By Hema Senanayake –
Reforming Money System; Global Economic Revolution Is Overdue: Part 6
This is the most difficult subject in economic governance. It is not commonsense. Due to its highly technical nature I honestly regret that I will not be able to discuss the technical details as to how I would propose to reform the monetary system. Yet, I need to convince my readers as to what I am proposing to do differently. In this regard I could not figure out a simple methodology other than submitting an open challenge. For opting to this approach I humbly apologize to President Maithripala Sirisena and Prime Minister Ranil Wickremasinghe in advance. I like to begin this discussion as follows.
I would rate the Governor of People’s Bank of China, Zhou Xiaochuan as the most brilliant governor of any central bank. Perhaps you might think what qualification I have in order to evaluate the brilliance of central bank governors around the world. Kindly ignore that question for the time being. Let me submit my argument.
Since the end of World War 2, the United States dollar emerged as the major international reserve currency. In the year 2008 the United States economy crashed and there was a big time meltdown in its Financial System. The future of the U.S. dollar became unpredictable. By that time many of the Chinese financial assets were tied up to the U.S. dollar. Chinese president was worried about the value of the U.S. dollar and if the dollar had depreciated the real value of Chinese assets held in the U.S. dollar terms would depreciate accordingly. Somewhere in March 2008 the Chinese president intimated that the world would need a new global currency.
President Obama was quick to respond. “I don’t believe that there’s a need for a global currency,” said President Obama Tuesday night during his prime-time press conference (Forbes, March 26, 2008). A couple of days later the governor of Chinese central bank Zhou Xiaochuan released a text in response to President Obama’s above assertion.
In that text it was mentioned that, “The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history.” Let me give you a few clarifications for the benefit of non-economic readers. The term “credit-based national currency” refers mainly to the U.S. dollar. Why the U.S. dollar is credit-based? It is because the creation of most dollars is based on a system of credit issuance not by printing money. The use of a national currency which is created by the designated commercial banks during the process of lending is now used as an international reserve currency. Hence, the quote literarily meant to say that the acceptance of dollar as international reserve currency is a rare special case in history and China want to change it.
This is a statement that can be uttered only by a person who understood the current banking practice completely. Now, well within a decade after he released this particular text, Chinese national currency is almost an international currency today, thanks to the brilliance of the governor of Chinese central bank. The methodology the China is using is the signing of currency swap agreements with almost all economies.
Now my challenge is simple. I am not proposing to appoint any person as the governor of the Central Bank of Sri Lanka (CBSL), who cannot explain the true technical meaning of the statement of Zhou, mentioned above. This is not personal and that is why I apologized from the President and P.M. at the beginning of this article. Was this point a concern when P.M recommend the name of a person as the governor of CBSL and was the same point a concern when the President appointed the nominee as the governor? Out of respect, we do not expect any response to these questions from both gentlemen.
Perhaps, now you might argue or think that our governor of CBSL is not going to make our currency, the rupee, an international currency like China did. So that, any experienced banker or Charted Accountant with professional reputation could suit for the job. No sir, that type of thinking is wrong. Why?
It is because, not only the international reserve currency is credit-based, but also our local/national currency too is credit-based. Due to this very reason the maintaining of the value of rupee is truly a huge technical task. If the governor of CBSL truly understands as to how credit-based money system works, then only he can make our system strong, flexible and resilient in order to achieve national economic objectives. Perhaps, you might now think whether I have my doubts about the CBSL’s performances. Yes, unfortunately, I do. Now, you might demand me to submit at least a few evidences. Let me begin with a minute paper of the Monetary Board.
This particular Minute-Paper of Monetary Board was dated February 23, 2015. It says that, “…Accordingly, the Board instructed the Superintendent of Public Debt to conduct a 30 year Treasury bond auction during the week and arrange to list sovereign bonds in Euro Clear Exchange in future.” The idea itself in regard to the listing rupee denominated sovereign bonds in Euro Clear Exchange is ample evidence to show that the newly appointed governor of CBSL has not had any clue as to how our own national credit-based currency system works.
After the Monetary Board decision, they did the bond auction on February 28, 2015 pushing the interest rates up and CBSL increased the volume of bonds by 10 times. This is the infamous bond scam reported and discussed in many forums including parliament. After I found the above decision of the Monetary Board which is usually chaired by the governor of CBSL, I now feel that making undue profit from insider dealing from the alleged bond scam was not the prime reason to increase the volume and the rate of interest. Why do I say so?
Let us assume that governor of CBSL or any other influential man come to the Monetary Board meeting and say that he has all necessary contacts and international debt market experiences and would arrange to list rupee denominated bonds in Euro Clear Exchange. In order to do it, he would argue that there should be sizeable volume of bonds and possibly a higher rate of interest so that sovereign bonds might be attractive to euro-zone when listed in Euro Clear Exchange.
Now, if you are member of the Monetary Board and if you do not have any clue as to the risks which our credit-based currency system faces and as to how the credit-based international reserve currency system works, what would you do? You would agree with the proponent of the idea. Was this the way that the above mentioned Monetary Board decision made? Now I may suggest readers to make their own investigation as to what has happened in regard to the listing of rupee denominated sovereign bonds in Euro Clear Exchange mentioned in the above Board decision.
Not only that, my point is that if CBSL had any hope in listing of sovereign bonds in future in Euro Clear Exchange, it would not have printed money around Rs.200 billion within a period of eight months or so after making the said Monetary Board decision because ours too is a “credit-based currency system.”
Let me submit a few more examples. The CBSL decided to reduce the loan-to-value ratio for 70% in auto leasing. Subsequently the Minister of Finance wanted to increase it to 90%. From the budget 2016, it has been proposed that commercial banks must refrain from carrying out leasing businesses. But as far as I know there is no proposal to prevent commercial banks extending loans to their own leasing subsidiaries. Then they proposed to stop issuing duty-free permits to senior government executives. Again the government had to succumb to the GMOA (Government Medical Officers Association) pressure and has promised to continue with issuing permits. Then the government increased import tariffs of small cars. All these actions have something to do with monetary management. This kind of monetary management can only be defined as the execution of monetary policy by administrative rules. This shows the failure in understanding and managing the local credit-based currency system.
In our new economic model we are going to accept the credit-based currency system or in other words we are going to use Fractional Reserve Banking System and would never appoint a person as the head of the CBSL, who would not understand that system. In many developed countries especially after the Great Financial Crash of 2008, many economists voice against Fractional Reserve System. Our acceptance of Fractional Reserve Banking is not without reason. In fact the choice is a requirement arising from a very unique systemic contradiction in the macroeconomic system. This could solve the problem/contradiction at demand-and-supply level in the real sector but it moves the contradiction into the financial and debt regime and we need to resolve it too. We will discuss about these matters in the future.