We could print more money, but that would only deepen the hole

FRIDAY,MARCH 30: That three hundred year old law doesn’t mean that the connection didn’t exist before then. The connection between action and reaction is absolute and eternal.

In 2012 in Bermuda, “Newton’s Law” is particularly pertinent; especially regarding your job, your job future, and your ability to carve out a good near-term future for yourself, your family, or your business.

Last week, Bermuda College Economist Craig Simmons pointed to looming dangers. The devaluation of the Bermuda dollar, the possibility of the return of exchange controls, and a continuing rise and increase of our general economic malaise.

Craig says: “More importantly, the reduction in the size of the savings pool will drive the real exchange rate higher at a time when the self-correcting mechanisms emanating from the economic contraction are trying to lower costs and prices which are key components of the real exchange rate. The importance of the real exchange rate cannot be overstated.”

On February 24th 2012, the Minister for Finance said that she will issue a ‘local bond’*.

Craig notes this: “Over the next year, the Government proposes to issue IOUs in the form of bonds...”

The suggestion is that the Bond, up to $200m *, will be denominated in Bermuda dollars for sale to Bermudians in Bermuda dollars.

So that $200m must exist already. Must already be sitting in various savings accounts cash. Or that $200m is currently invested in something else and can easily be made available after selling off those ‘other’ investments.

However, the latest Bermuda Monetary Authority [BMA] report shows that there is no pool of un-invested Bermuda dollars lying around waiting to be invested. Instead, the existing and large gap between BD$ on deposit and Bd$ on loan is covered by foreign dollars.

So, in a novel new move, Bermuda might use its capacity to create about $140m additional Bermuda dollars by printing more Bermuda money as happens in the US, UK, and elsewhere.

Reserves

Under its empowering 1969 legislation, the BMA must maintain ‘external reserves’ to cover at least 50 per cent of the value of the Bermuda dollar notes and coins in circulation. For decades, the BMA has maintained cover of more than 100 per cent. In their last Report [for YE 31 Dec 10], the BMA had $136m in ‘external reserves’ cover for $127m of notes and coins in local circulation.

Under existing legislation, the BMA can stay with that $136m in ‘external reserves’, but can print and issue another $140m of Bermuda dollar notes and coins to go into local circulation.

This will bring the total amount of Bermuda dollar notes and coins in local circulation up to $267m, and still have cover.

So in a perfectly legal monetary move, the Bermuda Government can email its UK money-printing and coin-minting firm, tell them to run off another $140m worth of Bermuda dollars, BA that money in from Gatwick, and then use it to purchase up to $140m of any ‘local’ Bond that the Government issues.

The Government can then use those $140m crisp new Bermuda notes and bright new coins in Bermuda, and can spend it on all sorts of things.

This kind of financial move makes complete sense — if this Government is that desperate for cash and so unwilling or unable to take the other strong actions needed to fix its self-created Debt problem.
The immediate action will be that for about ten months, this Government will be able to avoid borrowing from foreign lenders.

But it stops making sense twelve months later when consequences, reaction, and reality appear. Twelve months after this ‘money-printing’ and ‘new money issue’, all Bermudians will face a barrage of fresh new and massive national financial problems; and still have to go back to foreign lenders for another tranche of foreign dollars.

First will be a devalued Bermuda dollar.

This will instantly make all credit card purchases far more expensive than now. Second, this Bermuda Government will have to impose exchange controls in order to manage and control the outflow of Bermudian dollars.

This will affect every person’s and every business’s ability to take or send money overseas.

The devaluation decision will be made by Bermuda’s bankers. They will ‘adjust’ all banking transactions that involve Bermuda dollars and any exchange of those Bd$ for US, Canadian, UK, and other foreign currencies.

The banks will act to protect themselves. No Government feat or legislation can alter these practical banking decisions.

Devaluation will cause a rapid rocketing-up of all local prices. Bermuda will, for the first time ever, find itself in the kind of economic and consequential social tailspin that we Bermudians have avoided for over 400 years; but that we have witnessed in so many other countries (Argentina, Brazil, Germany, Greece, Iceland, Jamaica...)

This is only a beginning... More next week... Craig, thanks for the warning.

“You can avoid reality, but you cannot avoid the consequences of avoiding reality.”  — Ayn Rand (20th Century).

*Budget Statement, 24 Feb 2012, page 9.