Innovators Love a Stable Peso 1 of 3

Note: This post has been re-written in a more accessible and longer style. Please click here for link to Post 132, the better version.

An independent central bank is the linear descendant of the gold standard; in fact, its very innovative replacement fit for our time. The operative word here is “independent.” By being independent and working to keep the currency value stable, the central bank is expected to keep the politicians’ tendency to overspend from tanking the economy. The independent central bank, like the gold standard, is expected to provide an anchor to its currency’s value. A stable currency favors savers, innovators and the long-term investors which is generally good for the society in the long run.

Before 1935, during the days of the gold standard, countries fixed the value of its paper money against its physical gold reserve. If the politicians overspent say for unnecessary wars, on inefficiency from corruption, from buying votes in elections or from deficit spending, there will be ultimately more paper money printed per unit of gold. This is a de facto debasement of the currency. Eventually, the ruling politicians have to re-align the paper money to the physical gold. Doing so, by contracting the economy or by devaluing the paper money, often causes a depression that, in turn, causes that government to fall as those who suffer most, the truly poor and the fixed income earners, led by the status-rich educated among them revolt bloodily or with people power.

In 1935, under Bretton Woods, the world shifted to the dollar standard with the US$ pegged to gold. Adjusting their economies and keeping to the gold standard after a world war and with the ongoing great depression was too hard for the politicians. (The Americans had a good deal here as the US$ become the reserve currency and the seigniorage – i.e. like being able to write their debt in US$ – that came with it.) But just in another thirty years, the world’s politicians again managed a great separation between US$ as standard and the underlying gold.

In 1972, President Nixon, still fighting the Vietnam war, finally refused to let the Americans pay for the profligacy of the world’s politicians and delinked the US$ from gold. The rest of the world shifted to floating exchange rates with a lot of suffering. This was also around the time of the first oil crisis. So the adjustments all over the world were quite severe.

Finally, in late the late 1980s, the world invented the independent central bank. It was supposed to be free from fiscal responsibilities that became the full responsibility of the government. The Reserve Bank of New Zealand was the first bank to formally adopt an inflation target in 1988 (See Post #35) thereby cementing a monetary anchor – the original role of gold.

In spirit, the Philippines is aligned to the rest of the world. We took the opportunity in 1992 to create an apparently independent Bangko Sentral ng Pilipinas (BSP) out of the ashes of the old Central Bank. A close investigation of the enabling law (Click for CB Act 7653.pdf.) shows that independence is not real. The BSP is still pretty much under political control. Only this time, the BSP is clearly under the President with the usual boom-and-bust consequences.

This brings us to the real story for this entry in Part 2 of 3 of this post.

(Click here for Part 2 of 3 and here for Part 3 of 3.)