As a result of the perilous state of the Barbados economy, accentuated by a recent 3 notch downgrade by Moody’s and a follow up visit in June by the IMF after a worrying Article IV Consultation in December 2013, the conversation about devaluation and management of government debt has become a topic of national interest. In the public’s interest BU highlights Walter Blackman’s perspective on the two issues which he shared on another blog.
Hants – Currently $1 Canadian = $1.84 bds. Cheffette all chicken roti cost $5.50 Canadian. So after a 5 to 1 devaluation the roti will still cost $5.50 Canadian but $60 Barbados. Please correct me if I am wrong.
Walter Blackman – Hants please allow me to reconstruct your question correctly. A Cheffette roti currently costs BDS$10.12. Since Canadian $1 = BDS$1.84, it would take Can$5.50 to purchase the roti. If the exchange rate were changed to Canadian $1 = BDS$5, the same roti that sells for BDS$10.12 would now cost only Canadian$2.02. In short, a devaluation would cause a product manufactured or produced in Barbados to become cheaper to Canadians. The economic argument usually made is that this cheaper roti price would induce Canadians to buy so much more rotis that Barbados would ultimately earn more FOREX selling the roti at $CAN 2.02 rather than at $CAN$5.50.
Hants – So a roti could still sell for $10.25 bds but a box of Kellogg’s cornflakes
Walter Blackman – Yes. The roti that cost BDS$10.25 before the valuation, would continue to cost BDS$10.25..using the ceteris paribus (all things being equal) assumption.
Let us assume that a box of Kellogg’s corn flakes was produced in Canada and sold for CAN$24. When the exchange rate was $1 Canadian = $1.84 bds, the box would have cost BDS$44.16. If the exchange rate were changed to CAN$1 = BDS$5, the price of that same box of Kellogg’s corn flakes would skyrocket from BDS$44.16 to BDS$120.
The economic argument is that the devaluation would make Canadian products more expensive for Barbadians and would have a dampening effect on Canadian exports to Barbados. In other words, Barbadians would import less Canadian goods, and this would reduce our national usage of Canadian FOREX. The economic argument, of course is highly theoretical. The social problems generated by a devaluation, on the other hand, are very real. if almost everything you use and eat came from overseas, and a policy was implemented to choke off this external supply, what do you think would happen?
Lawson – Walter how does that effect real estate, should I wait to buy , will I need to join the Kendal shooting club and buy a glock to get my corn flakes home. Riots, starvation, diseases, crimes?
Walter Blackman – As long as you are sure that a devaluation is inevitable, and you have foreign currency, you should wait. If you have Canadian dollars, a devaluation of the $BDS relative to the CAN$ will make everything in Barbados, including real estate, cheaper. In fact, if the devaluation is deep enough, a multinational corporation might be able to offer an attractive price to purchase the whole island!
On a more serious note, you are on the right track when you started talking about the need to protect yourself and your assets from the social fallout of a
Bush Tea – Hants has a point.devaluation. How long do you think Cheffette will keep the BDS $10.25 price? Practically EVERYTHING in that roti is imported or contains high percentage of imported inputs…
Walter Blackman – Bush Tea, Your point is well taken. Similar to Einstein’s equations and his law of relativity that broke down in the face of a black hole, economic arguments for a devaluation would break down in the face of a small, open, fragile, corrupt, mismanaged country like Barbados. Economic theory will quickly give way to social chaos. Immense pain and suffering will result.
Let me give you an example.
Pretend for one moment that Barbados did not have one cent of FOREX, so no roti ingredients could be imported. Your local cows and your local chickens will suddenly loom large in value, and as the current practice suggests, they will be stolen and sold without any questions being asked by the buyer. The thieves would be quite willing to kill you, the owner, to defend their cows and chickens which they did not raise.
This situation would in turn drive you to the point where you and many others in your predicament would decide to purchase one of the many thousands of guns on the island, with a view to maiming or killing your Barbadian brothers and sisters. A downward social spiral would be set in motion.
Added to the social chaos would be an economic double whammy that would develop to bite you in your backside. Because of the devaluation, you would now have an excessive amount of Barbados dollars chasing few locally produced goods – the classic definition of inflation. Add high unemployment into the mix, and you have a stagflation nightmare. It would take us years and years to wake.
Barbados Underground – So Walter to follow your explanation, will the printing of money ultimately have the same effect?”up from such an awful dream.
Walter Blackman – The printing of money creates its own problems, and if it continues unabated, it can trigger a devaluation. I suspect that many Barbadians have heard about “printing money” but they don’t quite grasp the concept and its inherent dangers. Please allow me the opportunity to get the concept of printing money across by using a simplified example.
Let us assume that there are 300,000 Barbadians, and each Barbadian must purchase a can of food every day to survive. The only product sold in Barbados is this canned food and there are only 300,000 cans on this particular day. For convenience, let us also assume that our total money supply amounts to $3 million, and the price of a can of food is $10.
Suddenly, the government decides that it wants its friends and members of the political class to have , not one can of today , but an additional hundred thousand cans. The additional 100,000 cans of food of course cost $1 million at current prices. Government doesn’t have the money, so it orders the Central Bank to make the money available now, and promises to repay the Central Bank later.
The government has now imposed a new monetary policy on the Central Bank. In this simple example, The Governor of the Central Bank is forced to increase the money supply of Barbados from $3 million to $4 million. Note carefully that no more cans of food have been produced, so we now have $4 million dollars chasing $3 million worth of goods. Prices will rise and inflation will set in before this new situation settles on an ultimate price for a can of food.
In the real world, the resulting inflation will wreak economic havoc. Businesses will have to spend more on operating costs, and will have less to save or invest. Interest rates will rise. There is an inverse relationship between interest rates and bond prices. So people who are holding government bonds (which are now paying relatively low returns) would now receive low prices if they try to sell the bonds. Investors would not be interested in lending their money to the government, or even investing in the country. More than half of the extra million dollars put into the economy by the Central Bank would be used to purchase foreign goods, and this will put a tremendous strain on our FOREX. The country would eventually come face to face with the threat of a devaluation.
The blogmaster invites you to join the discussion.