Economic Illiteracy is a DANGEROUS thing!

After a long flight from Chile, I'm back in Quisqueya!

My my, its incredible all the rumors and negative attitudes towards the economic situation in the DR has mushroomed on DR1 during the time I was gone!

Let me explain a bit of economics here, because its obvious many people don't know enough to realize that the appreciation of the Peso is actually GOOD!

As you read the following, keep in mind that in the short run prices are considered STICKY, because they don't move as they should in ANY CAPITALISTIC ECONOMY IN THE WORLD IN ECONOMIC SHOCKS!

In the long run, prices are flexible and can respond to changes in supply and demand. In the short run, many prices are "sticky" at some predetermined level.

To see how the short run and the long run differ, consider the effects of a change in monetary policy. Suppose the Central Bank suddenly reduced the money supply by 5 percent. In the long run, a 5 percent reduction in the money supply lowers all prices (including nominal wages) by 5 percent whereas all real variables remain the same. Thus, in the long run, changes in the money supply do not cause fluctuations in output or employment.

In the short run, however, many prices do not respond to changes in monetary policy. A reduction in the money supply does not immediately cause all firms to cut the wages they pay, all stores to change the price tags on their goods, all mail-order firms to issue new catalogs, and all restaurants to print new menus. Instead, there is little immediate change in many prices; that is, many prices are sticky. The short-run price stickiness implies that the short-run impact of a change in money supply is not the same as the long-run impact.

The failure of prices to adjust quickly and completely means that, in the short run, output and employment must do some of the adjusting instead. In other words, during the time horizon over which prices are sticky, the classical dichotomy no longer holds: nominal variables can influence real variables, and the economy can deviate from the equilibrium predicted by the classical model.

To further explain how contractionary monetary policy affects the economy, take the United States in the 1870s, as an example.

Before the American civil war, the United States was on a gold standard. Paper dollars were readily convertible into gold. Under this policy, the quantity of gold determined the money supply and the price level.

In 1862 (I think it was that year), after the civil war broke out, the US treasury announced that it would no longer redeem dollars for gold. In essence, this act replaced the gold standard with a system of fiat money. Over the next few years, the government printed large quatities of paper currency (called greenbacks for their color) and used the seigniorage (printing money without backing) to finance wartime expenditure. Because of this increase in the money supply, the price level approximately doubled during the war.

When the war was over, much political debate centered on the question of whether to return to the gold standard. The Greenback party was formed with the primary goal of maintaining the system of fiat money (that is what most money is today, fiat- meaning that its legal tender just because the government says so). Eventually, however, the Greenback party lost the debate. Policymakers decided to retire the greenbacks over time in order to reinstate the gold standard at the rate of exchange between dollars and gold that had prevailed before the war. Their goal was to return the value of the dollar to its former level. (Notice a connection between 1800s USA and Current Leonel's policy - with some noticeable differences of course).

Returning to the gold standard this way required reversing the wartime rise in prices, which meant aggregate demand had to fall. (To be more precise, the growth in aggregate demand needed to fall short of the growth in the natural rate of output). As the price level fell, the economy experienced a recession from 1873 to 1879. By 1879, the price level was back to its level before the war, and the gold standard was reinstated.

Lets go back to the DR now.

A lower exchange rate and sticky prices will increase the unemployment level, temporarily. As unemployment rises, demand for the goods/services drops and the price levels will drop a bit to reflect the drop in demand. As prices drop, demand will increase because people will have more real income at hand. An increase in demand would cause output (or production) to increase to meet demand. The higher production requires more labor, and thus increases employment - reducing the unemployment rate. The newly employed (those who became unemployed before) will be hired at a pay that has already caught up to the new price levels, thus causing the average person to be better off economically.

Notice, we are seeing this effect right now. Things are going for the better, most of you guys need to learn to see things in long term perspective and you need to read an economics book prior to making false gloomy predictions about how you think a strong peso would be bad for society, when in fact the opposite is true.

And for whoever called me a "shill" let me make it clear that I DO NOT WORK FOR THE GOVERNMENT, nor do I receive a cent from them either.

In this world, there is no such thing as something for nothing. In the end, everybody gets exactly what they paid for and rebounding our economy back into the trajectory of prosperity will not come for free! But in the end, the current costs will be worth it!

Firstly Nal0whs, I would like to say that most of what you have posted here seems to be quite considered, it is obvious however that you have become somewhat more verbose since your earlier predictions of currency appreciation have come to fruition (I guess that is only natural) One thing that you said recently though demonstrated that maybe not everything is as considered as it should be, you said that one long term benefit of the current situation is that Banks will in time reduce their interest rates to such a level that businesses including those foreign ones will be able to borrow money at sensible rates. Well, I am sorry but this little prediction of yours seems to hold no weight at all, in the UK and the States you can borrow as much hard currency as you want right now for very little indeed, when I left the UK a year ago the business that I ran had a 20 million sterling flexible credit line (About 40 Million US, for those Americans who I speak to who think the Dollar has higher value than sterling!) and that cost me about 0.5 percent a month a fixed loan of such an amount would be considerably less. OK so for your prediction to come true then first the banks here would have to be competative with such rates as that, which seems quite doubtfull and secondly if they were what interest rate would they be offering on savings??? Let me tell you, such a low one that if ANYONE had even one peso saved in a bank here they would have to be considered fit for placing in an institution!! Without the high interest rates offered on savings here who would risk it? The banks would go out of business over night as all money was transfered to the States or the UK where your money is at least safe!
Conclusion - Its not gonna happen, and if it does the country will have to file for bankruptcy!

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I still stand behind what I said about interest rates. My prediction was not to become reality over night!

Let's look at a bit of recent American economic history (since the US is the most successful economy to date, though its on shaky grounds right now).

The early 1980s saw the largest and quickest reduction in inflation in recent U.S. history. By the late 1970s inflation had reached the double-digit range; in 1979, consumer prices were rising at a rate of 11.3 percent a year (if not, very close to that figure, I might be off by a point or two). In October 1979, only two months after becoming the chairman of the Federal Reserve (The American Central Bank), Paul Volcker announced that monetary policy would aim to reduce the rate of inflation - JUST LIKE LEONEL IS TRYING TO DO RIGHT NOW. This announcement began a period of tight money that, by 1983, brought the inflation rate down to about 3 percent from double digits!

How does such a monetary tightening influences interest rates? According to the theories, the answer depends on the time horizon. In the long run Volcker's change in monetary policy would lower inflation, and this in turn would lead to lower nominal interest rates. Yet the theory of liquidity preference predicts that, in the short run when prices are sticky, anti-inflationary monetary policy would lead to falling real money balances and higher nominal interest rates.

Both conclusions are consistent with experience. Nominal interest rates did fall in the 1980s in the US as inflation fell. But comparing the year before the October 1979 announcement and the year after, real money balances (M1 divided by the CPI) fell by around 8.3 percent and the nominal interest rate (on short-term commercial loans) rose from 10.1 percent to 11.9 percent. Hence, although a monetary tightening leads to lower interest rates IN THE LONG RUN, it leads to higher nominal interest rates in THE SHORT RUN.

Good thing for the Dominican Republic, that we are a relatively small economy, though the largest in the Central America-Caribbean region. The good thing about small economies is that they swing much quickly and easier between growth and decline than bigger economies. As such, it would take less time for the DR long term predictions to become true, contrary to how long it would take for an economy much bigger than ours.

In other words, the short term in the DR is much shorter and the long term comes much quicker to the DR than other larger economies. As such, don't jump to conclusion that my predictions are not valid, because the time period of transition is half way through as we speak. What Volcker did to the US to reduce inflation and interest rates (the tighter monetary policy) is what is being done right now here, in the DR and as such, the results will mirror those experienced by the US and all other capitalistic nations that have gone through such problems.

1. I was surprised to read about the large amount of foreign trade that exists between here an the US about 2.5 Billion in the last year, at todays rate does that mean that there will be 5 BILLION next year!!!???? or will the DR just export half as much or even less (This doesnt sound too good to me as 2.5bn is about 3k per person)

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Given that the DR is tied up to the US economy like a parasite, US-DR trade will most likely decrease slightly, given to the increase of cost for US goods in the DR.

This is simply a wake up call to the DR to begin diversifying its trading habits with the other 140 or so nations of the world and not just the US and to further encourage the development of our own industries if we wish to be much more in charge of our own destiny.

2. Please somebody tell me who sets the exchange rate and what factors are considered in this process, and can somebody really buy a large amount of US from Banco Central at its published rates?

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The exchange rate floats against the Dollar and Euro primarily. We are not allowed to fix it in any way, otherwise the IMF will impose their iron fist upon us. Remember, the borrower becomes the slave of the creditor while the outstanding balance is in place. The DR is a virtual slave of all its creditors, as such we must obey whatever they say, even if it is good or bad for us.

Nominal Exchange Rate is not nearly as important as the Real Exchange rate. Nominal exchange rate is the relative price of the currency of two countries. The real exchange rate is the relative price of the goods of two countries. That is, the real exchange rate tells us the rate at which we can trade the goods of one country for the goods of another.

For the sake of simplicity (and because many people here are more used to the US dollar), consider a single good produced in many countries: cars. Suppose an American car costs US$10,000 and a similar Japanese car costs 2,400,000 yen. To compare the prices of the two cars, we must convert them into a common currency. If a dollar is worth 120 yen, then the American car costs 1,200,000 yen. Comparing the price of the American car and the price of the Japanese car, the American car costs one-half of what the Japanese car costs. In other words, at current prices, we can exchange two American cars for one Japanese car. That is what the real exchange rate is.

The real exchange rate = Nominal Exchange Rate x Ratio of Price Levels

The determinants of the real exchange rate are as follows:

1. The real exchange rate is related to net exports. When the real exchange rate is lower, domestic goods are less expensive relative to foreign goods, and net exports are greater.

2. The trade balance (net exports) must equal the net capital outflow, which in turn equals saving minus investment. Saving is fixed by the consumption function and fiscal policy; investment is fixed by the investment function and the world interest rate.

3. Is the type of currency appreciation that we have seen here in the last few months unprecidented and if it isnt could someone give example of recent (Not the 1870's) cases and their outcome.

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First, everybody must realize that the current appreciation of the peso is nothing more than the stabilization of the currency at its natural exchange rate. During Hipolito - because investors did not had faith in Hipolito and/or his policies - a huge premium was added to the Dominican exchange rate, pushing the price of the dollar to record highs. Now that Leonel is back, just by his mere presence has begun to put more confidence in the economy and his administration, simply based on his past experiences of economic growth and maintaining economic growth. Remember, when Leonel was in power 1996-2000, the DR economy was booming among the fastest in the world, even though the other booming economies of southeast Asia and elsewhere were experiencing economic meltdowns and Argentina went ballistic afterwards. The DR should have fallen with the rest of the clan at that time, and yet it didn't. That is mostly due to Leonel's economic policies! It's no secret that as soon that Hipolito took control, his economic initiatives became clear and 6 months into his administration the country was running into trouble, though Baninter simply made it much worst and Hipolito's loss of faith in the eyes of investors by the time Baninter happened simply did not made matters any better.

As such, the other country that experienced something similar to this in recent times was Mexico. Keep in mind, Mexico is way bigger than the DR (it's the 10th largest economy in the world and Mexico City alone is the 30th largest). As such, swing in the Mexican economy took a slight longer and a slight slower pace than in the DR, but the result are pretty much the same. What really helped Mexico was the Free Trade deal with NAFTA after its currency plummeted.

Guess what, the DR is now at the edge of starting the CAFTA free trade deal at the time that its rebounding from economic calamity. It doesn't take a rocket scientist to see what's going to happen next, and here is a hint, its good for everybody.

However, the downside is that we won't develop our industry any further with the free trade deals and we will depend on others for our own survival and many anglo-American companies will come in with heavy subsidies backed by their governments. Other than that, its a sweet deal in many ways.

Thanks, and sorry for the rant

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No problem, I'm used to rants by now.

Escott said:

Let me explain some economics to you. In two months the peso against the US dollar went from 48 to 26 to one. Also in the same 2 months instead of a decrease in lets just say Presidente which was 150 pesos for a 6 pack it is now 180 which is a 20% difference HIGHER.

Dominicans only lose 20% of their buying power while those that rely on foreign earned income suffer a 70-100% loss in buying power.

So show me how you know enough about these things to say it is a good thing? (shaking head)

Scott

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Because I never said that in the short run things were not going to be tough!

In the long run it will work out for the better. The current crunch is the price we must pay for future success. You know, things never remain constant in anything.

Quite frankly, the long run is more important than the short run.

I think I made my case already.

All that is left is for us to wait and watch it all unfold. Afterall, search my posts and tell me when have I predicted something in Dominican Economics that have not come true?

I'm not talking predictions as of this week or even as of August, since the full effect of the economic transformation is still in its process, but I am talking about my economic predictions from the Spring of 2004 and prior to that.

All that is need it is a bit of patience, because time moves a bit slow and only through time will everything be seen.

By the way, the economy will end this year with a positive increase of about 1%. That means, more businesses are opening than closing, that is a sharp contrast when Hippo was around. That means more wealth is being created and thus, more jobs.

Next year the economy is slated to increase by 5%!!!!!! People, that is fast economic growth by any standards and those are predictions from the World Bank, IMF, and the CIA!

Keep in mind, Leonel has not even been ruling for a year and things are looking bright already. Hipolito had 4 years and everything looked gloomy then.

The facts don't lie.

Interesting how the average Dominican seems more relax now that the economic transformation is taking place. During Hippos time it was the average Dominican screaming in the streets and protesting for the collapse of the Peso and the Foreigners were simply saying "Oh, how sad, oh well, its good for me!"

Now, the Dominican joe feels much more at piece since his expense has gone down (Diario Libre recently showed a decline of 22% plus or minus a point or two for the Canasta Basica or Canasta Familiar), but the foreigners who survive as if they still live in the US buying imported items are now the ones crying and whinning.

People, it will all be fine and well by this time next year. In fact, by the Spring we will see the positive effects a bit more clearly than it currently is.

As I said before, all that we need to do is wait.

And remember, you are in the Dominican Republic. This is not the place or time to be whinning because whinning gets you NOWHERE!

Thanks Nals for the response, whilst I think that you skirted around the issue of bank interest rates and didnt offer any more flesh to put on the bones of your previous argument I accept most of what else you wrote.

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I didn't skirted around the issue, its just that you need to give it more time. Things don't happen over night. Now, if by April things don't look as sweet, then ask me what went wrong, but given my previous "performance" in these predicting deals, I don't think there will be a need for such action. Lets wait and see.

But still, I am waiting for an answer as to who or whom sets the daily exchange rate as published by Banco Central and can you actually buy large amounts of dollars from these guys at their published sell rate? As far as I can see BC sets a rate daily and the casa's de cambio and commercial banks all follow that rate, so whom inside BC and how do they determine the rate of exchange?? You would think that this would be an easy enough question to answer, no?

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The daily exchange rate is not set or fixed by anyone other than the market forces responding to government fiscal policy and the rules of supply and demand.

However, if you are wondering where this balance of prices for the currency takes place or who looks over these figures, you are going to have to look in the Foreign Exchange Market.

That market (more commonly known as the FX) is where all currencies of the world are traded and they hand the info. at the end of the day down to the bulk of the central banks of the world. The FX is located in NYC I believe, but I'm not too sure about its location.

Usually the info is then revised by the treasurer, but in reality the treasurer here in the DR simply looks over the info and signs (to accept and take the responsibility of the accuracy of the information), not really asking much questions or demanding more "proof" that such exchange is acccurate, simply because alot of respect is given to the Foreign Exchange market. Any arbitrgeur knows about this market, its just like the stock markets and the commodities markets, just that the FX deals with currencies.

P.S. I am currently keeping 4000 Pesos in a safe deposit box so that when the rate is at one to one in a few months I have got the air fare out of here!!!!

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Nick, remember its Leonel whose the president. He won't allow the peso to reach a par with the US Dollar. Only Trujillo did that and only Trujillo paid the debt! Ever wonder what was the purpose of "La Obelisca" on the Santo Domingo Malecon? Commemorating the payment of the national debt by Trujillo. The guy was an S.O.B., but he had one of the biggest sense of pride for being a Dominican and sometimes, it showed quite positively towards the republic.

I mean, what other dictator in the world paid the national debt of their country? What other dictator put the value at par with the US dollar according to market forces? What other dictator caused the greatest level of prosperity, economic growth, and wealth in the history of that given country?

Only Trujillo did such thing, though he was one heck of an S.O.B.

President Nixon once said "Trujillo may be an S.O.B., but at least he is the Americans S.O.B."

I think otherwise...

I remember in the mid to late 1980s when the Peso was around RD$6 to US$1. Aah, the memories of a strong currency!

By the way, we can stop using the word crisis. We are not in a crisis anymore, the last time I checked we are under a recovery as we speak.