Introduction:
Once again the governor of the central bank has come out singing the old song, this time he is way out of tune. The boast about foreign reserves has now become a mantra for the economically literate members of the Barbados elite, but as always, there is hardly any sound evidence to substantiate the claim. It is a declaration of faith and any one who questions its wisdom is on-believer, a heretic.
Let me explain in simple language the role that foreign reserves play in a macro-economy. Basically, foreign reserves are a hedge, an insurance against external shocks to the economy: geopolitical conflicts, pandemics, tsunamis, etc. The theory is that the reserves would be used to keep the nation going by having enough foreign exchange (is money to exchange for vital commodities). This theory had lots of relevance during the oil crisis of the mid-1970s, when the Middle East oil-producing countries imposed an embargo on the rest of the world, which effectively brought manufacturing industry in the then developed world to a halt.
Prior to the oil crisis the ‘reserve’ was gold, until Nixon drove a coach and horses through the fixed exchange rate and abandoned the gold standard in 1971. Even then there was no great demand on foreign reserves and the world recovered, thanks largely to a huge oil find in the North Sea, but generally due also to better economic management. Academic economists held on to this like a crab to a swimmer and would not let go and from 1973 the US started intervening in the foreign exchange markets, shoring up the greenback, a policy it kept in place until the mid-1990s.
Even so, from about the early 1980s, members of the Federal Open Market Committee (FOMC) were questioning the effectiveness of a policy of intervention, until it was eventually abandoned. Contrarian academics such as Michael D. Bordo et al have also pointed out that intervention was more a hindrance than a help and often impeded economic growth.
In real terms, the world has not experienced the externalities implicit in the foreign reserves theory, since the Second World War, even though some economists, mainly in developing nations, hold on to the notion like the old belief in the medicinal magic of bush tea. Gordon Brown, then chancellor of the Exchequer in the UK, had such a dim view of his gold reserves that he sold Britain’s reserves for £9bn. Apart from the lost in terms of the price of the precious metal, Britain has not suffered particularly from the decision.
Foreign Exchange Policy:
Foreign exchange policy must be a central part of overall government and central bank monetary policy. It is not just an end in itself. However, the governor and the wise men who advise him have stubbornly dismissed decoupling from the greenback, or even devaluing the Barbadian dollar out of hand without the courtesy, or obligation, of putting an economic case for their position.
Even though one can understand less economically literate people taking a sentimental view about the strength of the Barbadian dollar, the reality is that, given the current economic circumstances, this position is unsustainable. Barbadian reserves stand at Bds$1.3bn, not particularly high, but more than moderate, given the strength and needs of our economy. There is a lot of good that the $3m tied up in under producing investments and in unused accounts, including playing on the foreign currency and money markets.
One way out, simply, as I have said before to much opposition, government should decouple from the Greenback and fix against a basket of currencies and goods, including our leading trading partners. It should then devalue against the other currencies, whatever the background noise, including the pound sterling and the US dollar. This will make imports from the US more expensive, which is what the economy needs, given the current account deficit, and encourage tourists to visit from the UK, our main tourism market. Further, by adopting a fixed income strategy, which the central bank does not have at present, the bank could play the foreign exchange markets astutely.
Easing investment pressures on the national insurance scheme would also allow a shift in investing for income – and growth – strategy for the scheme, allowing the much-needed cash to come back in to the local markets. In fact, a competent foreign currency strategy would allow the central bank or its agents to play the currency markets using maturity dates to hedge instead of stock-piling foreign currency reserves. A good example of this is that the Barbados central bank claims it keeps currency reserves as a hedge for externalities over a month or so; most central banks – mainly developing economies – hedge for up to six months. But by playing the currency markets (which are intertwined with the money markets) and hedging for up to a year, carefully using maturity dates – overnight, weekly, monthly, three-monthly, bi-annually, or annually – the same insurance cover the central bank is seeking would be there, and more. Barbadian taxpayers are paying the price fore this ignorance.
Foreign exchange markets are the most liquid in the world, changing sums of up to US$4trn in a single day. This is a missed opportunity.
Monetary Policy:
From re-reading the Central Bank Act it is not clear what is the statutory remit of the central bank. Is it monetary policy, inflation targeting or economic stability, or all three? Further, what methodology, or methodologies, does the central bank apply in its forecasting? Most central banks use the tried and tested dynamic stochastic general equilibrium models, times series models or official forecasting for their forecasting.
But, it is not clear which model the central bank uses, even though it is fair to say that all three models failed to predict the 2007/8 banking disaster – so much for the mathematical accuracy of econometrics. By not making it clear what is the in-house model, despite what governor Worrell is on record as saying about forecasting models, it makes it difficult for independent people to shadow the central bank’s forecasting.
What we do know, is that we have a government that is selling debt at over 7 per cent, the magic number that most economists believe is passing debt on to future generations, just talk to finance chiefs in Spain, Ireland, Greece and Italy.
Yet, in Barbados, there is no public discussion from the main opposition party, for the simple reason that it has no real alternative, total silence from our academic friends at Cave Hill, and a central bank governor playing the warm-up act to the ruling party.
When last was the selling of government debt discussed in public, or even in our leading newspapers? It is important to be clear not only about the nominal value of the bonds, but of the coupon rates and t he maturity dates, since government can, and do, default – and I would not put this above this government. Just ask Al Barack, a local businessman with a $70m outstanding debt which the government could easily resolve by giving Mr Barack a.draw-down facility at the central bank of about $250,000 a week, no more or less than it would give a retail bank or large corporate.
In the meantime, toddlers not even in school, and some still unborn, have already been left with huge debt by a government mismanagement of the economy and which is clearly out of its economic depths.
Social Costs:
The economy aside, it now seem the only Plan B they government has, no doubt advised by its magic circle of wise men (and they are men) is to open the door to so-called economic citizens, in other words, gangsters and Mafiosi, to use the good name of Barbados to launder their ill-gotten gains and live it up on the West Coast. This is a policy that even the traditionally well-off white Barbadians, the Roebuck Street boys, should oppose with a vengeance.
Ignoring for the time being the carrot of citizenship dangling before global gangsters, which is a reality, at its very basic economic citizenship fuels house-price discrimination, the very weapon used by white Americans to introduce a policy of red zoning for the lending of mortgages in the 1960s until it was outlawed, then of sub-urban flight, white middle class people segregating themselves in suburbia away from black and Hispanic people.
It is this blatant racial discrimination, as much as anything, which led to the sub-prime lending crisis of 2007/8, which led to the banking crisis and then the global recession which we are still experiencing. Put simply, following the cheap post 9/11 money, in which people who clearly could not service a mortgage or car loan were nevertheless given one, the only growth area was with the low-paid, inner city dwellers. These were the sub-prime borrowers, sometimes disguised in the language of actuarial finance as risk perception and risk management, or in everyday language, lending to people who are likely to default on their repayments.
So, what we have is a situation that is outlawed in the US and UK being accepted as public policy in Barbados – the substitution of money, instead of race, to discriminate. Do the arithmetic: it is generally conceded that the loan to value of a sustainable repayment mortgage is between three and five times annual income. If the average salary in Barbados is about Bds$40,000, then five times that is $200000, and that can just about buy a reasonable house in Barbados. These are hard lessons the government must learn, not just grabbing at money.
Analysis and Conclusion:
In the meantime, there is a social cost to excessive foreign reserves, including starving the economy of liquidity, stifling the funding of small and medium enterprises and the self-employed, and, more generally, building up balance sheet debt, including so-called guarantees, when stock-piling cash in the expectation that something terrible may happen to the economy. There is a point when this crude and unusual expectation becomes paranoia.
Stockpiling foreign reserves is like storing gold in Fort Knox, it does not serve any useful purpose apart from the psychological one of making people feel better about themselves. In the case of contemporary Barbados, it is like having debt piling up on a credit card while pretending to save. As Martin Feldstein observed at the height of the banking crisis (Financial Times, December 10, 2009),: “The role of foreign exchange balances has changed from being short-term funds used to bridge export-import gaps to being long-term investment funds. “In this new world, the dollar has shifted from being almost the sole ‘reserve currency’ of many countries to being the primary ‘investment currency’, a role that it will continue to play far into the future.”
This raises other questions about the management of our foreign reserves, our fixed income policy and how we play the markets. In short, it calls for other competencies and forms of knowledge which, which respect, are not yet available in Barbados in practical terms because of the immaturity of the markets.
Apart from playing the money and foreign exchange markets, credit default swaps can go wonderfully as a hedge against external shocks. By reducing the foreign currency reserves, the central bank could kick-start a local money market, with corporates and banks with too much liquidity trading short-term unsecured loans at an attractive bid/offer rates.
In the final analysis, there is a need for a new economic settlement and the global banking crisis and the following recession was a unique opportunity for our business and political leaders to come up with a new stability and growth paradigm, which put people and their welfare at its heart. They have failed. As the economist Kenneth Boulding has said: “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.”
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