The Case Against Fixed Exchange Rates

As we noted when we talked about Sri Lanka’s problems, you cannot have a currency shortage if you have a floating exchange rate. If the price can change, supply and demand will balance out, which is how markets work.

There are other reasons why we might not want to allow people to try a fixed exchange rate. At least some of those other reasons being the effects of other things that are then done to try to maintain that exchange rate.

There is the stupidity of trying to reduce the profits of banks in forex trading for example. Insisting that there can only be Tk1 margin on a dollar means fewer people will trade dollars. Fewer trades will of course mean less dollars – quite the opposite of what is being attempted in the first place. There are also those more general cries to banks about the profits they make from trading – but if people are making a profit from trading, it shows that they are providing something of value to consumers.

It’s the only way to make a profit in a market after all. We might even point out the demand that forex volatility reduces – yet this price change is the very thing that prevents there from ever being a currency shortage. The whole bureaucracy management system here seems to be aimed at producing, not avoiding, these Sri Lankan problems.

But the truly appalling example is what a fixed exchange rate does to economic freedom. Because now we have bureaucrats demanding that import duties, tariffs, be increased in order to defend the exchange rate. What’s worse is something many don’t think about, but it’s worse.

Now, okay, I’m a journalist, a profession famous for its thirst. So my opinions on the price and essentiality of beer will be different from those of the population of a predominantly Muslim, non-drinking nation. My take on spice, being British and a bland food lover, will also be different.

But then that’s exactly the point.

It is a fundamental axiom of welfare economics that we all have our own utility curves. In other words, we all favor different things. Or, our definition of “the good life” differs from that of our neighbour. This means that our definitions of what is an essential good, what is not essential, differ from person to person.

Yet here are bureaucrats, dēska jaki, defining at a stroke what is essential, or not, for the whole nation. Deliberately doing everything possible to reduce this freedom and freedom to live our own lives by changing national prices according to their own biases.

There’s also the fact that their list of non-essentials is insane – and I’m not just talking about thirsty reporters. Mobile phones are an input to economic growth, they allow people to talk business and therefore increase growth when there are more of them. So, does anyone else think that something that makes the future richer is a “nonessential”? The same goes for refrigerators and air conditioning — food doesn’t rot, people don’t melt — or at least are able to keep running during the hot part of the year, the hot part of the day .

But, worse than all of this, is that bureaucrats have seized this power to determine our lives in pursuit of something that shouldn’t be happening anyway – having a fixed exchange rate. And this is the greatest loss resulting from bad economic policy. The commotions, the idiocies that are perpetrated, that are made to try to defend this first bad decision.

In order to have a fixed exchange rate, the suggestion now is that a fool in a suit should be allowed to decide how much your beer should cost. Far better not to have a fixed exchange rate – because we shouldn’t anyway.

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