Costa Rica’s Central Bank intervenes to prevent dollar from bottoming out

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December 4th, 2013 (InsideCostaRica.cm) Costa Rica’s Central Bank has stepped up its intervention in the Monex wholesale currency market, purchasing $45.9 million in three days between November 28th and December 2nd.

 

The most substantial intervention occurred on Monday when the Central Bank purchased $29.1 million, which represented more than half of dollar transactions during that session.

 

The pace of trading had slowed yesterday, with the average price of the dollar coming in at ¢500.24.

 

Costa Rica’s exchange rate “band” system sets both a “floor” or lower band and a “ceiling” or upper band for the exchange rate of its national currency against the dollar.

 

When the value of the dollar vs. the colon reaches the bottom of the band, the Central Bank intervenes by purchasing dollars in the wholesale market.

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    • http://alligatorsnroadkill.blogspot.com/ John Dungan

      You know, I kept reading this kind of thing during the three years I lived in CR, and I still see it, and finally, I have to ask: why? If they are so sure that the dollar will lose all value, would it not be to Costa Rica’s benefit to let if fall all the way? Meanwhile, why is it that all major purchases in CR are still in dollars? I wonder if any of this is true.

      • http://insidecostarica.com/ Timothy Williams

        A strong colon versus the dollar is bad for exports, effectively making things like coffee, pineapples, bananas, etc more expensive in export markets, and such exports make up a considerable amount of the economy. Most exporting countries want their currency to be “cheap” compared to the dollar – for instance China, which goes to great lengths to keep the value of their currency artificially low against the dollar (and inversely, the dollar strong against their currency).

      • http://insidecostarica.com/ Timothy Williams

        Also, the currency market in CR is not like the international currency market (the colon is traded internatonally of course).

        On international markets, exchange rates are more about the value of the currency itself.

        In CR, it is simply supply and demand of dollars in the local market.

        So if a big multinational company dumps a ton of dollars into the company, just for example, that increases the supply of dollars, making the dollars weaker in the local currency market. So really, a weaker dollar in the local market is symptomatic of a lot of direct foreign investment (and hence dollars) in the local currency market.

        • http://alligatorsnroadkill.blogspot.com/ John Dungan

          Well, it all sounds like so much double talk to me. As I recall, whenever I wanted to transact anything local, I was required to change dollars to Colones, and I have to believe that a multi-national corporation would have to do the same. Therefore, my question is: when, exactly, has any big multinational company ever dumped tons of dollars into a CR company?

          • http://insidecostarica.com/ Timothy Williams

            That was really just an example. Its not so much they “dump it in” but they do purchase the exporters’ products in dollars (pineapples to microchips), which end up in the banks here, and thus in the currency market, and the more the supply, the less they are worth (just like any other commodity).

            You also find that during the tourist high season, the dollar tends to weaken as all of the tourist dollars increase the dollar supply in the country. Then in low season, the dollar will generally bounce back some.

          • http://insidecostarica.com/ Timothy Williams

            That requirement to exchange into colones is also a way for the central bank, ultimately, to get excess dollars out of circulation in an attempt to keep the dollar strong against the colon (and the colon cheaper as a result) by reducing the supply of dollars.

      • P mattingly

        Firstly, the dollar will not lose all of its value but to answer you question of why not let it float is the important part of this economics 101 discussion.
        There is the economic thought that advocates exactly that. To let a currency float would be good for a country long term but in the present state would be painful politically in the short term.
        If left to float, the colon would seek its own level in the international market place according to how cheaply and efficiently it can produce its GNP compared to other countries. Or how efficiently it can grow, transport, ship and sell pineapples (using my former example) compared with other countries that produce pineapples (coffee, bananas, etc.)
        However, in a socially bent country that wants to take from those that produce and give to those that do not and offering more benefits than it has money to pay for, it cannot compete with other countries and tries to make up the difference by making the same mistake of borrowing, propping up it currency and heading down a road that will end badly.
        CR has a long history of bad labor laws, heavily taxed businesses, power unions that control government and thereby society to get what they want and government permitted monopolies (electric power, fuel production, telephone, insurance, ports, etc.) that only lead to inefficient industries all of which making it next to impossible to compete on an international market.
        These ‘low hanging fruit’ source of funds are easy targets for the government to grab the money it needs (i.e. the new $5 exit tax at the border, tax only ‘rich people’s’ houses only, etc) Classic example of this is currently taking place in Venezuela which has grabbed banks, CEMEX (Mexican cement company), foreign oil company’s assets, etc as example of low hanging fruit. But this fruit, once forcefully ripped from the tree, does not grow back and the tree dies.
        Ideally, a country’s currency should be tied to its ability to produce products and services…its GNP, and not how cleverly it can borrow, dodge and hide to make up for its incompetence.
        This would lead to short term hurt in the economy as the ICE would have to lay off hundreds of workers that it does not really need to operate that have padded the political payroll for decades, teachers who do not teach well, dock workers who do not work but spend their time on a perpetual strike, and a fuel supply company that constantly screws up one time after another and everyone just lets it pass. But what politician has the courage to stand up and explain this as a plank of his platform to get elected?

        Politicians get elected by promising to give away ice cream to low informed voters who don’t realize the true cost of that being offered…nor care if it doesn’t effect them directly.

    • Ken Morris

      Tim has explained most of this well, and importantly included mention that the dollar is bottoming out BEFORE the high tourist season begins and the country is flooded with those dollars. Basically, the dollar remains in sorry shape in CR.

      However, I suspect that Tim’s assertion that a weak dollar is a symptom of a lot of foreign direct investment by multinationals paints an overly-rosy picture of what’s going on. I have checked the foreign direct investment numbers, and unless some multinational recently invested a lot, I don’t see the kind of upswing in foreign direct investments that could explain the weak dollar.

      Instead, I see (1) lots of money laundering, probably mostly by drug gangs; (2) global currency speculators, who aren’t investing in the sense of creating jobs but are simply playing the currency market; and (3) bigger loans secured by the government, which flood the market with dollars.

      Although there are always winners and losers in currency fluctuations, whichever way they go, those of us with dollars are I think hurt by the three just-mentioned trends.

      • http://insidecostarica.com/ Timothy Williams

        Ken, you are absolutely correct on the speculative capital coming into the country for no reason other than playing the currencies. I wanted to mention it, but figured if I did, then I would have to explain what the speculators were doing, and didn’t have the time to write that much.

        The bottom line though, at the end of the day, the reason the central bank intervenes is an overly-strong colon is bad for the export sector.

        Any country that is a net exporter actually wants their currency to be reasonably weak against the dollar.

        In fact, the US has been putting pressure on China for years to increase the value of their currency against the dollar, claiming that China is keeping their currency “artificially” low, giving an unfair advantage to Chinese exporters.

        The US doesn’t have this problem with their own currency because A) the dollar is an international reserve currency so people buy US exports in its own currency and B) the US hasn’t been a net exporter for quite a while.

        • Ken Morris

          And you are absolutely right about the weak dollar being advantageous to the export sector, and I suspect that protecting it (as well as the tourism industry) is a main reason the powers that be resist allowing the dollar to float freely.

          However, I’m either not sure what you mean by “net exporter” or believe you are mistaken about CR being one. I recently checked the numbers in connection with CAFTA’s 5-year anniversary. I discovered that CR’s balance of trade is negative and has worsened during that period. Basically, CR is importing more than it exports. Probably worse, though I don’t know, is that some of the goods counted as exports may be things assembled here under the auspices of a multinational headquartered elsewhere, making them not exactly exports in a true form. The exports I do see–bananas, coffee, and pineapples–also aren’t desirable ones, since they’re essentially unfinished goods, which leaves CR in a position of importing the value-added goods.

          In case you can’t tell, I can get in over my head fast with economics, and among the things I don’t know is whether tourism and service operations like call centers are or ought to be considered exports. Obviously these business don’t ship physical goods abroad, but it would seem to me that their economic effects are something like exporting. But in the way the numbers are conventionally calculated, I believe that CR is importing more than it exports.

          • http://insidecostarica.com/ Timothy Williams

            Costa Rica includes services (but not tourism) in its exports – for instance, software development, business process outsourcing (BPO’s) and call centers. Which, likewise, also benefit from a weaker colon (although their workers might not, necessarily, other than having a job in the first place).

            I honestly haven’t checked the trade figures lately. But no question that both physical exports and what CR calls “service exports” are a hugely important part of the economy, which benefits from a weaker colon.

            • http://insidecostarica.com/ Timothy Williams

              Also, I probably should have made my statements as an “export driven economy” rather than a “net exporter” – would have been more accurate. Obviously almost all durable goods, textiles, manufactured electronics here are imported.

    • P mattingly

      “When the value of the dollar vs. the colon reaches the bottom of the band, the Central Bank intervenes by purchasing dollars in the wholesale market” Article sounds like CR is trying to help out the poor dollars that is dropping by buying dollars, but it ain’t so.
      There is classic currency manipulation going on in CR by the central bank to try and keep the national currency afloat. They do this by buying or selling dollars using their own currency. Most all countries do it that mismanage the spending of the government. Countries with no debt (Norway) don’t have to do this as they have more money than they can spend from oil royalties and small population.
      Williams is correct in that a country wants its currency to be ‘cheap’ in relation to one of it’s biggest trading partners (U.S.) so CR will be able to sell more of its exports.
      Let me use a pineapple example;
      Let’s say you can buy 5 pineapples in CR for 500 colons or at the current exchange rate, $1 will buy 5 pineapples for export. If the colon / dollar ratio would fall to 100 colons for one dollar, then $1 would only buy one pineapple for export. This would make it more difficult for CR to sell pineapples since other nations that export pineapples would be selling more / dollar and CR would lose trade advantage. CR can try to keep a trade advantage by buying $45mm worth of dollars in the international money market last week, not so much to ‘support the dollar’ but to keep the exchange ratio of dollar to colon from falling below 500:1.
      Now the important piece of the puzzle:
      Problem is, where does CR get $45mm dollars in order to be able to buy dollars?
      Answer; the government prints money to cover the shortfall of tax revenue coming in verses money spent (learned it from a master….the U.S.) and borrows in the international market to cover their spending (sound familiar?) It prints colones and sells them on the international money market and buys dollars and it is able to temporarily keep the 500:1 exchange ratio.
      With CR reportedly borrowing 1/2 of what it spends now (compared to 40% in the U.S.), it is a fools came that will end badly some day both for CR and the U.S.
      Solution which is politically unacceptable………..let the currency float and control government spending and reduce borrowing from anyone and anything to keep the country afloat. China has barges full of dollars floating offshore from CR available for investment in CR………but at what cost? Get rid of Taiwan? No problem, build us a football stadium. New roads and bridges, no problem but take China’s really cheap exports into CR and wipe out the local production.

      • http://insidecostarica.com/ Timothy Williams

        Correct – Central Bank here pays for the dollar purchases through interest-bearing bonds (which ultimately costs the state and taxpayer the interest on those bonds). Justification (by central bank) is the cost of issuing those bonds is less than the export sector contracting (and lost jobs and tax revenue), etc that would go along with it. Not saying I agree, nor disagree, I’m not formally educated in economics. Just stating the bank’s reasoning.

        • P mattingly

          You are absolutely correct. That is the excuse the central bank (government) uses to justify what they do. The problem is that there is no end game. What happens when they have to borrow 110% of what the gov spends? The country is broke and everything must implode and everybody loses, except the speculators that can see it coming. Viva George Soros vs. the bank of England. Score? Soros 1, Bank of England 0

      • Ken Morris

        I agree with your analysis, though wonder whether you might be minimizing the amount of drug money floating around CR. I don’t believe any of us knows how much money is involved, and wonder if it might be a lot. ICR ran a story not long ago about the number of cash deposits above $10,000 made annually into CR banks, and the figure struck me as quite high. Since I can’t imagine that many businesses routinely make cash deposits above $10,000 (probably some casinos and supermarkets do) I have to wonder who is making all those large cash deposits.

        Also, the dollar only started to weaken dramatically a few years ago, and hasn’t budged since. To be sure, one reason for this is US policy. However, I don’t think the management of CR’s public budget all the sudden became markedly less responsible then. Something else therefore has to explain the overnight change from an appreciating to a depreciating dollar, as well as the continuing depreciation of the dollar. Since the change in the direction of the dollar occurred at the same time we were alerted to the arrival of the drug money, I have to conjecture that this may be one of the proximate causes.

        Of course, I don’t know, but I think your analysis can’t explain why there would have been a sudden and then persistent reversal in the value of the dollar. Your analysis can explain a trend, and I believe explains that correctly, but not a sudden change and/or worsening of the trend.

        Again, maybe Fed policy and this or that is enough to explain the sudden change a few years ago, but I’m not willing to discount the effects of drug money until I see some kind of evidence showing that it is negligible.

        • P mattingly

          The dollar started to really ‘weaken’ in respect to other international currencies when the U.S. cranked up the printing press and started a disastrous supply of money flooding into the world markets. Currently $85 billion a month of new money created.
          This is a more dangerous method of a country making its currency cheaper thus enabling it to export more ‘pineapples’. Both methods debase the currency and makes ‘pineapple’s more expensive in the long run as there is too many dollars available for the purchase of ‘pineapples’ and the price goes up..called inflation. This wipes out long term investments and people living on a fixed retirement income. The pain is more hidden but just as ruthless in the end.
          As far as your theory about influx of drug money, I cannot say since there is obviously no evidence that this is happening although I think it is. But again, it is miniscule when compared to the whole. For drug money to be ‘laundered’ and parked in CR there needs to be a large base of operation in the country. Mostly CR is a ‘bridge’ on the road to the U.S. where the consumption and revenues are created and a return path to take the money back into the country of production.
          Casinos on the other hand offer an easy, attractive way to launder the dollars that come back south. After being deposited in local banks and claimed as ‘gambling’ profits, the money is easily sent anywhere else in the world as it has been cleaned and taxes paid on the ‘gains’.

          • Ken Morris

            Again, I think you’re right about US printing-press policy being the proximate cause of the weakened dollar, since the timing is right and the dollar has weakened against other currencies too.

            You may also be right that the drug money is a miniscule part of the issue. Problem is that we simply don’t know. It would appear that CR is more of a “bridge” than a “base,” but it could be a big bridge and for all I know some are banking here as a base even if they live elsewhere. Casinos also offer an easy cover, as you note. Mostly, the stability of the country and the banks coupled with an influx of legitimate dollars might make it an attractive base. But it might well be a miniscule part of the whole.

            Thanks for weighing in. I don’t have a dog in this hunt but am simply interested in understanding what’s happening (since I’m paying around 30% more than I once was for most things with no increase in my dollar income).

            • P mattingly

              (since I’m paying around 30% more than I once was for most things with no increase in my dollar income).
              The result of printing so much money. The dictionary definition of ‘inflation’ is the growth in the money supply. It affects all of us and people on fixed income the most.

    • Yeims

      A very enlightening discussion.