Sri Lanka can ‘take-off’ after reaching $4,000 per capita income: Central Banker

Dec 17, 2012 (LBO) – Sri Lanka should be careful to have suitable policies to allow economic growth to take off after reaching a target of 4,000 US dollar per person income in 2016, a senior central banker has said.

Assistant Governor C P J Siriwardene told a forum of bankers that Sri Lanka was aiming to reach the ‘$4K’ target as quickly as possible in order to go beyond the ‘magic number’.

But some countries that reached the target got caught in a ‘middle income trap’ he said.

“They cannot compete with the low income countries, because low income countries have low wages, low cost of production, so they cannot compete with their exports,” Siriwardene said.

“At the same time they cannot compete with developed countries because developed countries were more innovative and have economies of scale.”

He said it was important to have the right policies to allow growth to be maintained.

Siriwardene said the United States was the first country to reach a 4,000 US dollar per capita income threshold in 1967.

Dollar Inflation

During the late 1960 US was printing money to finance the Vietnam War. Later combine with President Nixon’s ‘Great Society’ programs gold and gold backed money which had kept the world free of inflation for several centuries was breaking up.

The US dollars started to inflate during the 1920 in the first decade after the Federal Reserve was created triggering an economic bubble. In 1933 the dollar was devalued to 35 dollars an ounce from 20, a level the currency had broadly maintained from 1792.

In 1963 the US congress repealed the Silver Purchase Act, allowing the Fed to print one and two dollar notes instead of coins. A 1965 Coinage Act allowed copper and nickel coins to replace existing silver coins.

Meanwhile gold prices were going up in the world above the US dollar 35 standard set in the Bretton Woods as more dollars were printed.

Instead of stopping money printing, authorities tried to control world gold prices through what was known as the ‘London Gold Pool’.

In 1967 France withdrew from the Gold Pool, Britain devalued the pound and in 1968 the US congress repealed laws requiring gold backing of the dollar as more Treasury bills were bought by the Fed. The stage was set for even higher inflation and weaker dollar.

In 1971 with gold and oil prices surging to new highs, President Nixon closed the gold window, defaulting on the Bretton Wood agreement and plunging the world monetary system into unprecedented turmoil.

In 1973 fully paper fiat floating exchange rates came into being with the short-lived Smithsonian agreement also failing to preserve the Bretton Woods system of soft dollar pegs.

The 1970s, later called the period of ‘Great Inflation’ saw unprecedented worldwide inflation as paper currencies lost value against real goods and services.

Siriwardene said 34 countries reached the 4,000 dollar per capita level in the 1970s.

Japan and oil rich Brunei were the only two Asian nations in the group. Japan and Germany was among the first countrys to tighten monetary policy and reduce inflation allowing them to have industrial peace and focus on high value production.

Great Moderation

When gold rose above 800 dollars an ounce in 1980 and the US raised policy rates as much as 18 percent and Britain went to tight monetary targeting under Thatcher, inflation began to fall.

The world went into what was later called the period of ‘Great Moderation’. The world saw one of the longest periods of sustained economic activity in recent history. By the late 1990s oil was 10 dollars a barrel and gold was 250 dollars an ounce.

Siriwardene said in the 1980s decade 11 countries reached the 4,000 US dollar threshold, with South Korea and Singapore among them. In the 1990s, 17 countries reached the target with Malaysia being the only Asian nation.

In the 2000, the Federal Reserve began to print money again, creating what classical economists called the mother of all liquidity bubbles. The US began the second Gulf War and the Fed kept rates low. Oil prices shot up from 10 dollars to over 120 dollars a barrel.

The bubble collapsed in 2008 with the Great Recession with gold at over a thousand US dollars an ounce.

Siriwardene said from 2000 to 2011, 40 countries reached the 4,000 dollar threshold with Maldives and Thailand among the Asian countries.

But major reserve currency central banks have continue to print money, keeping inflation alive, and gold is now over 1,600 dollars an ounce.