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COLUMN – Fixed or floating exchange rates?

Today's CaribbeanIs the fixed currency exchange rate between the United States and some Caribbean countries affecting the latter’s international competitiveness? This is a question that deserves review as Caribbean countries struggle with difficult economic conditions caused, in part, by the rapid change in their terms of trade and the value of currencies in which such trade occurs.

Nine of the 14 independent Caribbean Community (CARICOM) countries have currencies whose values are tied to a fixed exchange rate with the US dollar. These countries are The Bahamas, Belize, Barbados and the member states of the Eastern Caribbean Currency Union: Antigua and Barbuda, Dominica, Grenada, St Kitts-Nevis, St Lucia and St Vincent and the Grenadines.

There is no evidence to suggest that these nine countries are performing more competitively than other countries in CARICOM that have a floating exchange rate.  Indeed, based on economic performance over the last decade, particularly as guaranteed markets for exports have disappeared and trade rules have changed significantly, the economies whose currencies are not fixed to the US dollar have done better.

Small states face real difficulty in competing with other countries across the world in the free trade environment that has developed since the 1960s. While it was possible in previous decades to prop up economies through import substitution protected by high tariff walls, those days are over. Businesses now have to stand on their own, competing with foreign businesses in their own market and for a place in export markets.

The issue of competitiveness is now central to the success of any small state in finding work for its people, including its annual school leavers.

The ability to compete is determined by many factors such as natural resources, available capital, skill levels, cost of production, and productivity. Additionally, good communications, transport infrastructure, and efficient, proportionate and cost-effective bureaucracies are all necessary for international competition. It goes without saying that a stable and peaceful environment is also vital.

The list may seem long and complex. That is because it is. There is no silver bullet that determines economic success and full employment. The recipe is multifaceted and made up of fast-changing ingredients.

An important element in the list is the exchange rate of local currency in international trade, particularly for countries whose economies are as open as those in CARICOM and which are reliant on tourism as export earnings.

Until recently, a system of international trade dominated by the US dollar has existed.  Created since 1947, the system represented a degree of hegemony never previously seen. In this context, the decision taken in the 1960s to link Caribbean currencies to the US dollar was a compelling policy step, especially in the light of the then existing world trading pattern and geographical factors in the region.

Among those factors were dominant trade with the United States in goods and services, including tourism; and significant aid and investment from the United States.

However, times have changed. Aid and investment from the United States has dwindled. Businesses in the region now have to be competitive on world markets and in their domestic markets against imports from which there can no longer be import duty protection.

The rules of the World Trade Organization, which give no special or differential treatment to small states, have put an end to protection of local businesses. The unequal reciprocal arrangements of the Economic Partnership Agreement between the entire European Union as a bloc and individual Caribbean states also put a detrimental nail in that coffin.

For its own domestic purposes, the United States government has adopted policies designed to keep its dollar strong against other currencies. Therefore, for those countries whose currencies are fixed to the US dollar, the cost of their exports to, and tourism from, other major markets is expensive and uncompetitive.

Local manufacturers, farmers and service providers also face severe competition in their own domestic market from non-United States countries.

To re-enforce the point, tourists to CARICOM countries as a whole are mainly non-American. Therefore Caribbean countries, whose currencies are tied to the high value US dollar, are prohibitively expensive for non-American tourists. Further, the United States is no longer the principal source of Caribbean imports. Consequently, the cost of imports from non-American sources is high and raises the cost of living.

The currency link to the US dollar brings no benefit other than for exports and imports to and from the United States. In essence the only market where the region operates on a level playing field is the United States.

World trade is increasingly no longer dominated by the United States or by the US dollar. The Chinese yuan, the Japanese yen, the European Union euro, the British sterling and even the Hong Kong dollar are assuming growing importance. China trade rivals the United States’ globally. Indeed, for many countries in the world, China is now their main trading partner.

In the Caribbean, imports of Chinese products are so high that China enjoys a large trade surplus with the entire region (including those countries with which it does not have diplomatic relations).

While there are many challenges that governments and the private sectors in CARICOM countries need to address so as to deal effectively with the problem of a lack of economic competitiveness, a fixed exchange rate tied to the US is one policy that should be scientifically reviewed. Setting their exchange rates against a basket of currencies, particularly the currencies of countries with whom their trade is increasing such as China, and those from which the majority of their tourists come, would seem to be considerably more advantageous.

By continuing to tie their currencies to the US dollar, the countries that do so also seem to be linking their fortunes to the policies of the United States alone –– policies that are made rightly in the interest of the United States alone.

In a world dominated by free trade, a fixed exchange rate appears to be an anachronism and inimical to the international competiveness of Caribbean countries. The fixed exchange rate between the US dollar and the currencies of the nine CARICOM countries named earlier, may be contributing to a weakening of their international competitiveness. It would be useful if the governments were to commission an independent study by leading Caribbean economists –– and there are many capable of doing the job –– to provide objective advice on the exchange rate.

If the nine can’t do it together, the governments of the Eastern Caribbean Currency Union should consider it.

(Sir Ronald Sanders is concurrently a senior fellow at Massey College, Toronto, and the Institute of Commonwealth Studies, London. Responses and previous commentaries:

One Response to COLUMN – Fixed or floating exchange rates?

  1. brerlou May 9, 2015 at 6:39 pm

    The problem is volatility, which equates to fragility. Ours is a small open economy, (SOE.) Any small open system in a large extrinsic environment is ALWAYS in danger of sudden changes in that environment impacting negatively on their status quo. The danger is even greater with respect to internal shocks, whether political, geological, or due to changes in the value of critical resources.
    Outside investors are well aware of these dangers which are then plugged into their equations as a risk factor.
    This has very little to do with current, past or future performance. Even with a blooming economy, we could go exploring for oil off the west coast one fine day, find it the next day, then have a well explode shortly after, coating our beaches with horrible black oil tar, which not only drives our tourists away, but destroys our struggling fishing industry.
    A hurricane or earthquake could destroy the tourist industry and infrastructure for a whole season, making it impossible for the government to service its annual debt obligations. Investors are well aware of these risks, inherent in SOEs. This writer could outline a dozen more, without much thought. Having an exchange rate pegged to a far more rugged economy is one guarantee to any potential investor, and we need those, that he will be able to get his money out on a timely and equitable basis.


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