Over 250 years after Sir Francis Bacon made the statement that “Knowledge is power”, Albert Einstein countered with his own “Information is not knowledge”.
The veracity of the quotes above was demonstrated in the response by the public to media campaign conducted by The Financial Services Commission against Alternative Investment Schemes. Notwithstanding, it is surprising that a similar approach is not been undertaken about the wisdom of converting to US dollars.
Chicken or egg
Over the years the fallacy has developed that the holding of US dollar provides a hedge against inflation. This is quite understandable given that successive Jamaican governments have, without much empirical evidence, proffered that devaluation leads to inflation.
Their insistence on this causation has led them to pursue inappropriate policies in defence of the local currency. Some of the direct results of this are high interest rate, misallocation of capital in the build-up of the Net International Reserves (NIR), uncompetitive export, trade imbalance, high unemployment, huge debt burden and diversion of resources from education, security etc. to interest payment.
The table below depicts the cumulative percentage change in inflation, US$ appreciation vis-a-vis the Ja$ and Jamaica Stock Exchange main index for the years 1971- 2008.
Returns on the JSE is 120% above inflation, and inflation is 350% higher than the U$ appreciation. This suggests that currency speculators must have impeccable timing to beat the odds, as it is only beneficial in the very short term. In such a case, trading on the international currency market is a better bet with higher leverage and more volatility.
Next stop
The recent slide of the Ja$ is playing catch-up with past inflation, however, the cumulative gap between the two is widening.
Years System Ratio: Inflation to US$ appreciation
1980- 1982 Fixed exchange- JA$1.78 3.8
1985- 1989 Auction system- JA$5.50 2.1
1991 Liberalization- JA$21.57 1.6
1992 Butch Stewart Initiative- JA$22.50 2.1
1996- 2004 Managed float- high inflation 3.4
2005- 2008 Managed float- inflation mostly double digits 4.3
The long-term average ratio is 3.3 and the short term is 4.0, which prices the local currency between $92.00 and $111.50
Lagging indicator
Movement in the exchange rate is a lagging indicator and is evident in the following table.
The equities market appears to move with or shortly after significant movement in the exchange rate. It is hardly likely that it will be any different this time; smart investors would see this as an opportune time to begin positioning in local equities.
