ECONOMYNEXT – The International Monetary Fund usually asks for upfront currency depreciation, which then brings more problems to the country, State Minister for Money and Capital Markets Nivard Cabraal said.
“Do you want to have a rupee which is depreciating? Tell me,” Minister Cabraal said responding to a question at a recent media briefing on why Sri Lanka does not go for an IMF deal despite balance of payments troubles.
“The first thing they will tell is to depreciate the currency. So many countries have gone and done that.”
When currencies depreciate, the price structure of the country is pushed up and more taxes have to be charged and the prices of energy and food commodities go up, reducing the real salaries of the working class and pushing up running costs of the government and companies.
Eventually the prices of non-traded items also go up. If the anchor currency (the US dollar in Sri Lanka) also prints money such as during the 2008 and now, the inflation created by the Fed will be added.
If there is foreign debt it will be retain its value (but bloated in terms of domestic currency) and the value of all domestic financial savings and pension funds will deteriorate, destroying capital and savings available for the future investments and growth.
Like the dollar debt, dollarized deposits will retain value.
In the downturn that follows a currency collapse, taxes on the public have to be raised to cover government spending especially salaries of state workers.
As a result IMF also asks for fiscal corrections.
“Do you want to have all these problems in the country? Social problems as well as public sector problems?,” Cabraal asked. “Do you want to have high interest rates?”
New Dealer Interventionism
IMF was set up after World War II by Harry Dexter White, a Keynesian and arch New Dealer with suspected links to the Soviet Union, to ‘lend’ reserves to countries which had printed money and faced a run on the central bank (a balance of payments deficit), when the Bretton Woods system of failed soft-pegs were set up.
The IMF tends to claim that a currency is ‘overvalued’ and had to fall, based on a belief among Mercantilists that balance of payments troubles were linked to ‘price effects’ or export competitiveness and not money printing that place artificial nominal incomes in the hands of the recipients of the newly printed money.
Usually Mercantilists claim that currencies are overvalued using a Real Effective Exchange Rate Index if the number is over 100.
However when stable pegged central banks in East Asia which are tighter than currency boards, mop up foreign inflows and run current account surpluses moderating domestic credit, the IMF claims the currency is ‘undervalued’ though the Real Effective Exchange rate may be in the region of 120 or 130.
The US Treasury then claims that the currency is undervalued or ‘manipulated’ and the IMF tries to push the central bank to arbitrary ‘flexible’ policy, which trigger monetary instability, output shocks and political upheavals.
Vietnam’s real effective exchange rate index was over 130 when the US Treasury labelled the dong as undervalued.
Explanations by the State Bank of Vietnam that it was using the strong exchange rate peg (external anchor) for domestic stability has no effect on Western financial media or Mercantilists in the US or elsewhere, who insist that East Asia is undervalued.
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The request for currency debasement and unsound money by the IMF may date back to the leftist or statist New Dealer policies, which involved busting the US dollar to 35 units to the ounce from 22 in 1934 and viciously barring US citizens from holding gold to protect themselves, analysts say.
Depreciation Cheering Squad
John Maynard Keynes himself had cheered Britain going off the gold standard in 1931 (floating).
The debasement eventually cost the Sterling its position as the global currency which went to the US dollar and reduced the UK to beggar status after World War II, while Germany which lost the War forged ahead with monetary stability and zero IMF programs.
“We feel that we have at last a free hand to do what is sensible. The romantic phase is over, and we can begin to discuss realistically what policy is for the best,” Keynes crowed in September 1931.
“It may seem surprising that a move which had been represented as a disastrous catastrophe should have been received with so much enthusiasm.
“But the great advantages to British trade and industry of our ceasing artificial efforts to maintain our currency above its real value were quickly realised.”
“No wonder, then, that we feel some exuberance at the release, that Stock Exchange prices soar, and that the dry bones of industry are stirred.
“For if the sterling exchange is depreciated by, say, 25 per cent, this does as much to restrict our imports as a tariff of that amount; but whereas a tariff could not help our exports, and might hurt them, the depreciation of sterling affords them a bounty of the same 25 per cent by which it aids the home producer against imports.”
The world was soon engulfed in the Great Depression, the rise of German nationalism and the World War II.
In 1946 Keynes himself had to beg for a 4.5 billion US dollar loan from the US (and 1.19 billion from Canada). Ironically a condition of the loan was that Britain resume convertibility (gold pegging).
Related: Anglo-American Loan
IMF, which was set up to lend reserves for deficit countries originally and was not shut down after the collapse of the Bretton Woods in 1971, is now involved in debt restructuring, which can result in a co-ordinated approach.
Key lenders such as the Paris Club and other lenders such as the World Bank also work with IMF programs. China has also fallen in line with in the latest G20 initiatives.
Both the gold standard and hard or sustainable pegs and pure floats are self-correcting on the balance of payments as long as interest rates are not pushed down with money printing.
A successful or sustainable currency peg works by changing reserve money (the monetary base) in step with the balance of payments. To change reserve money in step with the BOP overnight interest rates have to change daily, based on the (unsterilized) interventions made in forex markets.
The unsterilized forex interventions made by a peg, rations credit (for imports or purchases of assets of fleeing investors) in the banking system through short term changes in the volume of rupee reserves in the banking system and changes in interest rates.
A forex sale by the central bank, which contracts liquidity will reduce total credit banks can give to below the new deposits and loan repayments received by the banking system.
A purchase of dollars will add liquidity, making possible credit above the deposits raised. As a result outflows of dollars will match the inflows of dollars in a consistent peg with no or limited open market operations.
However if the rupees lost in the interventions are re-injected to the credit system again through open market operations or outright monetization (sterilizing or over-sterilizing the dollar sale) the credit correction will not take place and more foreign reserves will be lost due to outflows of dollars financed with the newly minted money.
To correct a built up mis-matches and weakened confidence, large hikes in interest rates are needed.
The IMF may also ask for a ‘float’ to end the cycle of forex interventions and liquidity injections which triggers a reserve loss and change the regime.
In a floating currency regime, there are no forex interventions or sterilization with new liquidity. The monetary base and interest are ‘fixed’ in the short term and the rupee reserves in the banking system are no longer altered unlike in a peg.
Domestic credit is immediately limited to available deposits and loan repayments and outflows of foreign exchange are matched to inflows through the fixed monetary base.
Any timing differences between outflows and inflows are reconciled through the floating exchange rate and the bank net open positions. In the medium term inflation is kept down by targeting an inflation index (and the monetary base) by raising or lowering interest rates through open market operations.
Dual Anchor ‘flexible’ Pegs
However the IMF, which loans money to the distressed central bank will not be able to recover the loan under a clean float. Therefore to collect forex reserves and repay the loan, the exchange rate has to be pegged (external anchor) again.
The IMF also usually advocates a regime that is neither floating nor hard pegged (flexible exchange rates) which switch between regimes and conflict with each other. Such currencies can depreciate indefinitely with no end in sight as happens frequently in Latin America.
Keynesians, using Mercantilist reasoning claim that the depreciation would help restore ‘export competitiveness’ and help fix monetary instability.
But in practice a pro-cyclical unstably-pegged central bank will later print money at the depreciated rate and get into trouble again, requiring another trip to the IMF, another steep rate hike instead of gently fluctuating self correcting rates changes.
Another depreciation, more ad hoc tax hikes, fresh hikes in energy and commodity prices as well as subsidies to help the worst affected poorest from currency depreciation follow.
As the economy and tax revenues contract mid-way in during an IMF program due to shrinking consumption from the currency collapse, more ad hoc tax hikes are made.
The IMF does not reform the central bank with the soft-peg or flexible exchange rate, which is the root cause of monetary instability and the central banks of such countries keep going back to the IMF again and again.
In Keynes’ own country the Bank of England went 11 times to the IMF before classical economists took control of the polity and put the brakes on monetary instability in 1978 and ended 40 years of exchange controls.
Economists call a soft-pegged central bank’s repeated journeys to the IMF, recidivism.
Further reading: Many happy returns? Recidivism and the IMF
The Bank of England’s IMF trips continued until Margaret Thatcher and her advisor Alan Walters ended them with tight monetary policy laying a strong foundation for growth until the European Exchange Rate Mechanism (ERM), which was another system of failed soft-pegs.
Thatcher’s advisor Walters, who took Britain out of frequent pilgrimages to IMF then resigned over the ERM incident. The ERM soft-pegs collapsed as predicted.
The pegs that collapse most often and end up in the IMF are in Latin America.
After the Great Depression created by the Fed, many once-stable gold standard central banks in Latin America were turned into unstable soft-pegs with US advice.
The Feds Latin America unit led by Robert Triffin, used a model inspired by Argentina central bank creator Raul Prebisch to change the operations of the central banks in the region or set up new ones. Prebisch himself was invited to participate in some of the Lat Am missions.
Both Philippines and Ceylon central bank was set up by the same Fed money doctor, John Exter. The Philippines central bank went bankrupt, partly helped by swaps and had to be recapitalized.
Depreciation at New Parity
Though the claim is made that depreciation will fix the balance of payments trouble, a soft-pegged central bank will keep printing money to keep rates low and at the new (lower) parity, and the currency comes under pressure again a few years later.
Typically forex shortages in soft-pegs trigger import substitution and default if they borrow in international markets.
Prebisch’s Argentina is the poster child for currency depreciation and IMF programs.
“It joined the IMF in 1956 and is now hooked on its 22nd IMF program. That’s a new program every 2.8 years on average,” explained US economist Steve Hanke in 2019, before a new wave of programs were done in 2020.
“More broadly, the list of countries with the ten highest number of loan programs includes 27 countries.
“These countries account for 42 percent of the total number of IMF loan packages, indicating recidivism.
“Moreover, these repeat offenders gobble up a disproportionate amount of the IMF below-market rate loans, accounting for 60 percent of the total.”
Most of the top borrowers are linked to Prebisch-Triffin style central banks with recidivis, dual anchor pegs.
Sri Lanka has gone to the IMF 16 times, one higher than Chile and Guatamala, which were also Prebisch-Triffin central banks.
How Sri Lanka, Latin America was busted by Fed money doctors creating strongmen, anti-Americanism: Bellwether
Sri Lanka went to the IMF in 2009 after Fed’s housing and commodity bubble collapsed. The rupee briefly floated to 120 and was re-pegged at around 110 to the US dollar.
But after liquidity injections and rate cuts in 2011 as the economy recovered from the 2009 crisis, rupee depreciated to 131 during the 2012 crisis.
In 2015 more money was printed (term repo deals terminated and then liquidity injected through outright purchases) as the credit system recovered from the previous crisis on the claim that inflation was too low and the rupee fell to 151 during a new IMF program.
In 2018 more money was printed at the new parity, during an IMF program to target an output gap and the rupee fell to 182 to the US dollar.
As the monetary brakes are hit to stop the depreciation, output falls and inflation spikes. Such ‘Stop-Go’ policies created low growth and high inflation (stagflation) in Keynesian UK and the US as well triggering Sterling crises and finally blasting the Bretton Woods.
Sri Lanka’s central bank however has no growth mandate.
From 2019 August liquidity injections were again made to target an output gap, during an IMF program which had a forex reserve target (requiring pegging or an external anchor) but also had a inflation target (domestic anchor) which requires a clean float to work.
In July 2019, before money printing for output targeting began, Sri Lanka had forex reserves of 8.8 billion dollars, a part of which was raised from debt. By February 2021 reserves are down to 4.55 billion US dollars and liquidity is still being injected.
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After December 2019, taxes were cut and unprecedented volumes of money was printed from March 2020 along with rate cuts under so-called Modern Monetary Theory which is a more intense form of output targeting that was used during the previous regime. (Colombo/Mar23/2021 – Update V)