> It’s always tempting to play populist and shower your people with underpriced imports in the short term. But in the long term this just never works.
I don't think this is quite true -- I have a feeling the Rajapaksa family is much richer today than otherwise and will continue to be so even if removed from power (just look at the Marcos family in the Philippines or Thaksin Shinawatra in Thailand).
But you'd need to introduce another explainer on the principal-agent problem for that!
Yes, I think the politics are interesting and complex. What's especially interesting is that these two macro mistakes -- overvalued currency pegs and foreign-currency borrowing -- show up again and again, in country after country. There must be some deep political-economic reason for that regularity!
As far as I know from India, it's an electoral issue just the way inflation is. Politcians promise the stabilization of the domestic currency as an election promise and then give central bank a dual mandate - currency targeting and inflation targeting. Keeping gas/petrol prices low is another irrational goal that's generally linked to foreign-currency borrowing as South Asian nations are net importers.
There is a standard term or concept called the gate keeper state brought into vogue by a Usa prof. It shows how the state controls things. Pegs on forex and capital controls would be part of it. It wasnt an economic concept originally but became a contended one in economics and especially in the context of economic development.
But pegs are always higher than the true value of the currency and are so to mask domestic inefficiency amongst other things.
The Professor is Frederick Cooper of NY. He is an historian. Hillbom, a Swedish economist and others, discussed it in the context of economics and development especially in Africa with some emphasis on the question was Botswana a development state or a gatekeeper state.
Great article. One lesson I draw here is *dont fuck with the people who produce goods and services other people want*. Tourism, tea, food, real things that can be sold.
Makes me grateful to live in a country (US) that, for all its flaws, still makes a lot of stuff, produces a lot of energy, and has a vibrant enough economy such that it can produce companies like substack that give Noah a platform.
Great article. I fear for Bangladesh, we've been running relatively large deficits since 2018, and the largest one last year, followed by increased government borrowing. We started experiencing large scale load shedding this month, which is something that didnt happen since 2014. The government said LNG was becoming far too expensive. Several austerity measures have been put in place already.
Hopefully they are smart enough to prevent a sri lanka like crisis.
I'd also note that Sri Lanka shut down their borders for a long time and had strict COVID rules in place despite not being able to afford them. They had a chance to become the one tropical getaway of 2020 with 100% open borders but missed out on that, sadly. Obviously its not their only problem but it was a big part of why it all collapsed.
1. The median age in Sri Lanka is 34 vs 47 in Italy and they have lower obesity levels than the West, so the virus was a much less of a bigger deal to them anyway.
2. Unless you do a China style zero Covid approach all travel restrictions are basically security theater. It’s all or nothing, there’s no half measures that work. So you might as well open up the border.
Not that putting all your eggs in the tourism basket is a good idea, but do you think absent the precipitous drop in tourism revenue, this would have happened? It does seem like it's hard to work around an 80% drop in your major industry.
Also, how do tourist dollars interact with the trade deficit? If I go to Sri Lanka, I'll either withdraw at the ATM or pay with my card, I pay in rupees but my bank (after some calculation) deducts dollars from me. These are rupees added to the Sri Lankan economy, presumably – how does that end up economically across a tourism sector?
I'm not sure whether this would have happened without the drop in tourist revenue. But looking at the sheer magnitude of the agricultural crisis, and at Sri Lanka's persistent trade deficits and high levels of foreign currency borrowing, my guess is that a crisis like this was very likely to come along sooner or later.
Tourist dollars are a source of foreign exchange for Sri Lanka. When you withdraw rupees at the ATM in Sri Lanka, your bank in the U.S. transfers dollars to that Sri Lankan bank in order to swap for the rupees that you withdraw. Those dollars are now held by Sri Lankans, and they can use them to purchase imports. Does that make sense?
Makes sense thanks! I wasn't sure if my bank actually added dollars to Sri Lankan accounts, or if they just sent rupees to the Sri Lankan one. But of course my bank can't print rupees so that doesn't make sense – the dollars have to get into Sri Lanka somehow.
In fact I presume all currency exchanges must in some way be regulated by the relevant central banks, unless an institution holds both and is just shuffling its own assets, otherwise the central banks could accidentally lose control of the currency.
I feel like conversations like this one is how smart people start getting into crypto. 'Ok but if I create a digital rupee peg and you create a digital dollar peg we could swap them without anyone intermediating...' and then you start thinking of it as an engineering problem and fall down the rabbit hole.
Heh. Probably so. In any case, crypto could add some interesting wrinkles to international finance, though I doubt it'll be transformative. I wrote about it a bit here!
Your bank can easily hold an account in another currency. It doesn't change much because ultimately the bank would need to buy rupees from Sri Lankan bank with dollars. But they probably don't want to bother with rare currencies.
The difference can be relevant with more common currencies. If you have a UK based card and use it in Europe to buy something or withdraw in euros (also in Polish zlots etc.), the terminal will often ask you if you wish the transaction to be in pounds (as per local bank's currency rate) or in euros and let your bank to do the conversion. It is almost always better to use the local currency and let your bank to do the conversion. Local banks exploit the psychology that you may feel more comfortable to see the final amount in your home currency, so they "cheat" you with very unfavourable currency exchange rate. Whereas your bank will use the standard (interbank or visa network) exchange rate plus some fixed fees. In this case all big UK banks have euro accounts and they buy and sell euros all the time.
Yeah, that's the situation I'm usually in, I keep USD in Canada and Europe (long story) and spend mostly European currencies, always using the interbank rate plus a fee. Just had never really thought through it on the banking end, with everything digital you forget that currency really does need to be 'minted' in some sense by its issuer.
I did learn this material in a semester of International Economics so maybe you don’t need years of business school for this haha! I did love Noah’s explanations though, some of them were better than my own professor’s.
I've been wanting to ask if you could write about Lebanon's crisis. But now I can just take this post, swap "Sri Lanka" with "Lebanon" and end up with a pretty accurate explanation of what's going on there.
One difference that seems like it might be relevant is that while Sri Lanka managed to officially end its insurgency, Lebanon’s role as a pawn of Syria and Iran hasn’t been helped by the past decade or two of events in those places.
But why would you single out China, as in "Second, be careful about borrowing a ton of money from foreign governments, especially ones like China"
(quick google): .
Source of Sri Lankan debt: China 10%; Japan 10% , Wold Bank 9%, Market-based borrowings ( mainly US dollar-denominated bonds) 47%, India 2%, Other 9%.
Note; for decades the IMF has signally failed to support infrastructure development around the globe, and only China's BRI has impelled Biden to step up with various BBBW schemes which have yet to materialize.
Finally, another quibble: are price rises due to supply constraints the same as "inflation" (meaning the devaluation of a currency)? Obviously the US dollar is not currently suffering devaluation vis a vis other currencies, as is the case in Sri Lanka., despite the high headline "inflation" rate in the US.
The reason to single out China is not because Chinese loans are worse than other loans, but because the Belt and Road projects that China has been pushing have had very disappointing results in terms of economic payoffs. China just hasn't been able to identify projects that are actually economical. Which is why outcomes like Hambantota are to be expected.
The IMF's job is not to support development; that is the World Bank. They have made quite a lot of loans.
Inflation and devaluation of a currency are two very different things. Devaluation means a currency is able to buy less foreign currency. Inflation means a currency is able to buy fewer products. Those are very different things.
Yes, thanks. I would expect not all BRI projects are failures; and the onus is on Biden to show he can do better., since the World Bank is proving to be not very useful - given the world needs $trillions in infrastructure development.
As far as I know there are a couple of BRI projects in Pakistan that are doing pretty well, such as Gwadar port. Other than that I've mostly just read about white elephant projects and overoptimistic assumptions that didn't pan out. But it's also true that many BRI projects are not completed yet, so we don't know the full picture yet.
I do not have high hopes for Biden's counter-initiative.
"The pundits who confidently warned us that China wasn’t using Belt and Road to create 'debt traps' have a bit of egg on their faces right now."
I don't know if I would put it that way. The original intention was not for China to acquire equity in the port. That was a provision triggered because the port failed commercially, which of course was not what the Chinese government intended either. (Why would they want to sneakily acquire assets that don't turn a profit?) This was a failure of due diligence on China's part.
Everything I've seen about Belt and Road suggests to me that it's a gimmick for Chinese construction companies to extract money from their own government by marketing foreign aid as a form of neo-imperialism. The fact that so many B&R projects are poorly executed means they don't even work *as* neo-imperialism: the Communist Party leadership has been persuaded that the initiative will win them new allies overseas, but so much of the publicity has been negative that it isn't necessarily having that effect.
I think this may have been true of old-school European imperialism as well. If you read early-twentieth-century writers like Orwell, they seem to take it for granted that Britain's wealth was based mainly on the exploitation of India and the other colonies. (That's what the imperialists themselves always said; the only difference was that leftists thought it was a bad thing and not a good thing.) But I'm skeptical that this was ever really the case. Imperialism certainly benefited specific interest groups and industries in the UK but even if those benefits outweighed the military expenses involved, I doubt they raised British living standards to any great extent.
But what were the real benefits? I think many Victorians and Edwardians took it for granted that if they didn't continue ruling India they wouldn't have any tea in the mornings, but why should that have been the case? You can still import things from territories you don't govern.
Perhaps British control of India improved the UK's terms of trade and allowed them to pay less for each ton of tea... but why? As far as I can see the main difference is that under imperialism the tea gets planted and traded by British firms, but that seems like a gain for vested interests rather than consumers.
I'm sure there's an extensive literature on all these questions; I just don't know anything about it.
I no longer have the references, but I took a class in industrial development and one of the things we read was a cost-benefit analysis of British imperialism (from a cold-blooded amoral stance). It found that generally imperialism was a net minus - except for India, which was a huge net monetary gain for Britain. It estimated exploiting India explained about 1/6 of Britain's economic gains during the Industrial Revolution.
For comparison, they estimated cotton/textile mechanization also explained 1/6, and couldn't identify specific causes for the remaining 2/3.
Isn't there some evidence that the slow macro crisis led to the fertilizer ban as Sri Lanka lacked the foreign currency to pay for the fertilizer itself? The organic ag ideology is then just a varnish on top, not the true causative element.
Well, the fertilizer ban destroyed the rice crop and forced Sri Lankans to import more grains, more than canceling out the forex gains from reduced fertilizer imports. On top of that the destruction of the tea crop removed a big source of forex. So it was just a mistake.
As always, you do an excellent job in digging in and explaining the details. Keep up the good work. And I do love this line, "As usual, Art Laffer was wrong."
Great explanation. Curious how you are thinking about China's quasi-peg of the RMB/USD and their large horde of FX reserves. It pairs with your discussion of OBOR efforts (Chinese infrastructure contractors in Sri Lanka). I think there's a predominant view that OBOR efforts across Asia and Africa are really about exporting excess manufacturing capacity in China which has grown to an arguably unsustainable level as a result of the peg.
The OBOR efforts are definitely to give pork to Chinese companies who had grown overly big in the era of cheap money, but the currency peg was only one small part of that. Much more important was China's macroeconomic stabilization policy, which dealt with every recession by giving cheap loans to unproductive construction companies, thus bloating the sector to an ungodly amount of GDP.
"the currency peg was only one small part of that"
So you think that the effect of keeping the RMB/USD between 6 and 8 for decades is actually small? Even though it led to massive current account surpluses which resulted in huge USD balances at the PBOC?
I am new to reading Substack and wow! what an explainer. On the china loans. Do you think there is also a big geopolitical strategy at play here? Sri Lanka gives a great port to surround india.
Thank you for this thorough, plain-English explanation of a phenomenon we may be seeing more of in the near term.
Seconded! It's so clear!
> It’s always tempting to play populist and shower your people with underpriced imports in the short term. But in the long term this just never works.
I don't think this is quite true -- I have a feeling the Rajapaksa family is much richer today than otherwise and will continue to be so even if removed from power (just look at the Marcos family in the Philippines or Thaksin Shinawatra in Thailand).
But you'd need to introduce another explainer on the principal-agent problem for that!
Yes, I think the politics are interesting and complex. What's especially interesting is that these two macro mistakes -- overvalued currency pegs and foreign-currency borrowing -- show up again and again, in country after country. There must be some deep political-economic reason for that regularity!
As far as I know from India, it's an electoral issue just the way inflation is. Politcians promise the stabilization of the domestic currency as an election promise and then give central bank a dual mandate - currency targeting and inflation targeting. Keeping gas/petrol prices low is another irrational goal that's generally linked to foreign-currency borrowing as South Asian nations are net importers.
There is a standard term or concept called the gate keeper state brought into vogue by a Usa prof. It shows how the state controls things. Pegs on forex and capital controls would be part of it. It wasnt an economic concept originally but became a contended one in economics and especially in the context of economic development.
But pegs are always higher than the true value of the currency and are so to mask domestic inefficiency amongst other things.
The Professor is Frederick Cooper of NY. He is an historian. Hillbom, a Swedish economist and others, discussed it in the context of economics and development especially in Africa with some emphasis on the question was Botswana a development state or a gatekeeper state.
Great article. One lesson I draw here is *dont fuck with the people who produce goods and services other people want*. Tourism, tea, food, real things that can be sold.
Makes me grateful to live in a country (US) that, for all its flaws, still makes a lot of stuff, produces a lot of energy, and has a vibrant enough economy such that it can produce companies like substack that give Noah a platform.
Great article. I fear for Bangladesh, we've been running relatively large deficits since 2018, and the largest one last year, followed by increased government borrowing. We started experiencing large scale load shedding this month, which is something that didnt happen since 2014. The government said LNG was becoming far too expensive. Several austerity measures have been put in place already.
Hopefully they are smart enough to prevent a sri lanka like crisis.
I'd also note that Sri Lanka shut down their borders for a long time and had strict COVID rules in place despite not being able to afford them. They had a chance to become the one tropical getaway of 2020 with 100% open borders but missed out on that, sadly. Obviously its not their only problem but it was a big part of why it all collapsed.
If they were OK with corpses piling up, sure.
1. The median age in Sri Lanka is 34 vs 47 in Italy and they have lower obesity levels than the West, so the virus was a much less of a bigger deal to them anyway.
2. Unless you do a China style zero Covid approach all travel restrictions are basically security theater. It’s all or nothing, there’s no half measures that work. So you might as well open up the border.
A tropical country is also far better suited to very inexpensive improvements to ventilation, which make a world of difference in transmission rates.
Posts like this are why substack exists. Thanks for writing this Noah!
Not that putting all your eggs in the tourism basket is a good idea, but do you think absent the precipitous drop in tourism revenue, this would have happened? It does seem like it's hard to work around an 80% drop in your major industry.
Also, how do tourist dollars interact with the trade deficit? If I go to Sri Lanka, I'll either withdraw at the ATM or pay with my card, I pay in rupees but my bank (after some calculation) deducts dollars from me. These are rupees added to the Sri Lankan economy, presumably – how does that end up economically across a tourism sector?
I'm not sure whether this would have happened without the drop in tourist revenue. But looking at the sheer magnitude of the agricultural crisis, and at Sri Lanka's persistent trade deficits and high levels of foreign currency borrowing, my guess is that a crisis like this was very likely to come along sooner or later.
Tourist dollars are a source of foreign exchange for Sri Lanka. When you withdraw rupees at the ATM in Sri Lanka, your bank in the U.S. transfers dollars to that Sri Lankan bank in order to swap for the rupees that you withdraw. Those dollars are now held by Sri Lankans, and they can use them to purchase imports. Does that make sense?
Makes sense thanks! I wasn't sure if my bank actually added dollars to Sri Lankan accounts, or if they just sent rupees to the Sri Lankan one. But of course my bank can't print rupees so that doesn't make sense – the dollars have to get into Sri Lanka somehow.
Yep. Exactly!
In fact I presume all currency exchanges must in some way be regulated by the relevant central banks, unless an institution holds both and is just shuffling its own assets, otherwise the central banks could accidentally lose control of the currency.
I feel like conversations like this one is how smart people start getting into crypto. 'Ok but if I create a digital rupee peg and you create a digital dollar peg we could swap them without anyone intermediating...' and then you start thinking of it as an engineering problem and fall down the rabbit hole.
Heh. Probably so. In any case, crypto could add some interesting wrinkles to international finance, though I doubt it'll be transformative. I wrote about it a bit here!
https://noahpinion.substack.com/p/crypto-and-the-global-financial-system
Your bank can easily hold an account in another currency. It doesn't change much because ultimately the bank would need to buy rupees from Sri Lankan bank with dollars. But they probably don't want to bother with rare currencies.
The difference can be relevant with more common currencies. If you have a UK based card and use it in Europe to buy something or withdraw in euros (also in Polish zlots etc.), the terminal will often ask you if you wish the transaction to be in pounds (as per local bank's currency rate) or in euros and let your bank to do the conversion. It is almost always better to use the local currency and let your bank to do the conversion. Local banks exploit the psychology that you may feel more comfortable to see the final amount in your home currency, so they "cheat" you with very unfavourable currency exchange rate. Whereas your bank will use the standard (interbank or visa network) exchange rate plus some fixed fees. In this case all big UK banks have euro accounts and they buy and sell euros all the time.
Yeah, that's the situation I'm usually in, I keep USD in Canada and Europe (long story) and spend mostly European currencies, always using the interbank rate plus a fee. Just had never really thought through it on the banking end, with everything digital you forget that currency really does need to be 'minted' in some sense by its issuer.
Masterclass in macro economics. Worth a years of business school
I did learn this material in a semester of International Economics so maybe you don’t need years of business school for this haha! I did love Noah’s explanations though, some of them were better than my own professor’s.
I am from iran
Your articles are wonderful
(O_O)🌹🌹
Thanks so much!!
Phenomenal article!
I've been wanting to ask if you could write about Lebanon's crisis. But now I can just take this post, swap "Sri Lanka" with "Lebanon" and end up with a pretty accurate explanation of what's going on there.
Thanks!! Yes, there are so many similarities among these emerging-market crises. But I'll write a post on Lebanon at some point!
One difference that seems like it might be relevant is that while Sri Lanka managed to officially end its insurgency, Lebanon’s role as a pawn of Syria and Iran hasn’t been helped by the past decade or two of events in those places.
Good article. Thanks.
But why would you single out China, as in "Second, be careful about borrowing a ton of money from foreign governments, especially ones like China"
(quick google): .
Source of Sri Lankan debt: China 10%; Japan 10% , Wold Bank 9%, Market-based borrowings ( mainly US dollar-denominated bonds) 47%, India 2%, Other 9%.
Note; for decades the IMF has signally failed to support infrastructure development around the globe, and only China's BRI has impelled Biden to step up with various BBBW schemes which have yet to materialize.
Finally, another quibble: are price rises due to supply constraints the same as "inflation" (meaning the devaluation of a currency)? Obviously the US dollar is not currently suffering devaluation vis a vis other currencies, as is the case in Sri Lanka., despite the high headline "inflation" rate in the US.
The reason to single out China is not because Chinese loans are worse than other loans, but because the Belt and Road projects that China has been pushing have had very disappointing results in terms of economic payoffs. China just hasn't been able to identify projects that are actually economical. Which is why outcomes like Hambantota are to be expected.
The IMF's job is not to support development; that is the World Bank. They have made quite a lot of loans.
Inflation and devaluation of a currency are two very different things. Devaluation means a currency is able to buy less foreign currency. Inflation means a currency is able to buy fewer products. Those are very different things.
Does that answer your questions?
Yes, thanks. I would expect not all BRI projects are failures; and the onus is on Biden to show he can do better., since the World Bank is proving to be not very useful - given the world needs $trillions in infrastructure development.
As far as I know there are a couple of BRI projects in Pakistan that are doing pretty well, such as Gwadar port. Other than that I've mostly just read about white elephant projects and overoptimistic assumptions that didn't pan out. But it's also true that many BRI projects are not completed yet, so we don't know the full picture yet.
I do not have high hopes for Biden's counter-initiative.
"The pundits who confidently warned us that China wasn’t using Belt and Road to create 'debt traps' have a bit of egg on their faces right now."
I don't know if I would put it that way. The original intention was not for China to acquire equity in the port. That was a provision triggered because the port failed commercially, which of course was not what the Chinese government intended either. (Why would they want to sneakily acquire assets that don't turn a profit?) This was a failure of due diligence on China's part.
Everything I've seen about Belt and Road suggests to me that it's a gimmick for Chinese construction companies to extract money from their own government by marketing foreign aid as a form of neo-imperialism. The fact that so many B&R projects are poorly executed means they don't even work *as* neo-imperialism: the Communist Party leadership has been persuaded that the initiative will win them new allies overseas, but so much of the publicity has been negative that it isn't necessarily having that effect.
I think this may have been true of old-school European imperialism as well. If you read early-twentieth-century writers like Orwell, they seem to take it for granted that Britain's wealth was based mainly on the exploitation of India and the other colonies. (That's what the imperialists themselves always said; the only difference was that leftists thought it was a bad thing and not a good thing.) But I'm skeptical that this was ever really the case. Imperialism certainly benefited specific interest groups and industries in the UK but even if those benefits outweighed the military expenses involved, I doubt they raised British living standards to any great extent.
India might have been the exception to the wastefulness of imperialism.
But what were the real benefits? I think many Victorians and Edwardians took it for granted that if they didn't continue ruling India they wouldn't have any tea in the mornings, but why should that have been the case? You can still import things from territories you don't govern.
Perhaps British control of India improved the UK's terms of trade and allowed them to pay less for each ton of tea... but why? As far as I can see the main difference is that under imperialism the tea gets planted and traded by British firms, but that seems like a gain for vested interests rather than consumers.
I'm sure there's an extensive literature on all these questions; I just don't know anything about it.
I no longer have the references, but I took a class in industrial development and one of the things we read was a cost-benefit analysis of British imperialism (from a cold-blooded amoral stance). It found that generally imperialism was a net minus - except for India, which was a huge net monetary gain for Britain. It estimated exploiting India explained about 1/6 of Britain's economic gains during the Industrial Revolution.
For comparison, they estimated cotton/textile mechanization also explained 1/6, and couldn't identify specific causes for the remaining 2/3.
Great piece --- one question:
Isn't there some evidence that the slow macro crisis led to the fertilizer ban as Sri Lanka lacked the foreign currency to pay for the fertilizer itself? The organic ag ideology is then just a varnish on top, not the true causative element.
Well, the fertilizer ban destroyed the rice crop and forced Sri Lankans to import more grains, more than canceling out the forex gains from reduced fertilizer imports. On top of that the destruction of the tea crop removed a big source of forex. So it was just a mistake.
As always, you do an excellent job in digging in and explaining the details. Keep up the good work. And I do love this line, "As usual, Art Laffer was wrong."
Just superb. Thanks for a semester worth of economics in one post.
This is literally what I learned in my International Economics class so you’re spot on haha.
Great explanation. Curious how you are thinking about China's quasi-peg of the RMB/USD and their large horde of FX reserves. It pairs with your discussion of OBOR efforts (Chinese infrastructure contractors in Sri Lanka). I think there's a predominant view that OBOR efforts across Asia and Africa are really about exporting excess manufacturing capacity in China which has grown to an arguably unsustainable level as a result of the peg.
The OBOR efforts are definitely to give pork to Chinese companies who had grown overly big in the era of cheap money, but the currency peg was only one small part of that. Much more important was China's macroeconomic stabilization policy, which dealt with every recession by giving cheap loans to unproductive construction companies, thus bloating the sector to an ungodly amount of GDP.
"the currency peg was only one small part of that"
So you think that the effect of keeping the RMB/USD between 6 and 8 for decades is actually small? Even though it led to massive current account surpluses which resulted in huge USD balances at the PBOC?
I am new to reading Substack and wow! what an explainer. On the china loans. Do you think there is also a big geopolitical strategy at play here? Sri Lanka gives a great port to surround india.
This is so valuable. Thanks Noah.