The Official Foreign Exchange Market: Failure is Already Coming

A line outside a currency exchange (Cadeca). (14ymedio)

14ymedio bigger14ymedio, Elías Amor Bravo, Economist, 27 August 2022 — There is no doubt that the issue of the moment, at least for those of us who are dedicated to the analysis of the Cuban economy, is the official authorization of foreign exchange in a series of establishments and for a fixed amount only for natural persons, while the 1×24 (US dollar to Cuban peso) exchange rate remains for other transactions.

In this blog we have already explained the reasons that lead us to think that behind this authorization there is something hidden, and the negative consequences that can be derived from it, but as the regime moves forward, we can only verify what we see happening.

An article has been published in the State newspaper Granma with the title “Why was the exchange rate of the informal market taken as a reference?” Its source is the website of the Central Bank of Cuba in a common entry with the Ministry of Economy.

What does the article say? Well, basically, to restore the operations of the official foreign exchange market in Cuba, which, it should be remembered, were interrupted by the regime shortly after beginning the Ordering Task* with the impracticable exchange rate of 1×24, there has been no choice but to “take into account the pre-existing conditions of the foreign exchange market in the country.”

And of course, that foreign exchange market is the informal one, which has been operating just since the regime decided not to make changes. Hence, the decision to implement an exchange rate for buying and selling similar to the one that exists in the informal market is justified. Can anyone think of the Cuban communist regime accepting the price of chicken in MLC (freely convertible currency) stores as the same as that in the regulated (rationed) basket? Difficult.

For those interested in communist dialectics applied to the foreign exchange market, the article will go down in history. Prisoners of the totalitarian ideology that prevents the contemplation of an economy as a continuously growing interdependent market, Cuban communists invent a sui generis definition of the exchange rate, according to which, it “emerges through a market process in which the supply and demand of foreign exchange are equalized, in which agents (households, companies and governments) have free and timely access to hard currencies, in exchange for national currency and vice versa.” Error.

The exchange rate, such as the price or level of production of the economy, arises from the interaction of domestic markets (goods, labor, assets, etc.) with external markets. The economy cannot set the relative price of its currency only with the currencies that go in and out, but with the destination they have in the national economy. Cuban communists are unable to observe this interrelationship, worried as they are about filling the coffers of the state for their own purposes.

And that’s where the second big mistake comes from when they say that “the state can influence in the establishment of a type of balanced exchange over the sources of supply and demand for foreign currency, through exchange, fiscal, monetary and other policies, but its ability to set an exchange rate is limited by the prevailing conditions in the economy.”

The state can say whatever it wants, but if the economy is in balance, which unfortunately doesn’t happen to the Cuban economy, it’s of little or no use for the state to intervene in the foreign exchange market. The only thing it can achieve is to alter the behavior of supply and demand, which is what it has ended up doing. Markets are looking for balance. Governments, with their economic policies, can influence it but not change it.

Therefore, getting the exchange rate right is not playing roulette, but knowing the equilibrium conditions of the economy and getting it to work. This is not the place to give lessons in practical macroeconomics to Cuban communists, but before acting as foreign exchange players they should start by reducing uncontrolled public spending, reducing the expansion of money in circulation, stimulating national supply through structural reforms, monitoring the value of the peso in terms of fundamentals of the economy; in short, doing things that help and don’t distract economic agents.

In reality, the same regime helps Cubans feel especially motivated to acquire a greater amount of foreign currency, by artificially maintaining a 1×24 exchange rate for the economic operations of the state and its companies and conglomerates, as well as another cheaper exchange rate for the general public. That duality doesn’t go anywhere and usually ends badly, very badly.

And if they want to tell the truth, the one thing that led to the birth of the informal foreign exchange market in Cuba was none other than the state, by renouncing its functions. If it now intends to “illegalize it,” this will be a big mistake, since it will reduce supply and increase prices, removing them from any equilibrium option.

At this point, it could be said that the regime’s decision to choose the exchange rate of the informal market for the restoration of official exchange rate operations in Cuba, should perhaps have led to the testing of other formulas such as a possible authorization of money changer as a form of self-employment that would bring to light the activity of the “informals.”

The informal exchange rate, although it reflects the serious imbalances that exist in the rest of the economic markets, is the one most suitable to deal with the supply and demand of foreign exchange for Cubans. The impossibility of the regime to promote its extension to all economic agents (the state and its companies) indicates that it’s not a general rate, but a partial solution, painted with a ridiculously large brush, that won’t result in anything good. Because the informal market is something very different from the cadecas [official currency exchange points], banks and airport offices. Everyone understands that.

On the other hand, charging as the regime does against the informal exchange rate, accusing it of being “impacted by speculative processes and the costs associated with informality” is unfair. It’s an argument that falls under its own weight, from the moment the regime makes it in this relaunch of the official foreign exchange market.

If the agents who attend the informal market feel motivated to exchange foreign currency (divisas) for national currency and vice versa, at the rate that governs operations, it will be for something, but not at all for those speculative processes or costs. This is unacceptable because it anticipates where the sanctions can come from.

Using the informal exchange rate to ensure that, since the relaunch of the foreign exchange market, the operations of buying and selling foreign currency take place as smoothly as possible through the financial system, is a clear interference of the state and the regime in the private activity of a market that has functioned efficiently and continuously since the changes were suspended at the beginning of 2021.

Good proof of this has been that from the beginning, that exchange rate substantially similar to the one that exists in the informal market has collapsed, and there are already places where the peso is quoted at 1×140 and continues to fall freely. The limitation in the number of authorized establishments, the rationing of dollars at 100 per person per day and the organizational clumsiness of the banks have led to long lines outside these  establishments, and the discomfort, protests and anger of citizens. These types of events rarely occur in the informal market, which is preparing to compete directly with the regime.

For those of us who defend the free market economy, attending these first steps in the foreign exchange market in which the regime is powerless to manage its role vis-à-vis private economic agents who operate efficiently and oriented by the needs of its customers, is a formidable spectacle.

Contemplating how the communist giant created by Fidel Castro is defeated by the Goliath of the informal exchange market is great news, which confirms how clueless the Central Bank or Alejandro Gil’s Ministry of the Economy are to face competition with the informal market under the current conditions in which the campaigns of repression and harassment that are supposed to arrive soon have not yet been unleashed. If this scenario were extended to the rest of the markets of the economy, totalitarian communism would have ended decades ago.

Communists are reluctant to maintain an artificially low exchange rate in the market of the population and non-state economic actors, because, as they say in the article, “this would imply constantly injecting foreign currency from other sectors of the economy, which in the medium term would make that exchange rate unsustainable and force the adoption of a new devaluation, which will allow the official rate to be approximated to market equilibrium to continue making foreign exchange operations viable.”

Well, then what do you think is going to happen in a few months with the decision they just made? There will be no choice but to depreciate the peso. Why don’t they wonder how, with the new exchange rate for the sale of dollars, the salary in pesos of an average Cuban has suddenly fallen by more than 400%? It’s true that whoever receives remittances won’t have complications because they will get more pesos, but what about internal inflation? Also, what happens to then 70% of society that operates only in pesos? Too many questions for the regime.

The official exchange market has been born in such unfortunate conditions, that far from fulfilling its purpose, it will pass without pain or glory, being inoperative in a short time. The economy can predict human behaviors with some ease when it comes to “free choice,” something that Cuban communists haven’t understood for 63 years. Failure is coming

Translated by Regina Anavy


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