07 Dec The risk of printing money in a dollar-scarce economy, or, for the “duchitas,” the dangers of Keynesian policies in a balance of payments crisis
The word duchita is something I learned from Santi and was quickly added to our dictionary. For us, it refers to people who are experts in something and enjoy showing it. So, when I ask him, for example, “How did the game go?” and he replies, “Good, Dad, there was just one duchita,” I understand exactly what he means.
Well, that’s it: duchita.
Balance of payments crises are nothing new in our region, having been an almost recurring theme throughout the last century, especially in its second half. These crises manifest in various ways, but the aspect that resonates most with people is often the harshest: a stark shortage of dollars.
Faced with a dollar shortage, governments in the last century (and even in this one) resorted to questionable measures: 1) capital controls; 2) import restrictions; and 3) higher tariffs. In simpler terms: 1) your freedom to buy and sell dollars is restricted; 2) you can’t import the phone you’ve been eyeing or subscribe to Netflix; and 3) taxes on imported goods increase, based on a bureaucrat’s decision about what is “non-essential”—like a fancy pair of branded pants.
In this dollar-deprived world, the economy begins to strain, and the cuculis of a recession start peeking through the doorway. Confronted with this, governments often face a risky temptation: implementing Keynesian policies, which could inadvertently swing the door wide open for the cuculis. Let’s explore how this plays out.
Imagine you run a small bakery and notice your employees are unhappy. The economic crisis, rising prices, and the holiday season have dampened everyone’s spirits, and even your signature empanadas are starting to lose their appeal. As my mom would say, “I must be sad because the food doesn’t have salt.”
To lift their morale, you announce a double Christmas bonus in the form of vouchers. However, because your finances aren’t in great shape either, you ask your employees to spend the vouchers exclusively at your friend’s store. Why your friend’s store? Because you’ve arranged to pay him back for the vouchers in 12 monthly installments, effectively taking on a debt with him.
At first, things seem to improve: the empanadas regain their flavor, your employees are smiling again, and everything feels magical—because all you had to do was print vouchers. But then comes the problem: you find out that many employees used their vouchers to buy cell phones and clothes from your friend’s wife’s store instead. Why is this an issue? Because after the holidays, she shows up with bad news—you owe her for the vouchers, and she demands payment in dollars. Your employees, in their resourceful way, had spent the vouchers on Chinese-made cell phones and American-branded clothes. Faced with this news, you faint on the spot.
Although this example is a bit exaggerated, it illustrates the core issue. When a government increases spending by printing money (Keynesian policies) in an economy short on dollars (a balance of payments crisis), it can worsen the dollar shortage. Why? Because people with that newly printed money often have no better option than to 1) increase imports, or worse, 2) attempt to convert the money into dollars. In such cases, the supposed cure turns out worse than the disease.
This is why, in a context of balance of payment crisis you’ll often hear calls for the government to reduce spending, as doing so could ease what economists—duchitas—call “exchange rate pressure.” In simpler terms, it would stop your employees from buying imported goods with their vouchers.
Latin America (Bolivia included) has navigated these economic waters and policy dilemmas in the past. What solutions have worked? Among others: liberalizing the exchange rate, cutting public spending, promoting exports, and lighting candles to a multitude of saints, hoping for higher export prices. In short, the solutions that worked often came with significant pain.
I have friends who are staunch ultraliberals and dream of returning to the gold standard. But that, dear friends, is a topic for another post.
Have a wonderful weekend,
S. Mauricio Medinaceli Monrroy
Bogotá
December 7, 2024
No Comments