized interventions,” Bellwether says.
“That is why in the end the Bretton Woods collapsed and Sri Lanka is suffering now despite rupee bonds being rolled over.
“They taught at Harvard and Princeton so generations of susceptible young people were brainwashed with these ideas.”
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In Sri Lanka’s Latin America style clause of open market operations was put as Section 90 of the US driven monetary law.
“The principle use of open-market operatiosn would ordinarily be to offset the effects of surpluses and deficits in the balance of payments,” Exter explained in 1949.
Exter, who seems to have been a partial skeptic of Keynesianism however cautioned in his paper and advised not to try to resist any fundamental changes in interest rates through liquidity injections and built in warnings into the law itself such as through Section 89 (1) (a) where he advised the central bank “not to alter fundamentally movements in the market resulting from basic changes in the pattern or level of interest rates.”
To break a cycle of sterilized interventions a float or higher interest rate are required.
On November 24, the book value of central bank’s Treasuries stock was 1,767 billion rupees according to official central bank data, though the disclosed number was 1,387 billion rupees, with overnight and term repo injections not counted.
The central bank stopped disclosing the full Treasury bill stock after it stopped giving bills to depositors in its excess reserve window (Standing Deposit Facility) reducing transparency of balance sheet data.
The estimated Treasury Bill stock of the central bank had gone up to around 1,830 billion rupees by November 30 compared to a disclosed number from around 1,750 billion rupees by end October.
The disclosed number of Treasuries held outright was shown to fall to 1,433.91 billion rupees on November 30 from 1,466.84 billion on October 29.
By December 16 the estimated bill stock had gone up further to 1,850 billion rupees based on available data after taking out repo transactions.
It includes 103.5 billion rupees injected to sterilize a reserve ratio hike, an unusual move also made to enforce the policy rate after the reserve ratio hike.
The central bank also started repo auction on November 17 in a bid to take out liquidity injected to short banks overnight from plus banks, both overnight and through term repos.
By December 16, 24.5 billion rupees had been withdrawn through term auctions and 39.15 billion rupees overnight. (Colombo/Dec17/2021)