Friday, June 21, 2024


Dhaka Tribune

OP-ED: Should foreign exchange be controlled?

With the world running on floating exchange rates, exchange control just imposes additional costs

Update : 21 Jun 2020, 08:59 PM

Money laundering has a specific meaning -- moving around cash or bank accounts that have been earned by illegal or untaxed means to make them seem pure and honestly owned. It is to wash that black and grey cash, that is, to launder it. 

Then there's what some governments call money laundering which is us doing as we wish with our own things.

Another way to put this is that it's just fine for the government to be keeping an eye on us to see that we're not crooks or tax cheats. But forcing us to sell all of our foreign exchange to the government, then buy it back, isn't. Bangladesh, unfortunately, tends toward that second situation.

The really annoying thing about this sort of system is that it's not actually necessary. The usual justification is that the government needs that foreign cash. Some things -- say, oil or natural gas -- cannot be bought from foreigners in the local currency. 

So, when a Bangladeshi -- whether individual or enterprise -- earns some dollars, or euros, by exporting, then it's righteous that the government should have it. In return for taka, of course. The government can assign that scarce amount of that foreign money to what the country really needs.

The problem here is that it rests upon an illusion -- that there is a shortage of foreign currency. There isn't and this is explained by our old friends the supply and demand curves -- page two or three of every economics textbook. We never have a shortage of anything as long as the price can change. 

It's only if we try to fix the price that perhaps people won't supply enough for the demand at that price. So, if we've got a floating exchange rate then we cannot, possibly, have a shortage of foreign exchange. All that can happen is that the price of it changes.

So, this idea of forced sale to the central bank isn't needed in the first place. But what's worse is what it leads to.

Now we've got politics determining who gets access to that foreign cash sitting at the central bank. A large part of what went wrong in Venezuela is that – essentially, you understand, and not to be specific about which individuals -- it was crooks that got it. 

Their friends within the government let them have it at a special price that created a profit, and then was shared among friends. The only people getting the short end of the stick are everyone else in the country. This also explains much of Zimbabwe's problems.

Of course, this doesn't happen here in Bangladesh. There is no corruption and, thus, we don't have to worry about it in the allocation of those foreign reserves. However, it is still true that politics in the wider sense decides who gets access to those reserves in order to be able to buy imports. 

It's possible to say that this is a good idea because that means that only after careful consideration in the political process is it decided which imports should happen.

Well, yes, and then there's reality which is that politics decides these things and, therefore, people devote a great deal of time and effort to politics in order to be able to gain access, so as to be able to import the things they desire to be imported. 

In a free market, they'd be devoting that same time and effort into producing something we consumers would like so that we'd give them our money -- which could then be used to buy those imports.  

That is, in a government-run foreign exchange system, you have to please the government to be able to import. In a free market, you've got to please consumers. Which system do you think makes us, the consumers, better off?

We do actually have some experience of this too. Up until 1979 (from 1945 onwards or so) no British person could leave the country with more than £25 (about £200 now, a couple of days' work at minimum wage) in actual money. Businessmen could gain special permission but at the cost of sucking up to politics as mentioned above.

It was also true that the value of the pound to the dollar, the Deutsche mark, and so on was fixed. It was insisted upon that to break up this system would be a disaster, the country would go bankrupt overnight, the pound would fall in value to near-nothing -- and how could anyone even dream of doing that?

At which point, almost the day she took office, Margaret Thatcher killed the entire edifice. Not only was there no disaster, but the economy started growing almost immediately. And the pound most certainly did not sink to some fraction of its former value. 

Oh, and, as above, people didn't have to appease politics to be able to import things, they just had to go buy the foreign currency at whatever the price it was.

In the deeper economics of this, it can be true that foreign exchange controls are a necessary part of a fixed exchange rate system. As the world runs on floating exchange rates now, the exchange control isn't necessary. In fact, it just imposes those costs upon the economy to no obvious benefit.

The correct policy is therefore not to have exchange controls. Sure, that gives politics and politicians less control over the economy, but then that's one of the joys of the policy itself.

Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.

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