It is ironic that the rupee which was created by a real occupation army - the British – was actually pretty benign under colonial rule.

The rupee took on the characteristics of an occupation currency only at the hands of our own vicious post-independence rulers who used it to grow the government like a cancer, making the state the biggest, most profitable and corrupt 'business' in the past 50 years.

This was done with the help of the Central Bank which was created in 1951 by then finance minister J R Jayewardene. Countless deficit budgets financed with printed money followed.

Numerous writers have already exposed the 2008 budget and showed it for the numbers game that it is. So much so that fuss-budget has little to add to it. However it looks like a less deadly budget than the 2007 one.

The last budget has turned out to be viciously anti-poor and a massive shock to the economy as 45 billion rupees was printed in just five months to cover its shortcomings.

It is well on the way to create another inflation record as well as darkening the future of our children with foreign commercial borrowings after creating a balance of payments crisis halfway through the year.

Of course it may be futile to blame the budget per se. The core problem is the current economic framework mostly authored and engineered according to the ideals propagated by the Janatha Vimukthi Peramuna and the rapid militarization of society.

This brings us to the subject of occupation currency.

Military Currency

Under generally accepted international occupation law, a conquering army can automatically confiscate assets of the state and levy taxes that the original government used to charge the population and run the administration.

Occupiers are not expected to confiscate or steal private property. However they can do the next best thing. They can issue their own currency.

By issuing a worthless paper 'military' or 'occupation' currency, an occupying army can 'purchase' goods and services from the occupying country and effectively finance the occupation.

Soldiers and defence contractors who are paid in occupation paper currency can buy the shops out and deprive the local population of goods. The new government can also 'buy' land, buildings and other assets or services by printing the new military currency.

The results are predictable.

Pretty soon the value of the occupation currency falls rapidly resulting in high prices, which is then followed by rationing or price controls and exchange controls. Automatically shortages and black markets also spring up.

This phenomenon was widely seen during the Second World War as Germany and Japan started to occupy Europe and Asia.

It was repeated all over Asia, in Malaya, Burma, Indonesia and the Philippines. In German occupied areas in Europe the situation was only slightly better.

Banana Republic

Japan issued a wide variety of occupational currencies under the Yokohama Specie Bank, Bank of Taiwan (for Pacific islands) and the Bank of Japan.

Of course the British also printed their own currency (hence the suspension of gold convertibility of the Sterling, exchange controls and rationing) but it was much more restrained.

One of the most famous military currencies is the 'Banana money' of Singapore. This was so called because there was a picture of a banana tree. Under Japanese occupation the price of rice increased about a 1,000 times in Singapore. Ration cards were issued.

In the black market, the old British colonial Straits dollars continued to be exchanged.

Then the population was told to grow its own food in home gardens as food became scarce. Manioc and sweet potatoes became staples (Ring any bells?). In reality food was being appropriated by the occupiers.

After the war the Japanese government refused to honour these currencies making people who have already been scammed through these high inflation currencies, completely destitute.

In Singapore the only people who escaped poverty were those who had managed to hide the old Straits currency. The British of course honored the currency as soon as they came back.

The 'banana money' must have influenced people like Dr Goh Keng Swee, who was Lee Kwan Yew's first finance minister, to maintain what he called the 'colonial relic' of a currency board (Read "Why a Currency Board") and shun the creation of a central bank after independence.

Military Rupee

Now you can see the parallels. Sri Lanka was set on a path of destruction from 1951 after J R Jayawardene created the Central Bank of Ceylon with money printing powers, after abolishing the colonial era currency board.

The rupee started to take on the first characteristics of an occupation currency during Dudley Senanayake's rule when central bank re-finance was given for agriculture and inflation and balance of payments problems raised their ugly heads.

But the real military currency aspects were seen only during the United Front government of Mrs. Sirimavo Bandaranaike. Pretty soon just like in Singapore we were growing manioc and sweet potatoes.

It is not that food production suddenly went down, causing prices to go up.

In reality government workers, and nationalized companies which were earlier making profits and were paying taxes, but which were now topped up with printed money from the Treasury were appropriating the goods and services of the country.

As a result the paper money was rapidly losing value. Classic inflation, in other words.

That is why the government's 'Api Wawamu' campaign is enough to send cold shivers down our spines. It is just like the Japanese occupation government telling Singaporeans to grow their own manioc and sweet potatoes in the 1940's.

The demonetization of the 50 and 100 rupee note in 1970 was another scam perpetrated on the people, in the name of bringing back 'black money'. This reportedly led some people to suicide. The same thing happened to people who held Military Payment Certificates in Vietnam.

The money for which the government had received valuable consideration from its helpless citizenry was made completely worthless.

Occupying Force

The force that is occupying Sri Lanka is not just the bloated 100 plus ministers. They are certainly the top generals.

But it also includes all the other million minions that live off the blood and sweat of the workers.

This includes the opposition and particularly the JVP which is the main force that is advocating the growth of big government and public sector recruitment. These are all our rulers, whether in government or in opposition.

These are people who can appoint another bunch of henchmen to their personal staff and get pensions for life after working for just five years, courtesy of JR Jayewardene again.

Then of course there are the government officials themselves. Under the British, permanent secretaries were real 'public servants' who paid taxes.

But after independence, and particularly after the changes brought by JR, 'permanent' secretaries became 'impermanent'. They also became political lackeys to ensure their survival. By extension these people became politicians, or worse.

The public sector unions are another set of rulers. These people earn tax-free salaries and tax-free pensions, give bad customer service to the real tax payers, demand salary increases every so often and resist all attempts to trim the government.

Over the last three years 100,000 free jobs have been given to unemployable graduates who have received a tertiary education at state expense.

This is in stark contrast to the girls and boys slaving away in productive jobs in our tea estates and garment factories to earn a real living and produce real goods and services to keep this country going.

A look at the growth of state salaries and the contrast to private sector workers amply demonstrates the way our rulers have been skimming away the blood of the non-state sector citizens.

The corporation workers are less harmful than central government workers because most of them actually produce something. But they also do not even pay their PAYE taxes. The corporation pays it for them.

And when their corporation makes losses and get Treasury subsidies they also contribute to inflation and poverty.

Of course some government workers work hard but are not properly rewarded.

Government for Rulers

Sri Lanka is then a government of the rulers, for the rulers and by the rulers. There is a clever campaign to oppose 'privatization' and preserve loss making firms in public hands, essentially in the hands of our rulers and their henchmen.

To top it all, the government unions and the politicians are engaging in a vicious campaign to demonize what they disparagingly label the 'private sector'. In reality these are the people who work. Instead they promote the growth of government and state enterprises.

They also get tax-free cars and housing interest subsidies after running into tens of thousands of rupees a month.

The designers of the 2008 budget raised car taxes again after giving themselves tax-cut cars. The injustices and the privileges taken by our non-tax paying rulers who call themselves 'public servants' are too numerous to mention.

Then of course there is the final unkind cut. The very provident funds of private sector workers who toil night and day, are now plundered by the state with the help of the Central Bank.

Central Bank employees themselves are getting inflation protected pensions topped up at the expense of the rest of the population while the EPF is taxed to the hilt out of its already meager income.

This then is the stark reality facing the man on the street outside the government. It is these heartless rulers who are dumping 20 percent inflation upon the poor in the name of home grown economics.

The axis of evil

How is this vicious system of government preserved?

The first is through taxes. Nobody questions the 'divine' right the rulers have to tax the rest of the people.

How did politicians who have never paid a cent in taxes, but eat subsidized meals in the parliamentary cafeteria ever get the right to criticize an amnesty given to tax payers who at least once in their lives had paid income taxes to the government?

Taxes can only be justified if the citizens get some services of equal value in return.

The other used to prop up the ever-growing state is the paper money system that generates high inflation.

The system is perpetuated through an axis of evil made up of the Treasury, a Central Bank that is subject to fiscal dominance and the banks, especially state-owned ones.

The Treasury forces the central bank to print money, or give up its reserves whenever it feels like it.

The government also borrows from state commercial banks. They in turn borrow from the Central Bank through the discount window. Like the central bank, the state banks are also run for the benefit of their workers, not ordinary people.

Already half the assets of one state bank are lent to the government. State banks have been bailed out three times at the cost of more than 50 billion rupees. A not inconsiderable part of the money has gone to top up the over-generous inflation protected pension funds of their workers.

It is no wonder then that the JVP and other politicians vigorously oppose any attempt to privatize state commercial banks. A vital cog in the wheel will be gone.

Incestuous Relationship

There is a close and incestuous relationship between a central bank and commercial banks, whether private or state-owned.

The Bank of England was created in 1694 by royal charter as a private firm to give a loan of 1.2 million pounds to King William III.

This is the same as the Central Bank of Sri Lanka giving 45.2 billion rupees from May to September 2007 to the government through Treasury Bills and driving inflation to 20 percent.

Though note issue later became a monopoly with Bank of England and it was nationalized in 1946, through the discount window every other bank could also have access to the power of printed money.

As a result every other commercial bank is also an extension of the money printing central bank. This is why it is important to restrict access to the discount window.

The US Federal Reserve has an even more peculiar history and an even more incestuous relationship with private banks - if that is possible. Due to early bad experiences with paper money, the US constitution expressly forbade paper money requiring it to be 'coined'.

However this concept was later diluted as the political power available through paper money overtook good sense, despite many a legal battle being fought. (The Liberty Dollar company which was raided by FBI last week is threatening to take this up again).

Central Banking absurdity

There was strong opposition to central banking in the US and President Andrew Jackson even refused to renew the charter of the Bank of England look-alike: the Second Bank of the United States.

However a banking crisis in 1907 which was averted because JP Morgan organized a lender of last resort facility persuaded a reluctant American public to entertain the idea of a central bank again because they disliked the idea of being dependent on the bankers even more than the control of government.

So great was the opposition that the new entity was not even called a central bank but was named the Federal Reserve.

Unlike the Bank of England which was eventually nationalized in 1946, the Fed is owned through a complex set of regional banks, which are eventually controlled by the big American banks like JP Morgan.

The Federal Reserve bill was hatched in secret by the Morgans, the Rockefellers and the Warburgs. This was not found out until 1916, three years after the Fed bill was passed amidst great difficulty.

It was no accident that on August 17, 2007 the Fed cut the direct discount window rate by half a percent, weeks ahead of the general rate cut for the rest of economy.

True, the big banks were running the payment system of the country and deserved some consideration but it shows the clout the big banks like JP Morgan have on the Fed and also the US government to prevent their profits from being hurt.

(If Ranil Wickremesinghe defaults on the sovereign bond in which JP Morgan was involved this columnist shudders to think of the consequences.)

It was Representative Charles Lindberg who said of the proposed Fed: "The worst legislative crime of the ages is perpetrated by this banking bill" and "This is the strangest, most dangerous advantage ever placed in the hands of a special privileged class by any Government that ever existed."

In 1810 when gold convertibility was temporarily suspended and the Bank of England was losing gold reserves and the ills of paper money were becoming evident, William Cobbet, a radical journalist who later became an MP wrote something similar in a series called Gold Against Paper.

This was around the same time David Ricardo's High Price of Bullion report for parliament (Read "The Thrift Column – Fiat Politics" ) came out.

Cobbett wrote this about the concept of money printing or central bank credit (a central bank buying Treasury bills for example);

"There is something so consummately ridiculous in the idea of a nation's getting money by paying interest to itself upon its own stock, that the mind of every rational man naturally rejects it. It is, really, something little short of madness to suppose, that a nation can increase its wealth; increase its means of paying others; that it can do this by paying interest to itself. When time is taken to reflect, no rational man will attempt to maintain a proposition so shockingly absurd"

History Repeats

This statement remains true even today. That is why borrowing 45.2 billion rupees from the central bank by selling Treasury Bills to keep the current economic framwork ticking is so absurd.

That is also why the Fed and the US economy are now in a pickle. The similarities with 1907 are shocking.

It is also why the Central Bank's move to restrict access to the discount window from next month should be applauded. But printed money is still available at 19 percent. So the axis of evil is still there.

From 1974 Sri Lanka had two 'bank rates' just like the two reverse repo rates we will have from December. But this did not help stop the rot. By 1976 93 percent of Treasury bills in issue were held by the Central Bank.

We seem to have learnt little since then. Just before the sovereign bond came the Central Bank held more than 80 billion rupees worth Treasury bills.

The axis can be broken in several ways. The best is to change the economic framework by improving the general understanding of economics among politicians. But this has not happened for 50 years and it may take as long to do so.

One option is to privatize the state banks. This has been tried and so far failed.

Yet another is to abolish the Central Bank in favour of a currency board. A currency board does not even have a discount window let alone money printing powers. It can only issue notes against foreign reserves. Currency boards are now suddenly in favour.

In addition to countries like Brunei and Hong Kong which have had them for decades (Singapore's currency board now has some central bank characteristics), Estonia, Lithuania, Bulgaria, and Bosnia-Herzegovina now have currency boards.

Belarus is set to have one from next year. The Soviet republics have suffered terribly from Ruble inflation.

Some countries like Ecuador have also opted for dollarization recently.

The other option, as many are now arguing, is to break the link between the Treasury and the Central Bank by making the Central Bank truly independent and introducing an inflation targeting law.

We need to change the system if we do not want to impoverish our people or as Cobbet said, 'pauperise" the rural poor:

"In all countries, where a Paper-Money, that is to say, a paper which could not, at any moment, be converted into Gold and Silver, has ever existed; … the consequence, first or last, has always been great and general misery."

Comments and brickbats to fuss-budget@vanguardlk.com. You may also use the comments tab .

Interested readers may download a copy of Cobbet's Paper against Gold from this locatio: http://www.archive.org/details/paperagainstgold15cobbrich

Cobbet was a colourful character and is the originator of parliamentary Hansards

Some other points. The United States Military Purchase Certificates were used for completely different purpose from the Japanese. When the US occupied a land, people preferred to use US dollars, resulting in a loss of confidence in the national currency and a fall in its value. In other words inflation.

To prevent it, soldiers were paid in MPCs which were to be used only in military shops and local citizens were prohibited from using them. However local citizens started to use them anyway. Periodic demonetization and exchange for new paper was devised as a means to discourage the practice.

But holders of the paper then lost its entire value.

The Allied occupation currency in Germany however created a problem because the Russians printed large amounts to pay their soldiers after taking the plates from the US. Unlike the US the Russian scrip were not made exchangeable for roubles. A later inquiry showed that the US had redeemed more notes than it originally issued.

British created a currency in North Russia in 1918 which came to be known as the British Ruble based on a sterling-backed currency board. At the time the Bolsheviks were printing money and so were their opponents, leading to rampant inflation.

Research by Steve Hanke and Kurt Schuler has shown that none other than John Maynard Keynes was behind the currency board scheme. A far cry indeed from his last work on deficit spending which ultimately made him famous but impoverished countless millions.

A soft copy of this work can be downloaded from www.cato.org/pubs/journal/cj10n3/cj10n3-3.pdf

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