Public Affairs - The Devaluation Follies

Claude Clarke, Guest Columnist

The Bank of Jamaica intervenes in the foreign-exchange market to prevent an accelerated slide in the value of the Jamaican dollar and the Opposition Jamaica Labour Party declares victory in the devaluation vs fixed exchange rate debate. I really don't get it. The central bank, under administrations of both political parties, has been intervening in the forex market for the very same reason for decades. The show on both sides could be called 'The Devaluation Follies'

It opened in 1990, when the Jamaican dollar was liberalised with neither reserves to back the currency nor policies to prevent inflation from undermining it. Since then, the run of devaluations has been unbroken, save for two instances of extreme economic insanity in 1996 and 2010 when Government attempted to make water flow uphill by revaluing the currency in defiance of economic logic.

While earlier devaluations were the outcome of uncontrolled inflation, today it is official government policy. But the result is no different: an economy characterised by uncertainty, sagging confidence, and chronic uncompetitiveness.

Devaluation can be an effective tool for reducing the foreign-currency cost of local production inputs, thereby making exports more competitive and for making imports less competitive against domestic production. But devaluation can only have these results if it is done quickly and is supported by economic policies and regulations to prevent the domestic inflation rate from rising above those of our trading partners.

30-year drop

The 30-year-long dribbling devaluation between 1990 and 2011, which averaged 11% per year while the Jamaican dollar lost 90% of its value, was unsupported by anti-inflation policies. Unsurprisingly, the period was marked by growing uncompetitiveness, worsening trade deficits, increasing debt, and deepening economic stagnation. With all the devaluations, our trade deficit as a percentage of total merchandise trade increased from 23% in 1991 to 60% in 2011 and the economy barely crawled at a growth rate of less than 1%.

In walks the IMF in 2012 and we are told that the same drip-drip devaluation will continue, this time as official policy. The prevailing view seems to be that the same creeping devaluation approach, now clothed in official garb, will bring different economic results. But the economy has continued to stagnate with near 0% growth under this new regime.

Our merchandise trade deficit has continued at the frighteningly high level of 60%. After 1994, the trade surplus in services (mainly tourism), which used to be enough to cover deficits in our merchandise trade, was no longer adequate. By 2011, the unfilled gap after applying the services surplus was more than US$3.5 billion. Debt has been the principal filler; and today our national debt is poised to pass $2 trillion.

The rapid growth in Jamaica's imports is easily traced to the 1995 break with the IMF, which cleared the way for uncontrolled government borrowing from the private international market. With inadequate production, the allure of borrowing to satisfy domestic consumption was never far. The removal of foreign-exchange controls in 1990 allowed opportunity to meet that temptation and the door to Government's irresponsible borrowing was opened. However, the restraining hand of the IMF had to be removed; and so in 1995, with some haughtiness, Jamaica bade the Fund farewell.

The unrestrained borrowing that followed not only created today's suffocating debt, it fed our growing addiction to imports, hobbled our productive engine, and caused our economy to fall rapidly behind those of nearly all our neighbours.

Day of reckoning

Like Bernard Madoff's Ponzi scheme, the ability to take on more and more debt allowed the Government to continuously delay the day of reckoning for our currency; even allowing it to be revalued at points to sustain the impression of economic well-being. But devaluation was inevitable. And despite Government's best efforts to prevent it, it always occurred - sadly, always too late.

Whether intended or not, the consequences of gradual devaluations on the economy have been the same: stagnation and decline. From the vigorous annual growth of more than 5% achieved in the late 1980s when the exchange rate was competitive and stable, since 1990, the economy has been at a virtual standstill, with growth averaging less than 1%.

Creeping devaluation, whether planned or accidental, has done nothing to overcome our chronic economic uncompetitiveness which is at the base of the economy's failure to grow. Yet it now seems to be at the centre of Government's IMF-led economic competitiveness strategy.

The declared objective of restoring the competitiveness of the Jamaican dollar cannot be faulted. But the same method that has consistently failed to achieve that result for more than 30 years will not suddenly become successful because it has been declared official policy.

It is easy to form the impression that neither the Government nor the IMF has determined why past devaluations did not result in a competitive currency. Had they done so, they might have found that inflation generated in the domestic economy (not including imported inflation) has consistently increased at a faster pace than devaluation, perpetuating our uncompetitiveness.

Among the principal reasons this outcome persists is that in the crawling devaluation scenario, there is an ongoing expectation of further devaluations. No prudent importer of goods for sale would cost his merchandise without adding a margin above the actual foreign exchange rate paid, to ensure that he has enough Jamaican dollars to replace the stock when it is sold. No one with an opportunity to buy anything in Jamaican dollars today would wait until tomorrow unless there is a danger of spoilage. These and other similar factors accelerate inflation, create an expectation-based exchange rate, and perpetuate economic uncertainty, lending instability to the Jamaican dollar.

The JLP understands people's apprehension of devaluations and recognises the political attractiveness of a 'no-devaluation' posture. I will not suggest that its fixed-exchange rate policy is political. However, the party will leave one with no other interpretation unless it states clearly whether it would be prepared to fix the exchange rate at its uncompetitive level and reveals what would be its strategy to make the Jamaican currency and economy competitive.

Our experiences of the last 30 years should demonstrate the folly of doing either what the JLP seems to be advocating or continuing what the IMF has endorsed.

Claude Clarke is a businessman and former minister of industry. Email feedback to columns@gleanerjm.com.