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A major point of discussion in this budget debate has been the proposal by the Leader of the Opposition that Jamaica should return to a fixed exchange rate system. That is there should be a fixed relationship between the value of the J$ and the US$. It was a subject to which he dedicated a great part of his presentation In response to some of my initial comments following his presentation, the Leader of the Opposition suggested that I needed a refresher course and that I needed to take a break from politics to review recent developments in the area. More of that anon. The issue is so important that I believe that it deserves serious treatment and I wish to start by indicating that the debate about the most appropriate exchange system for any given country is not new, nor is it an end in itself, even despite the build up given to it by the Leader of the Opposition. Any exchange rate system is established to accomplish certain macro-economic objectives. What are these objectives? I do not believe that any group of reasonable persons whether within this House or outside would have difficulty in identifying a set of objectives around which we could unite. The trick is whether or not they can be simultaneously achieved and if so, over what period. This list of objectives would include
The Leader of the Opposition cites various sources including some local academics in support of his argument. But one difficulty I face with his reasoning is that many of his references are dated with most of his data sets ending in mid 90's and in certain instances up to 2000. One is left to wonder at this arbitrary cut-off point. However, another difficulty with the discussion is that in certain instances the pursuit of the "fresh wind" leads the Leader of the Opposition into flights of fantasy. In making reference to the decision of his Administration in the late 1980's to artificially fix the exchange rate he states - "The lesson to be learnt, is the magically motivating dynamic force which a fixed exchange rate holds in the market" (page 47). (My emphasis) This dramatic language would seem to move this matter into the realm of magic rather than where it should remain rooted - in hard analysis. . Another difficulty we face with the Leader of the Opposition's presentation was a seemingly inherent contradiction between his advocacy of the fixed exchange rate juxtaposed with his demand that the market should play the dominant role. . On page 53 he proclaims "remove man from the centre of the equation and let market forces operate". I believe every one in this House was puzzled when that position was juxtaposed with "we must decide on the system we want to regulate the rate of exchange, then fix it and live with it as long as we can maintain its value (if possible, til God comes); if not, at least until two-thirds of the members in each House of Parliament make a change as should be provided by a system of law replacing the choice of man" (page 55). So here we have a situation of an appeal to the "magical motivating dynamic force", an exhortation to let the market forces run but at the same time a fixing of the rate and maintaining the established value, "if possible until God comes." Let us step back for a moment from this celestial reasoning and look at two of the examples quoted by the Leader of the Opposition - Argentina and Jamaica. Table 12 of the Leader of the Opposition's booklet provides data on the performance of the Argentina economy and a whole range of variables prior to and post fixing of the rate between the peso and the dollar on April 1, 1991. What is fascinating is that table 12 stops in the year 2000. In this era of internet, it is impossible to believe that the Leader of the Opposition did not, and does not, have access to data for the period subsequent. Every one knows or assumes that he is up to date and is fully aware of what is happening not only in Jamaica but elsewhere. I certainly did, and I still do. It is a fact that prior to 1991 Argentina suffered from hyper inflation which resulted in interest rates of the order so graphically outlined by the Leader of the Opposition in his presentation. It is a fact that subsequent to the fixing of the relationship between the peso and the dollar - fixed by law - inflation was brought under control, the economy grew, interest rates declined and foreign investments increased. But that is not the end of the story nor did Argentina cease to exist in 2000. One may have been tempted in that period to sing in glorious praise of the "magical motivating dynamic force which a fixed exchange rate holds in the market". The fact is that, that fixed rate, backed by legislation, locked Argentina into certain structural deficiencies which could not be adjusted in the face of the fixed exchange rate. Were Argentina an isolated island living on its own, then that could have been addressed, but it was involved in a trading block, and it borders next door to Brazil which operates with a flexible exchange rate system. The result was that over time, even as various indicators showed the improvements cited by the Leader of the Opposition, it was becoming apparent that the Argentina dream was becoming a nightmare. Its productive sector was becoming increasingly uncompetitive. I visited Argentina during the period being hailed by the Leader of the Opposition - a period when inflation was zero and I understood why. Prices were the highest I had seen anywhere they could be raised no higher. Even leather goods of equal quality could be purchased elsewhere more cheaply - in a country previously renowned for high quality, reasonably-priced leather goods. One takes no pleasure in what eventually occurred with Argentina. It is an issue to which I have made reference on previous occasions. A problem in a small domestic bank escalated as the Central Bank, totally devoid of any flexibility in responding to problems in the financial sector, because of the iron-clad legislation fixing the rate between the peso and the dollar, was unable to intervene. The result was that there was widespread panic leading to a virtual collapse of the economy and the society. Within a short period the country became virtually ungovernable with five Presidents and five Ministers of Finance being changed in a period of five months, November 2001 to April 2002 The highly touted magical formula of the legislation on the fixed exchange rate was abandoned as quickly as it had been implemented. Even today, although there has been some recovery, the problems remain. Argentina has reneged on its debt obligations and has offered its creditors a maximum repayment of 25 cents in the dollar. Many financial institutions with a long history of doing business in Argentina have simply cut their losses and left the country. Argentina cannot afford to use its reserves to clear its payment arrears as to do so, they would be wiped out. However, until some accommodation is reached with its creditors, it is forced to live outside of the formal credit system. There is much more which could be said about this example but that is enough for the first part of the "refresher course". I now turn to the issue of another example of a fixed exchange rate system referred to by the Leader of the Opposition, that of Jamaica. In his presentation he cited his struggle with the IMF which in the mid 1980's was committed to devaluation as the principal macro-economic tool. He indicates that after a long struggle in which he "stood firm" the then Managing Director of the Fund agreed with his decision to peg the rate of exchange at J$5.50 to the US$. He neglects to mention that this decision occurred only after the then Opposition held an all night vigil demanding that the exchange rate system be stabilized. But so be it. He may have forgotten, but we remember. He then proclaims the "magical results" following the decision to fix the exchange rate. History cannot be rewritten in such an arbitrary manner. It is true that the fixed exchange rate brought about increased stability. But it is also true that this rate, whilst fixed, was relevant for a decreasing percentage of the economy. The two major import houses at that time were taken out of the official foreign exchange market and their obligations were settled outside of normal operations. Even for those who participated, settlement of obligations was "when funds were available". Everyone knew that virtually every business and every individual had funds stashed away which they used to keep operations going, to be replenished whenever the Bank of Jamaica was able to provide them with some of the resources they had paid for months before. It later became known that the Bank of Jamaica, itself, in order to prop up this artificially fixed rate, was purchasing dollars on the black market. Therefore, let no one be fooled about this "magically motivating dynamic force" which a fixed exchange rate holds in the market. Like any other magical trick, once you get behind the smoke and mirrors - reality is different. In looking at the issue clinically, the obvious reality is that any policy decision is that there are pros and cons. The fixed exchange rate system, assuming that the fundamentals are right and the rate can be maintained, does provide all participants with a greater level of certainty and stability It also tempers inflation in that, ceteris paribus, a fixed rate will ensure that imported inflation will be the same level of that of your major trading partners and hence there is greater predictability in making long-term commitments. However, there are costs and a critical one relates to the removal of flexibility to respond to domestic and external shocks. The Argentine example demonstrates the potential negative consequences if the Central Bank is unable to respond to difficulties within the domestic financial sector. Consider the calamity if the BOJ had not been able to provide funding for distressed institutions during the period of turmoil in our financial sector. I can hear those suggesting that this turmoil would not have occurred within the context of a fixed exchange regime. Argentina is the obvious response to any such assertions. Consider also the difficulties in terms of the inflexibility of adjusting domestic costs as again the Argentine model demonstrated. It is a fact that the reduction in Jamaica's cost of production has been a critical factor in influencing the investment decision of ALCOA. But there are other issues. We have come a long way since the fixed rate system of the late 80's. At that stage our NIR stood at minus $560 million. Now we are at $1.6 billion positive. Many fundamental questions arise -
What of those who hold foreign exchange accounts - both companies and individuals? Would capital controls be reintroduced? The Leader of the Opposition failed to mention that all the Caribbean examples he cited had controls on capital flows in support of the fixed exchange rate system. But although he would prefer that man remains out of these decisions, how often would a re-assessment take place and how could we determine how much of a re-adjustment was needed? This proposal by the Leader of the Opposition is deserving of serious analysis but by offering it as a solution for all of our problems, he has done damage to his case. Can we forget that a few years ago the solution to all problems laid in the passage of the three bills? Where are the bills now? Have they been abandoned? The reality is that decision making with regard to exchange rate systems has become more sophisticated. There is a whole generation of decision makers in both the public and the private sector who are far more exposed to information and data, not just on Jamaica but on all our trading partners. An arbitrary decision to re-introduce a fixed exchange rate system just will not wash. Quote Professor Jeffery Frankel of Kennedy School, at Harvard University. …… "The Argentine crisis of 2001 dealt a severe blow to the conventional view that a country that was willing to make a firm and sincere institutional commitment to a rigidly fixed exchange rate, as under a currency board, could hereby import credibility, and achieve convergence in price levels and interest rates. ……. The situation is far worse than the remarkable fact that a supposedly ironclad fix came undone in a short period of time. Argentina's 1999-2002 recession has been so severe as to fully reverse the very good income gains during the heyday of the currency board, 1991-1998".
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