If it is one thing the macro-economists agree on is that currencies will depreciate, there is nothing a government through its agents the Central Banks can do about it. Countries respond to the challenge of managing the volatility of depreciating currencies in mainly two ways, a free floating exchange rate e.g. the USA and the dollar, and secondly share a common currency e.g. the EC and the Euro or the OECS and the EC dollar. A similar option to sharing currencies is to adopt a major currency e.g. Barbados adopting the US dollar. The Barbados dollar has been pegged to the US dollar since 1975.
Key things to watch for with a pegged currency: the fortune of the country will rise and fall based on the performance of the country to which its currency is pegged and the country will have to manage and dedicate its monetary policy policy to supporting the exchange rate.
In a nutshell the Barbados dollar peg is primarily a tool to assist planners in both the private and public sectors of a small, open but narrow economy avoid the costs and speculative forces of exchange rate fluctuations. By hinging the Barbados dollar to a credible currency like the US dollar expectations of inflation are kept in check and fears of depreciation minimised. These, in turn, are key factors for achieving sensible wage negotiation outcomes and uninterrupted flows of capital investment among the key considerations.
Sounds simple. But much depends on what external currencies drive import and export prices (i.e. who one’s main trading partners are); and what money domestic public debt is denominated in. By matching up the weightiest of these factors to the composition of the peg the aim is to eliminate – or mitigate so far as is possible – external currency impacts on the domestic economy. The peg has usefully served these goals since 1975.
Against these very considerable advantages, true monetary independence was surrendered. In downturns this means no independent ability to increase the money supply or lower interest rates – which are the classic contra-cyclical tools used in a free floating currency situation. Still, the question as to whether these can in any case be wielded effectively and with precision during a crisis is a fairly open one. It is also the current conundrum the US faces and the outcome of the current crisis will be documented as a case study for future students to study.
A close to zero interest rate policy and money printing at the speed of Usain Bolt in the US appear to have the dollar plunging. Other things being equal, this ought, if sustained, to stimulate the non-US dollar part of the Barbados export market whilst not affecting negatively the demand of US dollar buyers. In the tourist sector, for example, it may boost Euro zone visitors whilst perhaps even encouraging more US tourists by making alternative destinations – like the same Euro zone – comparatively more expensive.
On the import side, goods sourced from non-dollar producers become more expensive. Energy, despite the efforts from Caracas and the Middle East, is still traded in US dollars. A depreciating dollar means a higher energy bill for Barbados. It is also worth querying why the dollar is falling – research shows that currencies do not simply move in a vacuum nor are the effects of this discrete or readily quantifiable.
There are two schools of thought. Firstly, as financial markets anticipate economic recovery they are abandoning the safe haven quality of the dollar to take on more risk elsewhere. Secondly, markets are more and more concerned that vast increases in US money supply which pose a serious inflationary risk 2 to 3 years out. For example the Chinese recently expressed concerns about the strength of the US currency given its heavy investment in US treasuries. There is also concern by bond holders that the Bolt like printing of dollars will be inflationary and lead to a diminution in the long-term value of US bonds.
These are only termed schools of thought but time will tell. Today a recovery does look plausible, but driven by the largest international bailout and use of taxpayer cash in history. The consequences of that medicine are unclear. While significant US inflation in 2 to 3 years is possible it is hardly a certainty, the world is continuing to experience a serious deflationary event manifested in the widespread evaporation of asset values and destruction of money. It is not possible to calculate which effect will prove the larger.
However, in terms of the Barbados peg, public policy makers probably ought only to be concerned about extreme US dollar outcomes, such as Zimbabwe or the 1930’s USA, which would anchor the domestic economy to a currency with ingrained instabilities.Neither event appears likely at the moment making the larger issue for Barbados not so much the usefulness of the peg as the recovery of its two largest export markets – the US and the Euro zone. No amount of peg adjustment can get around the lower levels of disposable income and reduced aggregate demand these two currently suffer.
A question which our research has tossed-up is whether there is an identifiable alternative currency or currencies which obviates the need to peg to the US dollar? Further the US is a significant trading partner i.e.inflows from US tourist receipts and outflow from significant imports. The fact that oil continues to be traded in US dollars is a key consideration as well.
So the debate will no doubt continue but given the imponderables what better options do we have?
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