From December 2006, the Central Bank has boldly pushed up primary treasury-bill auction rates by refusing to print money, regaining its lost independence and apparently shaking off fiscal dominance of monetary policy.
In January the Central Bank's governor read out a road map for monetary policy 2007. Few realized that these were some of the most important words that a Sri Lankan central bank governor has ever uttered.
This may have been partly because people were skeptical, like this columnist was, and partly because Governor Cabraal has an unfortunate habit of saying lot of things at a lot of places about lot of subjects and as a result his words do not have the almost divine proclamation' value that other central bank governors' words have.
Policy rates are still laughably low, despite a 50 basis point hike last week, but with t-bill yields being driven up, policy rates have become irrelevant, at least for now.
What is important is that the breaks are being applied to the printing press with central bank's treasury bill stock being kept down by reducing its purchases in the primary auctions.
By end February the monetary authority seems to have even sterilized its annual provisional advances to the treasury.
As can be seen from the Printflation graph, inflation will soon start to follow the Treasury Bill stock or printed money levels downwards, as it has always done in the past.
It can be seen from the graph that the problem started in February 2006 when money printing suddenly accelerated as the debt moratorium ran out, and the effects of the first Mahinda Chinthana budget started to be felt, especially the public sector wage hike as well as defense procurements.
By April inflation was raging. Then things quietened down at bit. In September all hell broke loose again.Monetary Blunder
This was a result of a monumental blunder on the part of the central bank rather than simply a fiscally driven phenomenon. In September someone at the central bank seems to have got a bright idea that it was good to push the currency up to 102.
Central Bank had to sell more than 125 million dollars of precious reserves, (perhaps it was LIBOR plus money bought off the treasury) in this misguided attempt to artificially prop the currency.
It is a graphic illustration of the vicious spiral a monetary authority falls into when it tries to simultaneously defend the currency and maintain base money, so that interest rates would not go up.
This sets off a chain reaction of mutually re-inforcing monetary asset switches from foreign to domestic that creates a vicious downward spiral that is typical of third world countries that suddenly get into severe balance of payments troubles almost overnight.
This is exactly what happened to Indonesia at the height of the Asian currency crises.
First Central Bank sold 125 million dollars in September to get the ball rolling. That sucked about 13 billion rupees out of the system. You can see in the September Unravelling table, net foreign assets or reserves falling to 208 billion from 221 billion rupees.
This should have tightened the system and driven interest rates up. But Central Bank does not allow this. Instead it purchases treasury bills and prints money into the system to maintain base money and interest rates.
So Central Bank T-bill holdings go up from 37 billion rupees (Aug 28 number) to 55 billion rupees (Sep 28 number).
Then commercial bank credit to government fall from 94.8 billion to 77.0 billion and central bank credit rises, as an asset switch takes place from the banks to the monetary authority.
You can see that more cash also came from the central bank to the system – that was probably fiscally driven (see total CB credit number and T-bill holdings number ) which added fuel to the fire.
The bottom line was that banks or the public suddenly had around 20 billion in cash the central bank printed and repaid their t-bills with.
When this money was spent, inflation rises and there is demand for imports as well, which means more balance of payment trouble over the next two to three months at least.
If the central bank had continued to defend the pressure coming on the BOP from this 20 billion by selling more dollars, more foreign assets would have been lost and replaced with domestic assets. It is a vicious feedback loop, that goes downhill faster and faster.
This vicious cycle could have worsened and the entire monetary system would have collapsed like it happened in Indonesia in 1997 and in Sri Lanka in 1999/2000 during the Parivasa economic crisis.
Remember how quickly reserves fell to 900 million dollars at that time? And we had to raise t-bill rates to 22 percent to stop it under IMF advice?
In Indonesia the Rupiah fell to 18,000 and rates went sky high before the system stabilized.
Thailand devalued in July 1997, Indonesia hung on till October and managed to self-destruct her monetary system before asking for IMF help.
Yet IMF was blamed. Naturally that had to happen. This is the third world after all, so it is always someone else's fault, preferably the capitalists. In Sri Lanka it is oil prices. Why did the rupee fall in October and November and December when oil prices fell?
In Indonesia the central bank governor also had to resign eventually as well.
Even now Indonesia usually has the worst fiscal discipline among Asian Tigers. It had fuel subsidies like Sri Lanka, BOP problems and high inflation even in 2005.
Remember also that both Singapore and Hong Kong which do not have central banks but only currency boards, were virtually untouched by the crisis.
To get back to Sri Lanka, though a greater disaster was averted and the governor's job was saved by a 'devaluation' of the rupee, fiscal pressure to print money continued.
By end December total Central Bank credit to government rose to 112.9 billion rupees and inflation was 19.3 percent. By January it was 20.5 percent.
Imagine what is happening to the poor and the wage earners in this scenario? NSB savers got 5 percent last year. One year fixed deposits were paid 10 percent in January 2006. Yet by the end of the year inflation was 19.3 percent.
What about the EPF and ETF? One year T-bills paid 10.1 percent in January. See (The Thrift Column - Grand Larceny) for a detailed explanation on how the EPF is robbed by the authorities.
Poor pensioners and old people paid the biggest price. Their lifetime savings were busted. Imagine someone who had retired this year as a factory worker after working for 30 or 40 years? Let's say he got 500,000 rupees with 50,000 rupees as 10 percent interest?
He had lost about 100,000 of the purchasing power of his capital accumulated over several decades to inflation in the same period. In other words the Treasury with the central bank's help had plundered this amount.
That is why money printing is called an unfair form of tax.
This is what happened to retirees in Russia. When the Russian central bank started to print 10,000 Ruble notes, retirees' lifetime savings disappeared almost overnight.
Hundreds died in the harsh Russian winter because their savings were not enough to pay for electricity and gas needed for warmth.
This is what negative real rates mean. Some one who deposited 100,000 of hard earned savings last January would get 10,000 as interest but his capital would have eroded by 19,300 in just one year.
But they do not realize this. They object to a relatively harmless one percent tax on interest but are unaware that their capital is eroded ten times as much. It is a crazy world indeed.
While the government plundered lifetime savings, other fat cats also joined the party. Big companies borrowed, borrowed and continued to borrow at negative real rates.
They were being paid by the poor to use their meager financial savings.
The unmitigated gluttony of the richest of the rich in the past few years is shocking.
They were borrowing so much that banks even asked the central bank to relax single borrower limits!
Contrast the 3 to 5 billion that is needed to exceed the single borrower limit of a bank with a 10,000 rupee NSB savings deposit or a 20,000 rupee EPF balance of a factory worker.
It is the rich that can borrow most from the banking system not the poor. They buy real assets from the money - real assets that protect them from inflation.
And what of the working classes? What of the poor assetless factory worker who finds that last years five percent salary increment has been taken away by 20.5 percent inflation, while companies reported high profits as real wages went down?
The stock market went through the roof. The monetary policy led asset bubble sent land prices not through the roof, but the upper floors of high rises.
When land prices go up, the landless have to pay more to the landowners to get a piece of land. The haves again benefit at the expense of the have-nots.
What about the gluttony of the public servant who does not pay taxes? The unemployed graduate who has jobs created out of this plundered money? The cabinet minister who gets the 80 million rupee Benz or BMW from the money plundered from the poor and the private sector and corporation worker?
Even the salaries of the bloated public service are undermined by this rampant inflation.
According to Central Bank, the central government employees wage index rose 17.1 percent in 2006 in response to salary increases. Inflation was 19.3 percent. Even they are two percent behind.
This is third world economic policy. Whether it is called Rata Perata the Mahinda Chinthana or by some other name, these are real effects of the policies of people-friendly governments that stands for the working classes, and the poor.
These are policies that concentrate the wealth of a nation among a few. This is what happens in Latin America, in Argentina or in Hugo Chavez's Venezuela.
Will it end?
This cannot end overnight. The central bank has tightened policy, but there is a limit that it can do so. If it tightens too much and the rates go too high the over-leveraged companies would collapse and create bad loans.
There are already signs that credit it getting very tight. This can hurt the real sectors and eventually the banking sector. So the plunder has to continue at least at a reduced pace for a while. The poor must continue to pay the price for a 'soft landing'.
What we will eventually get, is a high-deficit, high-interest-rate economy which discourages growth and new jobs. Finally the buck stops at the treasury and wasteful deficits.
The only way to fix this is to cut the budget deficit and fix areas like the bloated public sector. But there is little hope of this. The government is proudly planning to hire another 7,000 unemployable graduates this year according to reports.
So the poor must continue to pay. The factory worker must continue to pay and feed the plunder even at a reduced rate, until the deficit is cut to manageable proportions.
This is not just the greed of the ignorant third world politician at work who deceives an ignorant population that has no conception of what happens in a paper money system.
Some economists also advocate deficit spending based on Keynesian economics. This has happened even in America. At one time the US government banned its citizens from holding gold so that they could plunder the people through the paper money system.
But the tragedy is that Keynes never advocated deficit spending as a way to run a country in the normal course of business. It was an extreme medicine to get a country out of a deep recession -- like chemotherapy to a terminally ill cancer patient.
Keynes has actually written much on the destructive effects of inflation, which most modern 'Keynesians' seem to ignore.
For example in 1919 he wrote about Lenin's supposed statement that debauching its currency was the best way to destroy a capitalist society.
"Lenin was certainly right," Keynes wrote. "There is no subtler, no surer way to overturn the existing basis of society to than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner, which not one man in a million is able to diagnose."
Not only capitalist, but any society based on paper money including Sri Lanka can be destroyed by debauching the currency.
One in a million
If only one in a million people can diagnose the problem according to Keynes, there are less than 20 people in this country who can do so. And his followers are not among them!
Neither are the savers who object to a one percent withholding tax, but put up with 10 percent negative real rates.
Though negative rates and money printing cannot be understood, most people understand the effects of it - like poverty. This country boasts of 6 percent unemployed but 40 percent of the households earn less than two dollars a day.
We know how it happened to Russia. Even now Russian girls come to Colombo as sex workers because of what happened to the Russian ruble.
Our women are going to the Middle East for mostly the same reason, and not just because JVP is opposing education reforms or reforms to the agriculture sector.
Our people are working as domestic servants in Maldives, a country that does not have a central bank, has the highest per capita GDP in South Asia, the lowest inflation in South Asia and perhaps registered the highest economic growth in the world in 2006 at 18 percent, for that very same reason.
In the early 1980's the J R Jayewardene government printed so much money for the Mahaweli program that brass coins were melted by the gunny bagfuls and made into screws. Talk about getting screwed!
The one thousand rupee note came at the same time.
Now we have the two thousand rupee note. The one rupee coin is smaller than the 50 cent coins two years ago. And the 50 cents coin is the size of the 25 cents one.
This madness, this plunder of the poor, has to stop. This growth at the expense of the poor has to stop. The central bank and its governor cannot do it alone. Support is needed from a low-deficit budget.
CB t-bill numbers have been updated. Please note that is it difficult for outsiders to tell exactly what is going on inside the monetary system from published numbers. The total CB credit to government is an end-of-month number, while CB t-bills is an end-of-week number (usually Thursday) and the dates do not match. That may make up for the discrepancy between CB t-bill holdings change and the total CB credit change. Also it could be provisional advances or other accounts about which information is not readily available to outsiders.
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