A case for devaluation

There doesn’t seem to be much consensus about a suitable plan to pull the Barbados economy out of the chasm into which it has fallen. All economic stimulus strategies require further public expenditure and particularly also foreign exchange expenditure. Government finances are stretched, our reserves are falling and, worse still, we are running low on the pragmatism that was one of our strongest characteristic.

Barbadians have always possessed a healthy level of self confidence. Perhaps we ought rightfully to be proud of the industriousness of a people that have quite successfully developed a thriving community on an island that is not much bigger than the average large town perched atop a tiny coral uptick in the middle of the Atlantic Ocean. However, too high an opinion of ourselves is going to lead to our downfall if we are not careful to avoid over-valuing Barbados.

There is already plenty evidence of incipient overvaluation in Barbados. When citizens and visitors are regularly remarking that they are not getting what they paid for, and when our self-serving attitude seems to suggest we cannot work together to address our problems, we have clearly started becoming delusional about our real value. The many social, economic and structural underpinnings identified by Sir Arthur Lewis that once made Barbados a model of development in the world, are now underperforming.

The best way to moderate this arrogance and “get real” again is to adjust the value of our currency. In the final analysis, all our public services and civic engagement are just as cost sensitive as any commodity. As long as the Barbados dollar is anchored at 2 for 1 against the US dollar, it is ipso facto sorely overvalued because the US dollar is sorely overvalued and so we will continue to lose competitiveness in the tourism and exports markets despite all the desperate discounts that BHTA members and BIDC plan to offer.

The US Dollar Index which measures the US dollar’s value against an entire group of world currencies like the Euro, the Canadian dollar and the British Pound, is currently at its highest level in 14 years and, therefore, so too is the Barbados dollar. Some people want to insist that the US dollar’s high value is just fleeting speculative mania and that the bubble is about to burst, but other more informed observers say that far from loosing strength, the Trump administration’s policies are likely to make the US dollar rise even further.

Researchers for The Economist magazine came up with the “Big Mac Index” in 1986 to simplify and illustrate the challenge of currency value comparison. Since then, the publication has used the model annually to monitor how currency values are trending between countries. It is based on the theory of purchasing-power parity (PPP). This proposes that in the long run, exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services. In this case, the price of an almost universally sold hamburger, the Big Mac, is used as the indicator.

The average price of a Big Mac in America in January 2017 was $5.06; in China, it was only $2.83 at market exchange rates. So the “raw” Big Mac Index says that the Chinese yuan was generally undervalued by 44 per cent at that time. Nowadays, an adjusted Big Mac Index addresses the criticism that you would expect average burger prices to be cheaper in poor countries than in rich ones because labour costs are lower and the adjusted index uses the “line of best fit” between Big Mac prices and GDP per person for the 48 countries (plus the euro area) shown here.

The chart below shows the overvaluation of the US dollar against these other currencies.The difference between the price predicted by the red line for each country, given its income per person, and its actual price gives a supersized measure of currency under-and-over-valuation. We don’t have a McDonald’s in Barbados any longer to give us our relative position on the chart but if we took Burger King’s double cheeseburger price of US$4.00 as indicative, our Barbados currency’s PPP is undervalued by at least 21 per cent against the US dollar, placing us more at the same level as the Euro.

Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible. Yet the Big Mac index has become a global standard, included in several economic textbooks and is the subject of at least 20 academic studies. Given that our economy’s principal source of foreign exchange for the foreseeable future will be the tourist industry, all but the blind can see that our obsession with a 2:1 exchange relationship with the US dollar is going to continue hurting us badly.

A fixed exchange rate made sense because our dollar’s steady value against a strong international currency served to help us keep prices of our imported commodities from the United States fairly stable. Of course, a pegged currency also helps entrepreneurs feel more confident about their foreign currency investment returns. However, “these benefits depend on the credibility of the exchange rate peg. People will continue to worry about devaluation, and investors will continue to shy away, if they are not convinced that the authorities have the wherewithal to defend the peg.”. (Delisle Worrell – 2016)

I believe strongly that it is time for us to stop “defending a peg” and start defending our economy. In fact, the old peg is broken already.From the day the Central Bank’s US dollar reserves fell below the level of equivalent (2:1) Barbadian dollars in circulation, our currency no longer had effective convertibility. My recommendation to the country’s monetary authorities is that it should:

(1) relax restrictions on Barbadians wishing to hold US dollar deposit accounts. In a 2007 Policy Research Working Paper, Dr. Patrick Honohan writes: “Restricting the holding of foreign currency deposits is seen as likely to result in an outflow of funds from the banking system as a whole . . . this could limit credit availability even further”. Furthermore, Barbadians both at formal and informal levels have been worsening the economy’s recession by hoarding money. The Central Bank would still promote a preference for us to save in our local currency by setting higher interest rates. While Barbados is already a partly dollarized economy, the incentive to hold US currency as a hedge will not be significant. The US dollar will be relegated to serve only for foreign trade transactions, short term operations and remittances rather than a store of value;

(2) allow the Barbados dollar to adjust its exchange relationship with the US dollar downward by 26% so that one US dollar would buy Bds$ 2.70 instead of Bds$2.00 (to provide for likely future US dollar strengthening). If the 2.70 figure rings a bell, it should, because the Eastern Caribbean Central Bank (ECCB) currency has been anchored to the US dollar at EC$2.70 to the US dollar since 1965. We have had the same history as the member countries of Organization of the Eastern Caribbean States. We share the same geo-economic area and so we have similar ambitions and challenges. Together the OECS islands have a population of 620,000. An eventual application for membership in a currency union with our neighbours should be a part of our vision for a strong Caribbean down the road, but pegging our dollar at par with the EC dollar offers increased regional trade and investment opportunities all around.

Our sacred dollar is patently overvalued. Some business houses and hotels have already tried to make amends by offering specials or trying to offer greater value to the extend their survival, but their tactics will not be sustainable. Yes, certain imports will be more expensive after we adjust the peg – principally petroleum products . Most of them, however, we should be using with greater self-discipline anyway.

Our merchants are finding cheaper suppliers in other countries. Currency adjustment will no more usher in a hike in the cost of living that our own inflationary pressure would because we are rather in a deflationary mode in which Barbadians are deferring spending for the rainy days that they imagine ahead. We will certainly be in for bad weather if we don’t put an end to our wanton boastfulness and get our currency’s value back on track.

(Lee Farnum-Badley is a retired development economist)

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