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The Cuban peso recovers ground against the dollar, what is happening?

Last October 2 the dollar reached the level of 200 Cuban pesos (CUP), stabilizing there for a few days to recently begin to lose value. This October 15, it was quoted at 195 pesos, according to the daily report of the independent publication The touch.

The big question is if the peso finally bottomed out, after last September alone it depreciated 30% against the US currency, in what is probably the largest market devaluation in its history.

Among the causes of such a collapse is what can be generically included as little confidence of Cubans in the macroeconomic management of the Castro government: Shrinking GDP —whatever the finance minister says—, imperceptible tourism, runaway inflation (mainly in food), runaway fiscal deficit, dizzying growth of M1 (money in circulation plus demand deposits), and scarcity reaching even stores in Freely Convertible Currency (MLC). Everything pushes the dollar to be used more and more as real money.

Also, of course, Speculation played a fundamental role in this historic devaluation. based on the expectation that the CUP would continue to depreciate —due to the imbalances described above—. You had to get rid of as many as possible before they were worth less.

But by speculation we must not understand the attempt to extract revenue from the currency value fluctuation, something that, carried out en masse, becomes a self-fulfilling prophecy and “artificially” generates the price increase that was predicted. Here, speculation must be understood as foresight, as self-protection after inflationary effects of the announcement on television by the Minister of the Economy, Alejandro Gil, last August, warning that the Government would extract foreign currency from the foreign exchange market… many dollars had to be bought before Mr. Gil opened his mouth again.

These being the root causes of that the peso is worth a fraction of what it was worth before the monetary systembecause the dollar reached 200 and stopped? Have those causes changed?

With an interesting methodology, The touch measures, in addition to the value, demand for american currencyfinding that in recent days that demand fell, as is logical, correlating with the braking that the dollar gave when it reached 200. But measuring the drop in demand is measuring the symptom, it does not explain the cause of such withdrawal in the purchase of dollars.

In an exhaustive article, Dr. Pavel Vidal makes a very accurate analysis of the fundamental aspects of the exchange rate in Cubaand concludes by stating: “We must prepare, then, to more sudden changes in the informal foreign exchange market (…), above or below 200″. That is to say, with scientific prudence, he declares that he does not know what will happen to the exchange rate.

However, that analysis did not sufficiently take into account an important psychological bias: the “left digit” effect, which once added does allow forecast the evolution of the dollar.

This well-known bias describes how the first digit disproportionately affects our perception of prices, and is the reason, for example, why some businesses label with the annoying .99, since demand increases a lot when a merchandise instead of 30, it costs 29.99… that’s how irrational we are.

Concrete evidence of the incidence of this bias in the exchange market we found it in the exchange rate history. We see that the dollar took a little over a month to go from 65 to 100 pesos, and then remained stagnant for a month and a half in that figure without real economic reasons for it. The 100 exerted the “left digit” effect.

At that time, some forecasted that the equilibrium exchange rate would be close to 80; while, DIARIO DE CUBA predicted that in a year the dollar would exceed 200 pesoswhich turned out to be a conservative forecast, although correct.

As the dollar approached 200 pesos, many Cubans again felt that it was very expensive, and at the same time foresaw that others would believe the same thing in a crude application of “theory of mind” – as I think, I know you think —, so they considered that it was better to wait and see what would happen. This psychological effect is what best explains the circumstantial inhibition of demand and its effect on the fall in the value of the dollaras the real macroeconomic fundamentals underpinning supply and demand are still as disastrous as they were a month ago.

The desire to emigrate only increases; the Government continues to extract foreign currency from the foreign exchange market; Desperate MSMEs look for dollars to import; the mules are gaining in organization; and the minimal existing supply of goods is available only in MLC or dollars, so presumably as it happened when it reached 100 pesos, there will now be a stagnation around 200 pesos because of the psychological impact of the figure. But in some time, when reality sets in, we will witness another accelerated devaluation of the Cuban peso.

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