Here I go again – More on the Currency War

President of Costa Rica Laura Chinchilla

I came across an interesting article in Reuters I would like to share. You can read my analysis first, or read the article first here.

There is a fair amount of government speak and econo speak there, and although I am not totally fluent in either, I will wade in because I am foolhardy.

In an interview with Reuters, President Laura Chinchilla said she was worried a capital controls bill sent to Congress could stall, reviving interest from speculative investors that have tipped the Central American nation into a battle over its currency.

I’ve talked about this before, but it bears looking at again. What, exactly, is this “Battle over its currency” that the President is talking about? I’ve posted the graph before but here it is again, with apologies:

The chart is a bit dated but the pattern hasn’t broken. The most fundamental thing to grasp is that the higher the colon/dollar rate is, the more a dollar is worth in Costa Rica. Looking at the chart, you can see that the rate has fallen rather sharply and is now semi stable after falling by a bit less than 1/6. If you live here or visit here or do business here, it means simply that it costs more to do those things if you pay in dollars.

On the surface, this seems like a winner for Costa Rica, as what they own and offer is ‘worth’ more in terms of dollars. But naturally, that’s not how it works out in reality. What really happens is that goods and services priced in colones are more expensive and the ‘market’ for such things shrinks as the consumers cut back or look for cheaper alternatives.

It’s a pretty old fashioned concept called ‘mercantilism,’ and it simply the idea that a country wants to export more than it imports. Obviously this is not possible, as total worldwide exports and imports are equal by definition, so what happens is that countries get into ‘trade wars’ trying to boost their exports while trying to reduce their imports. Somewhat like everyone standing on their tiptoes trying to watch a parade.

The primary way this is achieved is by currency manipulation. At this point I leave my comfort zone but my oversimplified explanation is that countries achieve this by doing things to undervalue their own currency. One of the ways this is done is by printing a lot of the currency you want to undervalue. You know, run deficits, that sort of thing (as if there are actual countries that don’t run deficits, but it’s a matter of degree).

It should come as no shock to any reader that there is a global economic slowdown in process. Even if you are doing fine personally, and I hope you are, there are major problems in some very important parts of the world, and in unimportant parts as well… take Stockton, California… please!

At any rate, it seems that President Chinchilla is not happy with the situation vis a vis the US dollar. I won’t go into the details of how the big swing in exchange rate happened because it’s over my head. But I can give you TWO personal examples of how it has affected ME.

1. My Social Security ‘check’ is worth less, buys me less.
2. I can get almost 8% annual return on a deposit made in colones.

That almost 8% used to be eaten away by the way the colon used to lose value against the dollar. But now that interest rate stands a fair chance of being amplified if the dollar continues to erode in value.

Am I the only one who noticed this? Apparently not… Foreign investors who get virtually nothing on US Treasuries have been instrumental in driving up the demand for (and price of) the colon. According to some economic theories, this should be a giant boon to Costa Rica, all this investment money coming in. If there has been a boon, I haven’t seen much of it, but then, I am not a member of the country club in Escazu.

Bottom line… if you have dealings with Costa Rica, the recent exchange rates have not been good to you, UNLESS you have invested in timed deposits and gotten a high interest rate plus currency appreciation. It’s been a mixed bag for me. If I had total confidence in local stability I would liquidate all my US assets and get 8% here on them. Trouble is, that is a big IF.

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Comments

  1. OMG I am looking to sell my home in NYC for the same reason and move to CR. Mostly I want to be out of the concrete jungle and into the wild. I have children I worry about. The manipulation of people and assets seems to be a global issue. So disillusioned. I thought the Latin American countries knew better.

    • vistadelrey says:

      Patricia,
      Don't run too quickly. The grass isn't greener in Costa Rica. Make sure you get information from various sources before you make the leap.

  2. I am wondering if it would be wiser to move to Panama whose currency is pegged to the USD. For now things would be cheaper but if/when (?) it fails I would think inflation and turmoil would set in whereas CR would be more stable. Thoughts anyone?