In the economic migration from central planning to full market environment Cuba will have a great need of incoming capital from the Cuban community in exile and from foreign investors. It will be crucial that these find security in their investments at all times. Cuba will also need to guarantee to all to all its residents in the island that the fruit of their labor and economic incentives will not be devalued at some point in the future.It is then natural to consider and evaluate now the feasibility of structures and mechanisms to guarantee consistently the value of the national currency by keeping it protected from domestic and international forces and factors that potentially could contribute to its devaluation.As part of this goal many will be willing to suggest delegating this vital function to the Cuban Central Bank (Banco Nacional de Cuba) following old and/or nationalistic sentiments. In attempting to grasp certain understanding of the intricacies of currency stability and gain insight of the different paths to follow in achieving it is worth looking at the variables that come into interplay.


For any Monetary Authority there are three variables of the currency that can be influenced and these are not different from those that anyone can expect of any article or commodity: its price, its quantity and its quality.The component of the nominal quantity or monetary base is under the direct control of the Monetary Authority.

The price of the currency or how much it takes to acquire it, can be expressed in terms of another that has a fairly constant purchasing power such as US dollars or German marks -- this "price" is also known as the exchange rate.

The last and quite frequently underemphasized variable, perhaps due to some misconceptions, is the quality of the currency, better known as convertibility to economists, international financiers and traders.

A currency can be considered to be convertible if it can be used freely and without government or Central Bank restrictions for the purchase of foreign goods and services (current account purchases), and also if it can be utilized to acquire any foreign financial assets such as foreign equities and/or real estate overseas ( capital account purchases).

When either the flow of the current-account or capital-account is totally or partially restricted by the national Monetary Authority, one can consider that capital controls indeed have been imposed.

These two aspects of the convertibility are of substantial impact in the overall transformation and enhancement of any economy.

Current-account convertibility allows the domestic products to go into competition with foreign ones if the trading quotas or tariffs are low or non existing. It will give the country feedback in the formation of the structure of prices in world markets and signal to the national producers and manufacturers which products and services they should concentrate on.

On the other hand, current-account convertibility will signal to the outside entrepreneurs that they will be able to retrieve some of their profits, making them more willing to continue investing.

No doubt based on the monetary events of this decade there will be many who will raise some concern about full convertibility. Among them, some will point out that domestic capital could depart on a large scale or that a large influx of foreign money may produce sudden appreciation of labor, land and other non exportable goods, thus contributing to economic depression.

It will also be mentioned that in the past many domestic enterprises and national banks borrowed heavily from abroad with debts that are payable in foreign currency but their income is in the national currency which, in the case of an eventual devaluation, can cause their bankruptcy.

All these possible concerns and objections to preserve full convertibility of the currency emanate from the inconsistent practices of the M-Auth and are not the result of the convertibility itself. Capital controls is a hidden way to manipulate the real supply of money since it makes the national currency less useful to fulfill the basic functions of money: to act as a medium of exchange and to be a store of value.

Capital controls have been implemented by many governments and monetary authorities in this century. Countries that restrain capital flow often do so because there is something wrong with their economic fundamentals. In reality, these controls are nothing more than a form of expropriating private property and inevitably leads to the reduction in the overall wealth of the nation. Countries that impose capital restrictions treat the symptoms rather than the disease. History has demonstrated that controls of free capital movements are porous and attempts to enforce them lead to corruption more often than not.

Similarly, capital controls increase the potential danger that the government may confiscate property and consequently foreign investors are less willing to invest new money in a country with such controls forcing up domestic interest rates to inordinately high levels.

Restrictions on convertibility do not retard or delay capital flight -- they indeed exacerbate it.

Let us not be fooled-- full convertibility of the currency is a guarantee to protect the right of each citizen to full ownership of his/her currency and other property.

Few countries in the world have full convertibility. Only around 40% of the countries reporting to the International Monetary Fund (IMF) in 1997 enjoyed it.

At his point and as a summary we can enumerate the degrees of freedom or variables of the currency exchange markets that potentially the national Monetary Authority may manipulate:

1. the supply of the national notes ( printed money) and coins.

2. the Exchange Rate of the national currency with respect to a foreign one.

3. convertibility or openness of currency and capital flows.


In the last few years several countries around the world have suffered mayor devaluations of their currencies while others immersed in similar geographical areas did not experience them.

It behooves us to look into the structures and functioning of the monetary authorities that led those countries to lose great amount of their resources.

Any Monetary Authority has at its disposal the control of any of the variables that any currency possesses. In some countries it opts to control one or two and in others it ventures to manipulate all of them -- resulting in different schemes of market mechanisms for international payments and exchanges.

In the case the Monetary Authority decides to set only the national monetary policy (and consequently the monetary base is domestically determined) while allowing the exchange rate and convertibility to be out of their domain, it is considered to be operating under the " free floating system".

However, in other countries the Monetary Authority sets the exchange rate between its currency and that of a sound one but does not interfere with the monetary base or the convertibility of its own currency. This is known as a "fixed exchange regime" and in it the monetary base is determined by the balance of payments in such a way that when the official net foreign reserves increase the monetary base increases and vice versa.

In both cases there are no conflicts between exchanges rates and monetary policy and both allow the market forces to rebalance financial flows and avert balance of payment crisis.

But there is another alternative that the Monetary Authority have attempted in many occasions while maintaining convertibility -- and it is known as the system of "pegged rates", confused quite often in many articles and publications of popular magazines with "fixed rates".

In this case the monetary base contains both domestic and foreign components. In this scheme the Mometary Authority pegs the exchange of its currency at certain level and at the same time attempts to compensate any change in the incoming or outgoing foreign currency by increasing or reducing the domestic component of its monetary base. In essence the Monetary Authority attempts to play with 2 of the 3 variables of the exchange market.

If at any time there is a contradiction between the offsets in the composition of the monetary base and the "pegged" exchange rate then a possible balance of payment erupts resulting quite often in devaluations.

In the presence of full convertibility and a miscalculation by part of the Monetary Authority in its domestic portion of the monetary base, there is certain amount of overhanging domestic currency which nationals or foreigners would like to have converted to a sound currency. This must be supplied by the Monetary Authority thus draining systematically its foreign reserves.

In response to this unsustainable runaway condition in the foreign reserves, the Monetary Authority in question responds by allowing the exchange rate to float or implements capital controls with the consequences already addressed above.

At this point the Monetary Authority is exerting influence over the 3 variables of the foreign exchange -- a task even more difficult than when already handling only two variables. This invariably manifests itself as " capital flight", as has been occurring in Russia and other countries.

Today there are variations within some of the foreign exchanges already described as different MonetaryAuthorities attempt to modulate their influence over the variables at their disposal but these do not change their basic results.

As a summary one can say that a well-known proposition of exchange rate policy states that of the three variables or tools of this policy -- the Monetary Authority can possibly achieve any two simultaneously and consistently but not three.


After having exposed the different schemes to target the variables of the exchange rate policy one may ask who are the different M-Auth that practice them and what is their record in managing them.


The most common type of Monetary Authority today is the Central Bank (Cbank) of any nation. Most Central Banks emerged in this century in many of the postcolonial periods of the countries in Africa, Asia and L. America and have continued in the post Marxist countries of Central Europe.

A Central Bank is a monetary authority that has the ability to chose a policy at will and has monopoly control of the supply of notes and coins and of the supply of the reserves of commercial banks and therefore considered to be a "banker's bank."

A typical Central Bank maintains a floating or pegged exchange rate. This exchange is not typically written into law and can be altered at will by the officers of the bank or the government.

It can also increase the domestic monetary base thus creating inflation at its discretion -- or if it suffers political or speculative pressures it can devalue the currency.

As reserves against its liabilities in the form of notes and coins in circulation the Central Bank holds variable foreign reserves and it is not required to maintain any binding ratio.

A typical Central Bank has limited convertibility or full inconvertibility of its currency. They restrict or forbid certain transactions particularly capital accounts. In general Cemtral Banks can alter at will or with the blessing of the government the exchange rate, the ratio of its foreign reserves or the regulations affecting commercial banks.

Historically, the government has fostered credit expansion to a high degree in many countries in the past. This has been accomplished by weakening the limitations that the full market forces place on bank's credit expansions.

As commercial banks overreach, the government can permit them to avoid payment of their contractual obligations and may utilize the Central Bank to bail them out with increased issue of standard money. In essence, the Central Bank becomes then " the lender of last resort" for all banks.

In many instances, Central Banks are not transparent and does not announce how much it will increase the supply of money but rather by much has already done it in the past.

Most Central Banks are highly politicized and even the most independent Central Banks such as the US Federal Reserve Board and the German Bundesbank yield to strong political pressures.

From different school of economics there are arguments against the discretionary policy Central Banks practice.

One argument emphasizes the lag in time between the changes in monetary policy that the Central Bank enforces and the change in resulting price variability. Another argument points out that in general many people such as traders and commercial bankers can make profits by correctly anticipating the policy of the Central Bank unless it practices random surprises which by themselves could result in unwelcomed uncertainty.

Lastly it is also felt that discretionary monetary policy is a type of central planning and it suffers from the same shortcomings of not knowing in advance which measure will be beneficial or harmful.

In terms of historical records Central Banks have a poor record mostly in developing countries. For the 101 developing countries reporting to the World Bank, the average annual inflation was 16 % in the period from 1965 to 1980 and 61% from 1980 until 1990. The comparable figures for 24 developed nations reporting to the same institution in the same periods were 7% and 4%, respectively.

National financial crises of recent years have been due to a combination of following certain policies: loose fiscal or monetary policy, government-directed credit, Central Bank pegged exchange rates, lack of transparency in government transactions and bailouts implemented by Central Banks or international lending organizations.

The recent currency events of Asia, Russia and Brazil have contributed to lots of articles and analysis about exchange rates, dollarization and currency unification. Some countries have anchored their domestic currencies with strong ones through the establishment of Currency Boards or the like.


As we approach the inevitable end of Marxism in Cuba and in a world of increased capital mobility there will be a premium on the future government of the island to maintain sound macroeconomic policies.

Cuba has a primitive financial system that can not intermediate efficiently between savers and investors because the peso is unstable and inconvertible.

A market economy needs a sound currency and a banking system that fosters real savings and lend them to people.

Today the Cuban Peso is inconvertible and has no value outside the borders of the island. As it now exists will be a remanent of socialism that deserves to be phased out and a continuation of the current monetary system will perpetuate the socialist charade. Cuba has long been and remains today an inefficient producer of monetary policy which should not be allowed to remain for the future.

A sound currency is a good and indispensable first step to promote sustained growth in Cuba and should be complemented by a fully operational private banking industry. National and foreign banks should coexist in open competition without the need for a Cbank.

To obtain the full benefits of participating in world markets, the post Marxist Cuba needs to make the Peso convertible -- the continuation of its Central Bank will be an obstacle to the development of the market economy due to all its attributes.

In Cuba after 40 years of mismanagement of its resources there is no room to perpetuate fiscal irresponsibility by the government and therefore the existence of a Central Bank is not an alternative but simple suicide.

In 1990, Paul Volcher, former chairman of the US Federal Reserve Board, indicated that he had then little faith that Cbanks in formerly communist countries could achieve full convertibility -- he has proven to be right.

If we allow the Cuban Central Bank (Banco Nacional de Cuba) to continue operational, people will remain skeptical of it for years. To gain credibility the Central Bank will have to keep the Peso overvalued and set high interest rates.

Cuba could certainly make the Peso convertible by maintaining a floating exchange rate rather than a fixed and even balance supply and demand for domestic currency against foreign money but it would NOT restrain the power of the Cuban Central Bank ( Banco Nacional de Cuba) to create credit and lead to inflation.

In some of the former communist countries of Central Europe and the USSR the government is still unwilling to resist pressure from interest groups that benefit from subsidies and from the monetary system that administers such subsides. Eliminating the Cuban Central Bank will do away with the channels for these subsides, which are not transparent to the public.

Up to now the Cuban economy revolves around the plan of the government. Although is obvious that it works poorly, the government has managed to mask real inflation by price setting and other measures initiated in 1993 at the beginning of the "special period". In a transition period they could reappear with a vengeance.

There is no question that political pressure from groups representing the old socialist order will favor inflation rather than stable money and prices. High inflation is fundamentally driven by loose monetary and fiscal policies practiced by governments and Central Banks.

To have a stable currency the post Marxist government needs to remove monetary policy from political influence.

Under communism, the banks are not real banking institutions. They are nothing more than conduits for conveying funds from the government to enterprises administered by high political figures of the Party. They are essentially like bookeepers of socialism. These existing banks and the Cuban Central Bank will lack totally the experience to operate as it is expected in market economies.

In the Cuba that we will inherit, government budgets needs must be financed, domestic capital markets do not exist, there is no experience with private commercial banks as it is understood in free enterprise environment and creation of a new taxation system appropriate for a market economy will take time. Past experience in former communist states show that tax revenues usually fall significantly in the first years of transition. Foreign borrowing or aid is not usually available in large scale to transition economies.

It might be that in the case of Cuba the exiled community will invest heavily and the US Government could provide a great deal of aid and cooperation -- but rest assured that everyone will wait until the new government proves that its monetary policies do not result in low expected returns.

Most countries of Eastern and Central Europe coming out of long years of Marxism have attempted to incorporate themselves into the economic environment of free markets. Are we going to set a similar goal for Cuba?

The example set by the successful Cuban community in the US will definitely influence all Cubans as we attempt to define our future with becoming economically " a la Miami".

The speed of allowing a real transformation to a market economy is directly proportional to the quality of the policies announced and implemented at the beginning of the transition.

We must choose between a dangerous monetary policy or a solid, reliable one.

Failure to adopt an aggressive and well defined monetary policy could plunge the island into an era of financial crises due to inflation and recession. These easily could and will be blamed on the " free market or capitalistic practices" of the new government bringing possible nostalgia for the "Marxist type of government" as it has already taken place in some countries.

To have a stable currency, Cuba in the future needs to remove its monetary policy from political influence and it needs to give its monetary reform instant credibility. Cuba will be in a great need of a monetary system which should rest on a sound banking system and the creation of an orthodox Cuban Currency Board.


Ricardo E. Calvo
January 2000

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