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Any government’s biggest enemy is INFLATION

8 months ago

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Friedrich Hayek famously said, “I do not think it is an exaggeration to say history is largely a history of inflation, usually inflation is engineered by governments for the gain of governments.” While there are many reasons for the ‘Aragalaya’ to advance and develop as a movement, the economic context for movements such as the ‘Aragalaya’ taking off should not be underestimated.  Those who remember our recent history will recall a similar ‘Aragalaya’ in 2001-2002 called ‘#JanabalaAragalaya’. During that time as well, Sri Lanka’s currency depreciated significantly and cost of living was on the rise. In fact, every time Sri Lanka’s currency depreciated and inflation started soaring, we would see similar kinds of people’s protests rising to prominence.  Inflation leads to crisis Today we are going through one of the largest crises in our history and the people’s resistance has been reflective of what we are going through. That is why it is said that the biggest enemy of any government is not the opposition, but inflation.  Unfortunately, many governments and central banks around the world have not realised this truth and have created inflation by lending their respective governments money without any control; they followed reckless monetary policies without understanding the gravity of their actions. Another currency crisis hit in 2011-2012, which led to the build-up of pressure on then President Mahinda Rajapaksa. Later, in 2016-2017, yet another currency crisis took place, with pressure mounting against the Yahapalana Government in connection with the Bond scam. Since 2019, Modern Monetary Theory (MMT)-led money printing has undoubtedly been one of the main reasons for the crisis we are experiencing today.  When countries that do not possess a global reserve currency as the national currency add money to their economy, that money will generally chase behind imports, which require foreign exchange. If the country allows the currency to fluctuate automatically, the prices of imports will increase and demand will drop without any forex shortages. But if a country is trying to control the exchange rate using its reserves, unless it has a mechanism to continuously build reserves, at some point it will encounter forex shortages followed by steep currency depreciation.  Perfect storm  Sri Lanka has often faced this same problem, which is also the reason we always face currency crises. The present crisis is of historic proportions, as it is accompanied by a perfect storm of so many other policy errors, along with deteriorating global conditions.  Since 2008, we have had the option of borrowing from markets. We complicated our problem by borrowing money at high interest rates to build our reserves as well as to keep the exchange rate controlled and artificially high.  Ultimately, we have lost control of everything, and now we have a USD shortage which has led to many shortages of essentials. Since we have borrowed money from international markets, we are now experiencing a debt crisis. Further, due to our own banks investing in sovereign bonds, the stability of our financial system is in question.  The graph shows the currency depreciation since 1970. We can observe what has happened in recent years to understand and validate Freidrich Hayek’s statement that history is a history of inflation.  Solutions  The first part of the solution is for all future and potential leaders and governments to understand that one of the main potential enemies of the country is the inflation they themselves have the power to create. On the other hand, central banks should understand that their excessive lending to governments can lead the country to absolute chaos and instability. Therefore, regulation has to come forward for inflation targeting and to have a limitation on lending capacity of central banks to governments to ensure stability in our financial system.  The already-drafted Monetary Law Act is a good starting point for the new government and finance minister and getting it approved with necessary amendments and inflation targeting is an easy win that will establish and indicate the direction of monetary stability. When inflation starts moving upwards, bringing it down is not an easy task, so we should make sure to keep it in check before it takes control and sends every other aspect out of control.  Sri Lanka is at a crossroads, where we undoubtedly need a sequence of reforms. If we implement the reforms that are required, we have the potential to become a tiger economy, but if we continue to behave with old habits and allow inflation to take us over with our bad monetary policy, we will become a failed state. 

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