Cuba says goodbye to greenbacks

2004-11-08T20:53:00.000-08:00

The Cuban government today made illegal after this week the use of the US dollar as legal tender on the island nation. This action appears to be motivated to provide a fresh influx of cash to the strapped nation, which has been under increasing pressure since the Bush administration has levied more stringent sanctions and embargoes on it. How this will turn out for Cuba in the long run is anybody's guess, as when inhabitants were trading goods and services for US dollars, their currency was backed with the full faith and credit of the US government, which is rather unlikely to default on its debt and therefore has such a strong currency that many other of the world's nations either use the dollar as their own official currency (Ecuador, for example), or peg their exchange rate to the dollar (like Brasil) rather than let it float as do other currencies (China). This appears to have been the reason why the Cuban government was content to look past the act that they were using the currency of a nation that in their eyes is their oppressor. When money changes hands either to or from the outside world and Cuba, it's easy to settle upon a rate at which to accept goods, because the dollar is easily quoted and fairly stable (although its strength is another matter: witness its record low this week with respect to the euro due to an increasingly inflating public debt). The situation in this case works out to Cuba's advantage in that it can still trade with its world trade partners and utilize the full value of the US dollar, without worry for any potential disadvantage due to an exchange rate that is not in their favor. In fact, it creates an impromptu arbitrage situation in that Cuba can choose to trade with one partner whose prices favor them instead of another with higher prices, and then turn around and sell at the higher price the same goods it just purchased at the lower price. Of course, this only works in a situation involving scarce goods and without the free flow of information among the trading partners -- so it may be a textbook case and nothing more. Nevertheless, it represents an inequity in the system as it was.

At issue is the fact that simply creating a currency out of thin air and without the backing of the credit rating and income (GDP) of the Cuban government -- neither of which are likely to be strongly in their favor, but that's another matter -- the Cuban nation cannot expect in this global economy to simply create a new currency and assume that anyone residing off-island will assign any value to it at all. Cuba is not a big player in global trade, what with existing US embargoes and the US desire to cease (officially) doing business with other nations that trade with Cuba. This is fine should Cubans only wish to trade with other Cubans and only within the confines of their island. But what will happen when the Cuban government has to acquire goods or raw materials that are not readily available in Cuba itself? Because it has been trading US dollars at $0.90 for 1 Cuban peso, the value of its currency is artificially propped up. Further, the government has been essentially printing its own money in exchange for dollars. We know from Macroeconomics 101 that a country cannot print its own money when the supply runs short without drastically inflating prices with a commensurate fall in the value of its currency. The the Cuban peso, whose trading value was inflated by the Cuban government's devaluation of the US dollar in order to remove them from circulation, will drop further due to hyperinflation.

Add to this the fact that Cuba is not a nation that enjoys a tremendously large GDP and its political situation is precarious due to Castro's somewhat unpredictable nature, and so will not attract investors in the same quantity as a similar nation with less currency risk created by lower political risk. Its currency is therefore less liquid. What you've got is a windfall for the Cuban government as it removes US dollars from circulation, but impending disaster for its citizenry in that prices for goods sold on the global market will skyrocket due to the worthlessness of the Cuban peso. What's good for the government -- building up its reserves in the form of a strong currency -- is not in turn good for the Cuban people, as their attempts to acquire goods from abroad will be stunted due to greatly diminished purchasing power.

Unless Cuba has plans to deal with the situation. The only way I see out of this mess looming over the heads of the Cuban people is for the Cuban government to disperse its newly acquired wealth to the Cubans by purchasing -- with dollars, mind you -- goods and services available from abroad in the global marketplace. This will transfer some of the benefit of the currency swap to Cubans themselves. They'll be able to trade amongst themselves for goods and services produced and originating wholly within Cuban alone, but should any component of those goods and services originate from outside Cuba, the potential price could be so astronomical as to be out of the reach of ordinary Cubans. Money transfers from Cubans living in the US might help, but with the value immediately sucked out of any transferred wealth once converted into Cuban pesos, many will opt to hold on to their money. And my guess is that the Cuban people now suffering a financial squeeze will feel the pinch that much more, which does not bode well for the future of the Cuban peso nor the government for which it stands.

Religion & Politics

Cuba says goodbye to greenbacks