Below is analysis of the financial meltdown in Edward Seaga's autobiography.

The financial shock that began in 1991 (see Chapter 10) ballooned unchecked over the next five years until it exploded with a catastrophic bang in 1996. The explosion left shrapnel scattered over the financial landscape which was still impacting on the economy a dozen years later.

This was not unexpected, given the developments of the first half of the 1990s, when the financial system was pulled apart by the inappropriate policies of Government and managers with bad management of their financial institutions.

To establish a baseline for these unfolding disastrous events, it must be recognised that the causes were neither natural disasters nor international happenings. There were no hurricanes, earthquakes or epidemics; no external crises, financial or political. In fact, the global economy was experiencing an exceptional period of stability and growth. Independent of external factors, the explosion was purely the failure of the players to measure up to the need to manage the shock of an imploding system caused by their own inadequacies.

The circumstances which seeded the implosion should never have occurred. The recovery in the last five years of the 1980s had stabilised the economy and restored reasonable economic growth. Even though the condition was still fragile, prudent handling and maintenance of the same course would have sustained the recovery.

This should have been no problem. Michael Manley had both promised the business community and publicly proclaimed 'continuity' of the policies of the then governing JLP to be the objective of his Government, if his party won the election. The PNP was successful in the 1989 general election.

As a new government, it made all the politically correct statements about the 'private sector being the engine of growth' and government the 'facilitator'.

right statements

However, as events would quickly prove, making the right statements and doing the right things could be substantially different. At the heart of the difference was a lack of knowledge of the inner workings of a market economy.

The problem which led to the undoing of the financial system was the extraordinary depreciation of the rate of exchange. This became possible once the auction system was abandoned. It had worked effectively in stabilising the rate of exchange. But the Manley Government was now being tutored by the IMF which, notwithstanding the success of the auction, wanted a system with free determination of the rate of exchange by market forces only.

The Manley Government had developed a poor reputation in the 1970s for its inability to mobilise the foreign exchange required to run the economy, and the Government of the day was tormented by the shortage of foreign currency. It ended its term of office with a mere US$11 million in international reserves, which became available only on the day before the general election of October 30, 1980. This vulnerability sent shivers through the business community, even in later years, whenever the rate of exchange showed any adverse movement. The rate had been stable for nearly five years at J$5.50 to US$1.00, from January 18, 1985 to October 31, 1989, using the auction system. But thereafter, even comparatively slight movements were signals to many of returning to the 'bad old days' of stressful foreign currency shortages.

Immediately after the auction was disbanded on October 31, 1989, the exchange rate jumped from $5.50 to $6.50. In place of the auction system, each bank was allowed to set its own exchange rate, another mistake which resulted in a return to the unstable dollar, reinforcing the perception of worse to come. Without effective corrective measures, this perception grew, and by September 25, 1991 the exchange rate had depreciated to J$13.97.

This was a huge fall from the $5.50 value in February 1989, when the PNP took control of the Government. Put another way, the exchange rate fell from J$1 being equal to US$0.18 to US$0.07 in that period of two and half years. It was at this point that panic took charge and a cataclysmic error occurred.

With the sharp adverse movement of the rate of exchange, it was clear that the economy was heading for serious trouble. Manley was under severe pressure from the business community and general public to act.

Depreciation of the rate of exchange resulted in higher prices for goods and prohibitively higher interest rates.

Manley was persuaded that the time was ripe to take the decision to repeal the remaining powers of the Exchange Control Act, which controlled the movement of foreign exchange. This would allow foreign exchange to move freely in and out of the country. He was told that with the removal of the psychological barrier restraining the movement of foreign exchange, scarce foreign currency would, in fact, flow into the country, since it would be free to leave any time at the discretion of the holder. In short, there would be no shortage of foreign exchange, according to top businessmen who urged him to take this critical step. While some genuinely believed that the move would be beneficial, others were acting in their own self-interest, irrespective of the impact on the economy.

The scenario mapped out to Michael Manley was possible in due course, generally speaking, but it would not hold during a start-up period, particularly when there was a severe shortage of foreign-exchange reserves. The more realistic expectation was that as soon as foreign-exchange movement in and out of the country was allowed, there would be immediate capital flight. In such circumstances, the Bank of Jamaica (BOJ) would require adequate reserves to restore the flight of capital. This expected reaction was ignored by the authorities, both government policymakers and the BOJ officials.

satisfy demand

The BOJ, at the time, had no net international reserves. The reserve balance was -US$372 million. There would be no foreign exchange to satisfy demand in the event of any capital flight. The BOJ, most of all, should have exerted more against free movement of the dollar to protect its own vulnerability.

In September 1991, I received information that a high-level delegation of business leaders from the leadership of the Private Sector Organisation of Jamaica (PSOJ) was going to Jamaica House to present their case to Prime Minister Manley. At that time, the House of Representatives was in session. I looked directly into the television camera filming the proceedings of Parliament for live broadcast. I spoke 'directly' to Manley, who was likely to be watching. I strongly urged him not to be misled by the appeal and spelt out what would be the consequences of removal of the regulations prematurely without backup by the BOJ.

But Manley ignored the danger of a flood of foreign exchange fleeing the system in the event of a premature decision. He was advised that this would not happen. He was prepared to court disaster by further aggravating the impact of a sharply deteriorating exchange rate.

portentous announcement

On September 25, 1991 it was P.J. Patterson, minister of finance, development and planning, who made the portentous announcement by introducing in the House of Representatives the Exchange Control (Removal of Restrictions) Order, 1991. He explained that only those sections of the Exchange Control Act which restricted the movement of foreign exchange were then being repealed. Some other sections had been removed earlier to gradually liberalise the system.

The remainder of the Exchange Control Act would be suspended. (This, no doubt, would also enable prompt restoration of the restrictions, if required). He explained that the order would now make the system 'free and open to real competition of market forces by allowing persons who earn or receive foreign currency to retain it here and overseas; permit all dealings in securities; and allow for imports and other obligations. There will be no attempt by Government to determine its own rate.' (Daily Gleaner, September 26, 1991). The Chamber of Commerce hailed the new system and the banks urged that foreign exchange be deposited with them (to reduce the impact of the black market).

As projected, the ensuing period produced an awesome shock. Between 1991 and 1995, inflation was crippling, averaging more than 40 per cent annually; interest rates averaged even more - 42.58 per cent, a prohibitive level. Economic growth plunged from a robust 5.5 per cent in 1990 to marginal levels, averaging less than one per cent up to 1995. Job creation almost fizzled out. Without doubt, this was historically one of the most negative periods in the Jamaican economy.


>>> See more next week.

Edward Seaga is a former prime minister. He is now chancellor of the University of Technology and a distinguished fellow at the University of the West Indies. Email feedback to columns@gleanerjm.com [2] and odf@uwimona.com [3].