With all eyes on the drop in the British Pound, it is another 'pound' that is utterly collapsing. Despite its official exchange rate is 8.88 per dollar, Egypt’s pound dropped to 16.11 per dollar in the black market, another record that extends declines over the past month to 19% and down over 40% since it devalued in March.
The Sovereign CDS market (which prices for both default and devaluation) is pricing in a further dramatic devaluation of the official rate…
Bloomberg reports that Africa’s third-biggest economy will close a $12 billion lifeline from the International Monetary Fund within two months, according to Prime Minister Sherif Ismail, as pressure grows on the country to weaken its currency to lure foreign investment and stimulate growth.
Ever since General Sisi ousted the Muslim Brotherhood, the Egyptian economy has remained in shambles. Businessmen are fed up. They are ignoring government gag orders, and are making their voices heard. And why not? They are losing sales, missing deadlines, and scrapping expansion plans because of limited access to U.S. dollars.
Where are the greenbacks that Egyptians demand? Well, even though General Sisi has passed the begging bowl, the cupboard is pretty bare (as the accompanying chart shows). This, in part, is due to the Muslim Brotherhood. The Brotherhood did one thing well: they blew through foreign exchange reserves like wildfire. Not surprisingly, the Sisi administration is squeaky tight about holding on to its limited reserves.
As we noted in March, the only sure-fire way to save the pound and eliminate Egypt’s USD shortage is to install a currency board. This would allow the quantity of pounds in circulation to be determined by a free-market mechanism.
So, just what is a currency board? Operating under currency board rules, a monetary authority issues notes and coins convertible on demand into a foreign anchor currency at a fixed exchange rate. As reserves, a currency board holds low-risk, interest-bearing bonds denominated in the anchor currency. The reserve levels are set by law and are equal to 100 percent, or slightly more, of its monetary liabilities. A currency board generates profits
(seigniorage) from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities. By design, a currency board has no discretionary monetary powers and cannot engage in the fiduciary issue of money. Its operations are passive, and automatic. The sole function of a currency board is to exchange the domestic currency it issues for an anchor currency at a fixed rate. Consequently, the quantity of domestic currency in circulation is determined solely by market forces, namely the demand for domestic currency.
There have been many currency boards, and none have failed. By design, they can’t be broken. Even the currency board designed by John Maynard Keynes, which was installed in North Russia, during the civil war, worked like a charm.
But, you may ask, what about Argentina’s Convertibility System (1991 2001). That system was not a currency board. It might have had the appearance of a currency board, but appearances can be deceiving, particularly in Argentina. Even though it linked the peso to the USD at a one-to-one rate, the Convertibility System was a system that operated with monetary discretion – unlike a currency board. And over long periods of time,
the discretion was wild.
A currency board would give Egypt stability, and while stability might not be everything, everything is nothing without stability.
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