Sri Lanka needs currency reforms to boost real household incomes: Bellwether

By Echelon.

Published on February 16, 2015 with No Comments


Harsha de Silva, the deputy minister of Policy Development and Economic Affairs in the Maithripala Sirisena administration, wants to boost household income, through a ‘social market economy’.

The new administration came to power partly helped by the economic hardships imposed from currency depreciation in 2012 and the downturn that always accompanies a balance of payments crisis or burst credit bubble.

The rupee fell from 110 to 130 to the US dollar in 2012 with heavy money printing by the central bank and CAL Research, a private firm measured inflation at 20.4 percent in January 2013 compared to official inflation at 9.8 percent.

On top of that milk powder and rice prices were kept up artificially through nationalist import taxes as part of a drive to create ‘self-sufficiency’. Sri Lanka received an inflating and currency depreciating central bank in 1950 – pushed by the US – when then finance minister J R Jayewardene helped the country join the Bretton Woods system of ‘non-credible’ or ‘soft’ dollar pegs by breaking the island’s hard peg.

Non-credible peg
Before the creation of the Central Bank, Sri Lanka’s rupee was hard pegged to India and to the US dollar at 4.76 to the rupee and 13.33 to the Sterling. It was legally not possible to move the currency as no money printing was allowed. Only interest rates moved. The currency moved against Sterling when gold and silver prices moved, until the Indian rupee went on the gold standard also.

But after 1951 the rupee went sliding as money was printed to finance budget deficits, or dollar interventions were sterilized with printed money to keep interest rates down (sterilized foreign exchange sales) allowing the elected ruling class to systematically impoverish the population, by destroying their salaries and savings.

In subsequent decades British Fabian socialist and nationalist polices – along with currency depreciation that destroyed investible capital – also ensured that creating new employment was difficult, further worsening the lot of the poor.

Among those who managed to prosper was an import substituting domestic production lobby operating under the cover of import duties and those with leveraged businesses or real assets rather than financial savings, like in South America.

Without sound money there will be no protection of the real value of salaries through inflation. There will also be no protection from the state against the loss of real value of savings and pension funds from currency depreciation.


Self-sufficiency, state controls
When a central bank prints money, the foreign currency shortages that result give import substituting business owners and other rent-seeking production lobbies a chance to push for higher tariffs and exploit an already impoverished population through self-sufficiency or autarky. The Nazis ran one of the best known autarkies in recent history. When World War II, the second such war triggered by German nationalism ended in 1945, her people were not only oppressed by nationalist Ernährungsautarkie (agricultural selfsufficiency) but also a host of other state controls.

After the war Germany was divided into four pieces. East Germany was under Russian occupation while West Germany was made up of US, British and French sectors. When the Allies defeated the nationalist administration in Germany, restrictions on the economy such as price controls and rationing that came with an inflating Reichsmark were continued. Due to price controls black markets were thriving and shops were without goods.

People in cities were travelling to the villages, sometimes on foot, for days on end, with whatever items they had, including household furniture and returning with grain and vegetables instead of going to work. Food production had halved. Industry was decimated.

With many people no longer wanting to use the Reichsmark, companies hired specialists or ‘compensators’ to engage in barter. Price controls had been in place from 1938.

Price controls were also in place in Britain, which had also printed money for the war effort, and Keynesianism – which was also based on money printing – was the new mantra. A socialist labour administration in Britain was no help either.

The National socialists and their predecessors, the socialists were helped in their national economic interventions by the ideas of the so-called German historical school, which eventually led to minority oppression.

Freiberg School
In Freiberg University however (ironically Adolf Wagner who brought protectionism to Europe had actually taught there) in the 1930s a school of thought emerged that saw through the problems of state planning and intervention. They became influential after the defeat of Hitler.

William Ropke, a leading member of what came to be referred to as the Freiberg School was a key person behind German currency reform, which would end inflation and provide sound money for people to trade, save and rebuild their lives after the war. Driven out of Germany by his opposition to the Nazis, Ropke came back from exile to advise the post war administration.

The man who actually helped create the broader conditions of what later came to be called the German Economic Miracle (Wirtschaftswunder) was Ludwig Erhard, another economist who had refused to join the Nazis.


During the war he had written out a post war economic plan expecting Hitler to be defeated and had given it to the resistance, who in turn gave it to the Allies. Having seen his economic plan, the US military authorities appointed him Economy Minister of Bavaria in 1945. In 1947 he effectively became the economic advisor to General Lucius Clay who headed the joint British and US occupation zones.

On June 20, 1948 aggressive currency reform was put in place, shrinking the money supply by more than 90 percent and issuing the new Deutschemark in place of the inflating Reichsmark in the first step to making Germany an economic powerhouse of the world.

My advisors tell me the same thing
At the same time Erhard freed the economy of controls. As legend has it, he caused media announcement signalling that many controls were eliminated along with the currency reform, after the occupational authorities went home for the weekend.

Journalist Edwin Hartrich, author of the Fourth and Richest Reich, enacts the following conversation between General Clay and Erhard after price controls and rationing were abolished. “Herr Erhard, my advisers tell me what you have done is a terrible mistake. What do you say to that?”

Erhard’s reply: “Herr General, pay no attention to them! My advisers tell me the same thing.”

Clay, who was personally sympathetic to free markets allowed Erhard to prevail. The rest is history.

Within days shops were filled with goods. Black markets disappeared. People returned to work, and absenteeism plummeted, giving rise to the German economic miracle.

In reality however Erhard had to battle the socialist Social Democrats whose economic planning in the 1920s had led to hyper-inflation and economic collapse. The Social Democrats found support among British occupation authorities, in trying to keep controls.Britain itself was under price and exchange controls and it had turned socialist. Freeing the economy to the dictates of the ordinary consumer was unthinkable to them.

The ration ticket
Erhard had to face stiff opposition from Brian Robertson, the British military governor. The Socialists moved two no-confidence motions against him. But Erhard persevered. “How dare you relax our rationing system, when there is a widespread food shortage?” he had been asked by a US military official.

Erhard is reported to have replied:“But, Herr Oberst. I have not relaxed rationing; I have abolished it! Henceforth, the only rationing ticket the people will need will be the deutschemark. And they will work hard
to get these deutschemarks, just wait and see”.

Opposition against Erhard also mounted when prices rose initially after controls were lifted. He was however convinced that it would be temporary and he was proved right. His absolute confidence was a source of annoyance to the British.

The French who kept the controls, were forced to liberalize to end the continued hardships experienced in their zone. Then attempts were made by British and US economists to reintroduce planning into the German economy through the Marshall Plan. Erhard managed to avoid it as well, through innovative ruses and allowed German business to grow the economy according to the needs of the people as dictated by prices and demand. He asked the Americans for Germany to be made a free trading nation again. He also managed to thwart the extreme deindustrialization plans of the Allies.


Social market economy
The Americans who now wanted Germany to prosper as a counter to the communist threat supported Erhard, allowing German industry to recover. Erhard did not favour heavy industry like the Nazis and allowed consumer goods useful to people to raise their living standards to be freely produced. The so-called social market economy (Soziale Marktwirtschaft) was born in Germany.

The ideology behind it was identified as Ordoliberalism, which was also based on sound money like Austrian economics but allowed some state intervention in breaking monopolies and in creating a social safety net for example.But with sound money and a strong currency, elected rulers lost their main tool of generating poverty and destroying the savings of the old and the weak. With low budget deficits there was no longer any need to Agenda The Price Signal destroy state debt through inflation to keep a fraudulent ‘welfare state’ alive.

Erhard went on to become Chancellor of what came to be known as the Federal Republic of Germany. In 1966 he resigned after a tight budget aimed at quickly reviving the German economy from a downturn was rejected.

Hidden history
But in the English speaking world, especially in the economics sphere, the achievements of Germany and Austria were almost unknown and no recognition was given.Instead, money printing and Keynesianism and development economics, another deadly interventionist philosophy was promoted. India regressed under Nehru’s successive five year plans with the rupee which was once the dollar of South Asia and the Middle East becoming worthless.

That is why in countries like Sri Lanka and India people like Ludwig Erhard are not heard of and nothing is taught in school about them either. German-speaking economists like Friedrich von Hayek won the Nobel prize only in the 1970s after the Bretton Woods system of soft-pegs collapsed ignominiously amid rocketing oil, food and gold prices.

Hayek’s policies were followed in Britain only after Margaret Thatcher was elected, allowing Britain to become a strong nation in the world, something Germany did at least two decades earlier.

Deputy Economics Minister Harsha de Silva will have a hard time creating a social market economy in Sri Lanka.

In Germany nationalists were completely defeated with the fall of Hitler and Erhard only had to battle the socialists. In Sri Lanka nationalists are alive and kicking and socialist planning is also flourishing with incentive schemes and other grand plans. Worship of the state is prevalent even among private business and school children are brainwashed in statolatry and nationalism with tax payer money centralized syllabi just like in Eastern Europe.

The 100-day plan of the administration itself is fiscally loose and is more in the line with a Social Democratic state plan than something that will protect the incomes of wage earners and the savings of the old and the weak with sound money.

The central bank itself which has a policy rate and intervenes in forex markets to stop the currency appreciating (or depreciating) is inherently unsound. Its operational practices, dating from the failed Bretton Woods system, are weighed heavily against sound money.

Without sound money, inflation and currency depreciation can lead to social unrest and strikes especially in the private sector and the blame will not fall on unsound money, state spending and public sector expansion. Instead it is the ‘free economy’ that will be blamed just like ‘capitalism’ was blamed in Europe for all economic ills coming from state and central bank excesses.


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