Should you worry about the Jamaican dollar?

Imagine paying 150+ dollars of your currency for 1 US dollar. That's Jamaicans’ recent reality.

We import 4 times what we export; much are commodities like crude oil and wheat. So when US dollars become more expensive, basic household expenses like energy and food become more costly too.

There’s more. The COVID-19 pandemic has been terrible for so many persons who got laid off, lost their jobs, or had their incomes shrink or even disappear—while rising bills piled up. So naturally, many Jamaicans are worried about the future and are looking for a way out.

Some may suggest that the authorities take action to remedy the Jamaican dollar’s depreciation. But might that really address the root of the problem? Could that overall do more good or more harm? And in the end, what hope could there be for Jamaica’s currency?

Consider this.

The root of the problem

Let’s take a simple example of how this can happen. Suppose one loaf of bread cost J$1 last year, but J$2 now. You’d be right to say that the price of bread doubled, or the value of the Jamaican dollar fell by half for bread. One dollar used to buy a whole loaf but only buys half a loaf today.

This is inflation—the fall in the value of a currency. Jamaicans are no stranger to it. But although inflation means each dollar buys less and can be tough on those with fixed incomes (like pensioners), what does it have to do with the exchange rate?

Let’s go back to the bread example, this time looking at bread prices in Jamaica and the USA.

• Suppose last year, the loaf of bread cost US$1. This year, one loaf costs US$1.01. Remember last year that loaf cost J$1 and now costs J$2. Prices, or inflation, rose faster in Jamaica than in the USA.
• Since last year, you could spend a Jamaican dollar and get a loaf of bread just as easily as you could spend it to get a US dollar—there is an implied a 1:1 exchange rate. But this year, you need 2 Jamaican dollars to buy a loaf of bread. You’d also need J$1.98 (which is just under J$2) to buy a US dollar. This implies that the exchange rate is now nearly 2:1.

Economists use the prices of enough goods to represent whole economies to work out implied exchange rates. This idea is called purchasing power parity. Since inflation in Jamaica has been much faster than in the USA over the past few decades, the Jamaican dollar depreciated relative to the US dollar. This generally holds in the long run.

In the short run, supply and demand also determine foreign exchange rates. COVID-19 naturally reduced the supply of foreign exchange from tourism and to an extent remittances—Jamaica’s two largest sources of US dollars. But we still import a lot. When supply is limited and demand is high, prices rise. This explains the short-run slide in our currency’s value.

The high inflation and mismatch between how much foreign exchange Jamaicans spend and earn is arguably the root of our dollar’s depreciation. So should anything be done about it?

What happens with a popular solution

Persons often look to the government to stabilize their currency. In Jamaica, this usually means increasing the supply of US dollars in the market. But where does the Jamaican government get US dollars to do that with?

It has to buy them. Just like many of us.

The Bank of Jamaica (BOJ) does not print US currency. So it cannot directly control how much US currency is in the market. Instead, it buys US dollars from persons who have them, like exporters, investors, or other persons and organizations that would like to trade US dollars for Jamaican dollars. So the BOJ gets US dollars at a cost.

If the government kept a fixed exchange rate, it would be willing to trade any quantity of US dollars and Jamaican dollars at one constant price always, regardless of what the market says. Meaning: if it pegged the currency 1:1, it would trade at 1:1 even if the market says US dollars are scarce and should trade at 1,000:1. Therefore, the BOJ would pay J$1,000 for US$1 on the market, and then sell that US$1 to the public for J$1.

That’s like someone buying something for $1,000 and selling it for $1—it’s just not sustainable. But that raises the question: where do countries with pegged currencies get the money to do that?

Some just do not have very volatile exchange rates, so the need to buy or sell at a loss or profit hardly comes up. Others borrow money to fund it. That creates a different problem—how to pay it off. Usually, that means raising taxes or printing more money.

• If the government raises taxes, that worsens the very hardship during this economic downturn that the intervention is supposed to prevent.
• If the government prints more money, it can easily cause inflation. That means prices rise and the value of the Jamaican dollar falls faster in the long term. In the short term, the government would trade those printed Jamaican dollars for US dollars to pay back its US dollar debt. These both depreciate the Jamaican dollar and worsen the problem to be solved in the first place.

Granted, intervention has its purpose. The BOJ intervenes to stabilize prices—to keep them from moving too quickly so that persons have time to adjust and plan properly. That does not mean that they try to keep prices the same forever. Also, the BOJ’s increasing the US dollar supply is not just to smooth out sharp price changes. Sometimes, there is so much demand and such short supply that some persons who want to buy US dollars cannot find any for sale. That’s when the BOJ steps in—to make sure that foreign exchange is on the market, regardless of price. If it intervened to a huge extent, it would be subsidizing the US dollar. Foreign exchange is not a subsidized commodity because of the reasons above—it is very expensive and unsustainable, and would eventually hurt the people that the subsidy is meant to protect.

With all that said, is there any hope?

The bright side

We established that inflation and a supply-demand mismatch caused the exchange rate to be where it is. What’s the outlook for each?

• The Bank of Jamaica has recently been increasing its efforts to target inflation. It can influence interest rates and how much money is circulating in the economy to keep inflation in check. Inflation also slows down when money doesn’t circulate in the economy as quickly as before. Given that persons are likely to hoard the cash they have under the current circumstances, inflation may be a lot lower than it could be for now.
• The exchange rate is reduced when persons buy less foreign currency and sell more of it. One simple way to reduce demand for foreign exchange is by supporting local businesses instead of importing so much. Having food, clothing, entertainment, vacations and anything else from local businesses means fewer US dollars being bought. For supply, the digital economy has been booming since the pandemic’s lockdown, allowing more Jamaicans to earn US dollars from their homes. When they sell those US dollars to get Jamaican dollars for local spending, the local currency gets more valuable. Finally, tourism may soon rebound after this pandemic and provide a lot of foreign exchange for the country.

A final note: floating exchange rate regimes encourage local development by making it more expensive to import and cheaper to export. As a result, persons may look inward to consume locally, but produce for the international market. Jamaicans often fear rises in the exchange rate because we import more than we export, so we buy more than we sell. Were the reverse true, a high exchange rate would encourage booming business. For example, the US dollar trades with the Chilean peso at nearly 790:1. This doesn’t mean they are poor—Chile is the most developed country in Latin America. Their exchange rate makes them attractive to import from (US dollars stretch further), and their exchange rate means that for every US dollar spent on their goods, they get many units of their currency. Rather than see the exchange rate as a threat, it may very well be useful for Jamaicans to see it as an opportunity.

On the whole, many call to the authorities in deep concern about the depreciation of the Jamaican dollar. Their concern is justified. With less purchasing power, rising prices and scarce traditional sources of income, it is understandable that Jamaicans are worried. Although decades of high inflation and excess demand for the US dollar has contributed to the exchange rate's level, there is little the authorities can do that will not make the problem worse. On the other hand, the market will reward Jamaicans for looking inward—for supporting local businesses, embracing the international digital economy and keeping on forging ahead to hopefully better times.