Thursday, May 30, 2013

Why US Currency Is So Hard to Come By in T&T

Average Trinbagonians who are not well connected or have friends or acquaintances who work in the commercial banks will all attest to the difficulty in getting foreign currency on demand. 

If $US cash is required for any purpose including travel or trade you are also subjected to waiting list and limited quantities or only granted $US if you are lucky or you encounter a "generous" teller.

This phenomena though unfortunate and inconvenient is to be expected when one observes current economic and foreign exchange market dynamics.

The T&T's Foreign Exchange Market in A Coconut Shell

The exchange rate simply represents the price of $US1 to $TT1. In a market that is not artificially distorted by the intervention of third party like a Central Bank the price or exchange rate would naturally be determined continuously by market dependent on supply and demand. 

Contrary to what most Trinbagonians might be lead to believe the Central Bank cannot simply decree the international market exchange rate at their discretion. They must enter the international market and actively trade to achieve their desired rate, this exercise is referred to as open market operations.

For example assuming the $US is held constant the Central Bank must:
1. Increase supply or sell $TT into the Forex market - if the $TT is appreciating (less likely)
2. Increase demand or purchase $TT using reserves of $US - if the $TT is depreciating (typical)

In other words in most cases maintaining the desired rate comes at a cost, for T&T must use its scarce $US resources earned from its exports to prop up the unsustainable $TT exchange rate on the international market. The reason there is constant depreciating pressure on the $TT which warrants increasing draw down on T&T's $US reserves to prop up our $TT is as follows:

1. $TT Money Supply Expansion

The supply of $TT is constantly on the rise due to the expansion of government expenditure - as with any market an increase in supply if demand is held constant leads to a fall in price because the less "scarce" the $TT the less valuable it becomes. As seen below the M2 money supply which is a broad classification of money in circulation has exponentially expanded -thereby increasing the supply and reducing the scarcity of the $TT
Moreover, T&T is very import dependent therefore when increases in the money supply abound a substantial quantum of it is channelled towards imports which requires $US which can only be obtained when more $TT is surrendered or supplied on the international forex market. Consequently this places severe downward pressure on the $TT exchange rate.

2. Inflation

The primary cause of inflation in T&T i.e. the government expansion of the money supply also stokes inflation and further weakens the $TT exchange rate. This occurs as when purchasing power or the value of the dollar decreases persons are less willing to save or hold on to their $TT dollars instead they prefer to get something of tangible value; such as consumer goods before the dollars they hold lose even more value -this further fuels less savings, more consumption and more imports. The frequency at which dollars are spent on goods is referred to as the velocity of money.

3. Demand for $TT on the decline

Energy sector production in T&T is down due to severe rolling gas curtailments on the Point Lisas Industrial Estate; causing not only reduction in our exports of LNG, but also, methanol, ammonia, urea etc over the last two years. Investment in this sector is also stagnant. When investment and production operations occur energy companies must purchase $TT to pay T&T workers etc using their earned $US which creates demand for our $TT, T&T has suffered greatly in this area since energy exports and investments are down.

4. The Suppression of The Savings Rate

The low savings rate is also placing downward pressure on the $TT. Higher savings rates offered to savers encourages under-consumption and more savings which also leads to less imports. In addition it encourages foreign investment capital causing appreciation of the $TT. For example the minimum saving rate in Barbados is 2.5% compared to the current savings rate in T&T of 0.2%. The commercial bank cartel in T&T which is not subject to real competitive forces has severely suppressed the savings rate even whilst the rate of decrease of lending rates have not correspondingly decreased as seen below. This observable occurrence is due to attempts by the commercial banks to squeeze revenues out of its customers.

It's also worth noting that limited investment options that offer reasonable rates of return are also severely lacking because the financial industry has little incentive to innovate since they operate in a privileged oligopoly environment where it's in the interest of the participants to maintain the status quo.
Read: Why Banking Service Levels in Trinidad & Tobago are So Poor
Economics 101

The fact that it is becoming increasingly difficult to get $US is a sign that there is a shortage of available $US.  This is a clear market signal that the price for $US in $TT is too low and should be higher i.e. there is depreciating pressure on the $TT

A disparity therefore exists between the $US amount demanded and the amount supplied, consequently a shortage occurs. The current price ceiling is leading to a shortage as the example demonstrates ----------------------->

All economic shortages are a function of price and when the price is set below the equilibrium rate where supply equals demand there will be a shortage

The Consequences

The current mismatch of pricing has consequences, most notably shortages which were alluded to earlier. already we are also seeing creeping instances of the following: 
  • Black markets - people willing to pay more for foreign exchange outside the traditional outlets such as banks and kiosks. Or people being forced to use travel money cards or credit cards instead of cash which come at a cost.
  • Artificial controls on demand, such as rationing which was alluded to earlier.
  • Non-monetary bargaining methods, such as time (for example queuing) or nepotism
  • Price discrimination - well connected pay one rate while the average citizen pays a less favourable rate. 
  • The inability to get any foreign exchange
If things continue along this path and get more tenuous the government, especially as $US reserves are depleted, will have no choice but to eventually surrender to market forces. This will involve another depreciation of the $TT which the government through the Central Bank money expansion has consistently devalued over the last 20 years.

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