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News : World Last Updated: Jan 17th, 2010 - 12:00:54

Treating the symptom by default
By Marston Gordon
Jan 17, 2010, 11:56

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In the run-up to the collapse of the indigenous financial institutions in the early 1990s, most of them were paying interest in excess of 50% to depositors. Anyone who was smart enough to participate in the government inspired ponzi ought to have known the relationship between risk and reward, and if they did not, experience was set to be the solemn teacher.

Unfortunately, the then minister of finance, the honorable Dr. Omar Davis decided that it was better to insulate people from their folly by putting the tab on taxpayers through the financial sector adjustment company (FINSAC), and in the process added a humongous amount to our debt burden. What is interesting about this deal is that the ponzi participants got a second go at it, in that, the government took over where the bankers left off by offering high interest rate on a slew of local registered stock (LRS) and government bonds; the ordinary passbook savers gave up huge spread to the financial intermediaries, but the more sophisticated players who dealt directly maximized their take.


Chicken home to roost

Easy money continued to lure would-be investors away from productive ventures, and as ponzi schemes multiplied the economy shrank. Then came the collapse, one-by-one from Cash Plus through to Olint, and finally now to the government ponzi paper. It took the International Monetary Fund (IMF) to tell the government whose interest they are here to protect, and have ordered an orderly default on domestic debt to minimize the threat to external creditors, notwithstanding the rhetoric that the constitution states that debt has the first call on the budget. The local financial institutions are going to suffer in untold ways, as in the good old days of historic profit growth, they also benefited in untold ways.


Root of the problem

In the 1930s currency devaluations was used to increase the competitiveness of countries, and in the clamor to outdo each other chaos ensued resulting in the Bretton Woods agreement. By 1971 the United States succeeded in destroying the agreement and establishing the US dollar as the dominant (sole) reserve currency; the Jamaican dollar was then worth US$1.30 compared to the current rate of US$0.01.

Since then, Jamaica has expended considerable time and effort to avoid what productive countries would envy. In the process of postponing the inevitable we chose to offer high interest rate as a compromise to devaluation. Devaluation is not evil it is an adjustment mechanism to keep in balance our income and expenditure of foreign currency. And no matter how much we reduce interest rate by fiat, unless the exchange rate is allowed to respond appropriately, something is going to give and it is likely to be interest rate. When it does, Jamaica will default on its external debt followed by massive devaluations.


Bank spreads

Governor of the Bank of Jamaica (BOJ) Mr. Brian Wynter is playing ball with the government in reducing interest rate; on December 17, 2009 the BOJ reduced interest rate by 200 basis points to coincide with the government’s Christmas tax package. Even with the default, Mr. Wynter has not come to terms with how he as governor is going to get the banks to narrow their spreads, because a reduction by the central bank does not translate into lower rates by commercial banks on loans.


Net International Reserves

It appears from a rough calculation that oil was priced in the budget at US$70 per barrel. Oil averaged around US$58 bbl at the time of the budget while we sat contented with the Net International Reserves (NIR) invested in US Treasuries (current 1 yr tenor yields under 0.5%). We are suggesting to Mr. Wynter, as we have to his predecessor, that he buy call options on oil and gas futures. In the unlikely event that oil price collapses, the impact is negligible in terms of dollars compared to the potential gain from increases, not to mention adverse risk to the economy.



The default on the local debt by the government of Jamaica is a very temporary fix in playing for time; three things that need to follow to show sincerity and structural changes are: devaluation, reduction of commercial bank spreads, and purchase of call options on oil and gas futures.



Source: Bank of Jamaica, Caribbean Policy Research Institute (Jamaica’s Debt: Exploring Causes and Strategies- Damian King, Latoya Richards)


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