Sri Lanka’s tragedy and the lost wisdom of D S Senanayake on money printing
ECONOMYNEXT – Sri Lanka’s economy is now shrinking, lifetime savings of the people have been halved, and inflation is the highest created in the history of the Latin America style central bank and the worst fears of those who nervously watched the money printing agency as it was created in 1950 have been realized.
Unusually it has been politicians in Sri Lanka who have sounded warnings from the beginning, though they went along with the interventionist ideology that sprang up among Anglo-Saxon academic economists of the day.
It has been politicians – and the general public – who have paid the price for the actions of the economists.
A Politician’s warning
It was a politician who sounded the first warning on central bank credit (money printing) the very same day that Sri Lanka’s central bank was created citing two countries that were experiencing severe monetary troubles.
“There are some I know who think that we should not have established the central bank. It is true that our experience in the realms of so-called high finance has been brief,” then Ceylon’s Prime Minister D S Senanayake was quoted as saying in news report reproduced in the publication, ‘Central Bank in Retrospect’.
“We made our decision to establish the central bank deliberately and with the full realization of its great possibilities for harm as well as its great possibilities for good
“We were fully aware that the central bank had been abused in many countries in the past.
“We need only to remind ourselves of how excessive use of central bank credit reduce the real value of the currency and resulted in the dissipation of foreign exchange reserve in countries like China and Greece after the war.”
It is not clear how soft-peggers in subsequent years were able to blame victims for its money printing and managed to persuade politicians to bring exchange controls and import control on the victims of the central banks policy.
That balance of payments deficits in a pegged regime come from money printing was successfully hidden in later years. It was done not only in Sri Lanka but also in the English speaking West and Latin America where similar problems – and similar solutions – were found.
Soft-peggers, in Washington in particular – now blame defending a peg for BOP deficits not money printing.
The solution is to de-control interest rates from the pegged central bank as Singapore and some other East Asian nations did. Controlling citizens does not solve the problem, as the impossible trinity of monetary policy objectives clearly shows.
Greece
Greece descended into near hyperinflation because the post-World War II administration failed to put the brakes in the wartime money printing of the Nazi military currency.
A communist insurgency was feared in Greece fanned by monetary instability.
Significantly, Greece was a country where the Marshall Plan agents (from America’s Economic Co-operation Agency) and Harvard style Keynesianism had strong influence; unlike in Germany where the hard money Austrians and Ordoliberals did everything they could to avoid Marshall plan interventions which were tied to various controls.
Greek tobacco exports collapsed as a direct result of the Marshall plan. Planners encouraged deficit spending and loose money. (The Great 20th Century Hoax)
Significantly also the Greek currency also continued to depreciated in the post Bretton Woods era from around 30 to over 360 to the US dollar, unlike Germany and German speaking countries in Europe.
Germany descended into hyperinflation from the 1920s and defaulted on its debt. Two US led plans like the IMF today, the Dawes plan and the Young Plan (with some central bank reform in the Dawes Plan) was unable to bring permanent stability and ability to repay debt and also World War I reparations.
As a result Germany went to the National Socialists and Hitler came to power. However after Hitler’s defeat West Germany went into a full stability mode, junking money printing and stimulus and became a stable export power house.
In China at the time, the KMT also faced troubles, somewhat similar to the problem Sri Lanka finds itself in now.
China
Several years before communist uprising came; China faced difficulties in repaying debt due to depreciation. The initial problem was the inability to repay gold standard debt with its silver backed money due to fall in value of silver.
The self-same Young of who tried to help Weimar Germany backed by Kemmerer – a money doctor who had set up several mostly stable Latin American central banks which were later tinkered by Fed’s Robert Triffin based on the model of Raul Prebisch’s Argentina central bank – cooked up a plan to restore external viability to China by charging customs revenues in gold.
However China descended in to high inflation later and the communists won. Later when the KMT fled to Taiwan and they had learned their lesson.
Taiwan the country now operates like a currency board and is an export powerhouse with a very stable exchange rate which brings low inflation. In general, to operate a strong exchange rate collect reserves, a monetary authority has to run deflationary policy.
China’s communist regime also fell to its knees in the 1970s when the Bretton Woods collapsed. One of the first reforms of Deng Xiaoping was to reform the central bank and halt its ability to print money to finance industrial and commercial activities.
In the same way as CB Governor A S Jayewardene stropped rural credit re-finance and built a barrier between the central bank and Rural Development Banks, economists under Deng separated the industrial and commercial credit divisions of the People’s Bank of China and built them into commercial banks.
A similar reform was carried out in Vietnam in 1989 after the Vietnam Dong collapse after the open economy started in 1983 creating unrest, boat people and poverty.
Shenoy’s Warning
B R Shenoy, the Indian classical economist who advised J R in 1966 to tame the central bank issued a similar warning to Jawaharlal Nehru when the second 5 year plan was developed Prasanta Chandra Mahalanobis . An arch planner, he could probably outdo Gosplanners themselves.
The 5 –year plans involved money printing state spending, now called s’timulus’ or ‘targeting an output gap’.
“To force a pace of development in excess of the capacity of the available real resources must necessarily involve uncontrolled inflation,” Shenoy wrote in his now famous Note of Dissent.
“In a democratic community where the masses of the people live close to the margin of subsistence, uncontrolled inflation may prove to be explosive 1 and might undermine the existing order of society.
“In such a background one cannot subsidise communism better than through inflationary deficit financing. Probably the greatest enemy of the Kuomintang in China was the printing press.”
In Sri Lanka communist insurgencies were also fired, the economy controlled and kids starved developing Marasmus and kwashiorkor amid trade controls on food.
Now Ranil Wickremesinghe is claiming misleadingly that ‘Fascists’ are raising their head and is cracking down on the Frontline Socialist Party and university students.
No Change
Nothing will change in Sri Lanka with monetary instability now a part of regular policy through flexible inflation targeting and ‘data driven monetary policy’.
In 2012 and 2018, the central bank missed reserve targets within IMF programs due to suppressing rates with printed money as private credit began to recover.
Make no mistake, save for a few, Sri Lanka’s neo-Mercantilists have been fully behind the monetary instability triggered by the agency by printing money to suppress interest rates.
They will cry from the rooftops to depreciate the currency instead of raising rates to stop money printing.
Economists who call for a float (isolating reserve money from the balance of payments) however were not asking for the same actions as those who asked to break the peg.
In Sri Lanka, the central bank’s suppression of interest rates, its re-financing of rural credit, including in years where there was no budget problem, its deficit financing at times, were all actions that were fully backed by the economists of the day, though deficits are later blamed.
After 2015 its open market operations, overnight auctions, term repo auctions, yield curve targeting through outright purchases, the buffer strategy, operation twists and money creation through Soros style swaps, including when there was no budget problems, inflationist-devaluationism of REER targeting have been almost universally backed by almost 98 percent of the economists of the day.
Most people in the country hardly has any understanding of how the central bank creates forex shortages and its opaque and liquidity injections justified with technical sounding esoteric words like ‘open market operations’, to bamboozle it hapless victims.
It is the helpless public who suffer most at the hands of a central bank. Their future is destroyed, their lifetime savings destroyed, and driven to social unrest and ant-government activity they sometime pay the ultimate price with their lives.
The politicians are ultimately blamed for policy errors – which is right since they made the law making it possible for economists to print money and deficit spend – and they get kicked out, sometime before their term ends.
Legislative power can beat flexible policy and bring a rule
In the same way it is politicians who can ultimately beat the neo-Mercantilists, the planners, the Harvard-Cambridge (Keynes-Hansen) interventionist nexus.
Liz Trust was kicked out by fellow politicians for pursuing policies that were greatly lauded from the day the Bernanke-Greenspan bubble burst (and the Great Depression).
In all other countries with monetary stability it was politicians (advised by classical economists in some cases) who finally brought the Mercantilists to heel. It was the case far back in 19th century England. Ricardo, Thornton, Prime Minister Peel comes to mind.
In Germany (after Weimar Republic) it was Ludwig Erhard, in Singapore it was Goh Keng Swee (after Japanese Banana money) in and China, it was under Zhu Rongjii final definitive reform took place in 1993, though there were others before him in 1978.
Greece had no domestic ideology get itself out of trouble. In fact there were calls by neo-Mercantilists for Grexit, and to depreciate the currency like Sri Lanka and reach debt sustainability through inflationist-devaluationism after its last debt crisis.
Though the central bank was set up when JR Jayewardena was Finance Minister. To be fair J R tried twice to get classical economic advice by bringing in B R Shenoy the best hard money economist in South Asia and Goh Keng Swee, the best hard money economist in East Asia.
Like Greece, like Latin America, there is no domestic knowledge in sound money Sri Lanka except in the case of economists like W A Wijewardene who practiced what he preaches in the central bank when he was there, and his then chief A S Jayewardene.
Politicians have legislative power to undo the wrong done under D S Senanayake, which was worsened in later stages by setting up rural credit department and making it easy to depreciate the currency without parliamentary approval instead of market pricing interest rates.
Only a politician, a finance minister, or a prime minister can undo the wrongs of 1950, tame the crisis- prone flexible inflation targeting peg – one of the deadliest policy conflicting monetary regimes of all time and tame the Cambridge-Harvard (Keynes-Hansen) dogma that has brought so much misery and instability to the world.
