Friday, August 24, 2007

Currency devaluation, social policy - Reflections from vacations

I just got back from a three week vacation in Costa Rica, where one US dollar gets you about 520 Costa Rican colones.

I know little of Costa Rica's economy, except that their main export is from agriculture and their main "industry" is tourism. Currently there is negotiations for a free-trade deal with the United States and every where you go graffiti shows opposition to a free-trade deal with the US. Their taxes are low with universal health care and education being the two most important items taking up the majority of the taxes.

I went to Costa Rica to explore the idea of learning Spanish, so I went for a two week introductory course and I stayed with a home stay family. The family consisted of grandparents and young adult grandchildren. What was strikingly different from Canada is this family with "retirement" age adults did not have entitlement attitudes towards pension, but continued working. They were a hard working family.

I would have to say our Canadian attitude towards entitlement and social programs leaves a foul taste in my mouth. First, not a senior currently collecting a pension paid for it. I so clearly remember my amazement as a very young adult with a job in the bank and seeing this pittance of a tax for pension and then also seeing how much seniors were getting in pension and I brought it up with my employer about how little the pension tax was compared to the pension payout and I was told that over the long term the money put in would pay for the pension and I was shown a bit of compounding, which still made no sense to me, but I simply assumed those older and wiser understood these things better.

I now know that our pension system was set up based on a pyramid scheme that would be illegal under today's law. The relative amount -- meaning correcting for wage increases -- we pay for pension today is much, much, much higher than what was paid in my youth, but it is still utterly unsustainable in terms of the pension entitlement expectations, and political leaders saying anything otherwise are either ignorant or lying. One day I will post more on the topic as I believe that I live in one of the greatest countries, but the unraveling of this pyramid scheme has the potential to destroy us, and could ultimately pit youth against age when age is defenseless. Certainly our currency and savings are at extreme risk from unsustainable debt and entitlement expectations and we are at risk of seeing it unravel as Mexico, Costa Rica and Zimbabwe have all experienced, unless we change our attitude and work together to make something sustainable and fair.

But, the Costa Rican people do not burden their children with their entitlement expectations, but instead continue to take responsibility for their economic future.

I wondered about the huge numbers for the currency in Costa Rica and I remembered traveling in Mexico in the 90s after their currency was grossly devalued and they were in the process of switching from old pesos to new pesos at a rate of 1000 old pesos is one new peso. They had periods of inflation of 30-40% per year, perhaps more. My Mexican friend in university in the 80s had talked about Mexican inflation and how her family had worked to move their money to more stable currencies as they saw the buying power of their savings rapidly decline. My last vacation in Mexico in the 1990s a Canadian dollar traded for about 3 Mexican pesos. Today it trades for 10.5 Mexican pesos so Mexico has continued to have a rate of inflation that grossly destroys the buying power of savings.

The young man at the school I attended talked about how over the previous few years if you had a US account you saw the number of colones increase pretty much daily as their currency deflated relative to the US currency. It made me wonder what had happened with government management of Costa Rica's economic resources. The young man in my homestay was highly interested and informed on political issues and he talked about the many social programs Costa Rica had at one time and their glory years of spending beyond their means and increased wealth. He mentioned the huge consequences to Costa Rica when one of their Presidents failed to yield to demands to cut social spending when their debt load to other nations was high. I do not know Costa Rica's full story, but it appears they faced a hyper-inflation due to high debt, an inflation that is not yet under control. I saw price increases of up to 25% at retail establishments in the mere 3 weeks that I was there.

There is something in place to control the currency exchange rate for the past year or so. The young man at the school said that you could no longer see your colones increase dramatically by holding a US account. What is this control? Currently in Zimbabwe there is an "official" exchange rate mandated by law. They have hyperinflation running at 4500%. At black market rates the exchange rate for 44,000 Zimbabwean dollars, the price of a loaf of bread, is about 18 cents. At the official rate mandated by law that loaf of bread costs $176.

Costa Rica is an inexpensive country for travel, but the tourist areas have become grossly expensive for the local people. The average price of meal in the tourist areas that I visited seemed about twice the price that I paid in San Jose in close proximity to the school, and other students said they visited tourist areas on the Pacific side where the price was double again to what we were paying in the Caribbean coast. A policeman`s monthly wage in Costa Rica is about $350 per month and with the prices I saw, inexpensive by Canadian standards, I can not imagine how they make ends meet. It seemed to me that the prices were anywhere from 20 to 75% less. Bottled water was about $1 as was pop. A lunch you`d spend $6-12 here was $2.50-5 in town, but as much as $7 in the Caribbean coast.

I discovered it is wise to always ask the price first because if you say what you want and then it is packaged, they will take you to the cleaners in terms of what they expect you to pay. I paid $2.65 for a coffee in a very small cup with two refills, whereas when I cautiously shopped for my coffee the next day I paid 70c for a coffee that was twice the size of the cup of the previous day.

In another example, the going price for the locals for a bag of cut mango fruit, the fruit of two very small mangoes or one large mango was 40c. I paid 60c, but my last day at the beach this other vendor, after I had confirmed the 60c price in the morning, had halved the amount in the bag and made it look the same by loading the bag with pits, which I only discovered after I returned to my friends, who had given me 60c for a bag each. He tried to charge $1.20 in the afternoon and I settled at 70c. I did not ask the price again before I just asked for it. So even asking the price earlier you still have to confirm the price again before you order. I found in many places Costa Ricans do not think twice about changing prices and the terms of what you think you`ve agreed to simply because they figure you can pay more.

Anyway, Costa Rica is a great country to visit right now, and depending on where -- ie Atlantic versus Pacific coast -- it is inexpensive by Canadian/American standards. The tours arranged for tourists are perhaps a little less expensive than a tour in Las Vegas or Disney World, but overall they are not cheap. They wanted $50-60 for a 3-4 hour jungle tour, and $70-80 for a river rafting tour, whereas you can find a room with a private bathroom for two people for as little as $35 per night close to the waterfront. Shop around and your meals will be less than $10 per day, but even going for the finest dining you would be hard pressed to exceed $25 per day.

I do wonder about how the currency is being set and about the rate of inflation as to whether Costa Rica will remain highly attractive for tourism.

1 comment :

Jay Walker said...

Hi Deb,

Interesting post - I was unaware that Costa Rica was/is having serious inflationary difficulties.

In terms of the Canadian pension situation - that has changed considerably from its inception as a "pay as you go" system (the pyramid system you refer to).

Canada made major reforms to its pension system and it's widely acknowledged that, of all the major industrialized countries, Canada's is on one of the firmest footings (Australia, I believe, being another). It is no longer a pay as you go system, since the reforms of the middle-late 1990's.

An excerpt from a UN report ...

"Under the reforms, the contribution rate to the Canada Pension Plan, which stood at 5.85 per cent in 1997, rose in yearly stages to 9.9 per cent in 2003. This level, according to an actuarial valuation from the Chief Actuary (Office of the Chief Actuary 1997), is the steady-state rate—the lowest rate at which revenues from contributions, along with the investment earnings from the reserve fund, will maintain the plan for the indefinite future without further increases."

The paper further goes on ...

"Nearly 10 years have passed since the 1997 reforms of the Canada Pension Plan were enacted. While pension plan financing requires a long horizon and 10 years is a relatively short period, it is nonetheless encouraging that the evidence to date indicates that the reforms have contributed substantially to the plan’s financial sustainability.

The actuarial valuation of the plan, tabled in Parliament in December 2004, showed that the contribution rate of 9.9 per cent was slightly higher than the latest estimate of the steady-state rate, which was 9.8 per cent (Office of the Chief Actuary 2004). A difference of one-tenth of 1 per cent may appear small, but, for a public programme covering all of the Canadian labour force outside Quebec, the amounts involved are substantial, and the cushion it provides for responding to unforeseen future economic or demographic developments is important.

The actuarial valuation projects that contributions will exceed costs until 2022, when a small part of the plan’s investment earnings will be needed for expenditures. The portion of investment earnings directed to expenditures will increase in subsequent years. However, in each year in the period covered by the valuation (2004 to 2075), only a part of the investment earnings will be required for expenditures, with the remainder of the earnings being added to the reserve fund. Thus, the reserve fund will grow year over year. Total assets of the plan, which stood at CAD 77.8 billion in 2005, are projected to grow to CAD 455 billion by 2025 and CAD 4,872 billion by 2075."

The report can be found here:$FILE/Battle-Tamagno.pdf

Jay Walker
The Confused Capitalist