Our economic ailments started long before the recession. A booming economy, like rum swizzle, is a fine way to avoid one’s troubles. The ailment I would like to focus on is Dutch disease: the emergence of a high growth sector (international business) that aids and abets the decline of a traditional sector (tourism). More importantly, I want to show how the pathology that caused the decline of the traditional sector is now undermining the competitiveness of the emerging sector.Dutch disease’s pathology starts with a dramatic increase in foreign currency earnings in an emerging sector. Since 1992, which is about the time IB came to play a dominant role, net foreign currency earnings have grown from $11 million to $1,200 million in 2008 or 10,000 percent. These additional dollars became part of a slew of domestic savings chasing a relatively limited supply of real estate. A property price bubble ensued.In the language of Dutch disease, construction, energy, information technology, and residential and commercial real estate are a part of the third sector, a non-tradable or domestic sector that is not an export. The pathology of the IB boom increased the demand for labour in the non-traded sector by drawing on the supply of hospitality workers. Unit labour costs, the cost to produce one dollar’s worth of output, in construction increased from $0.51 in 1996 to $0.81 in 2006, or 59 percent, according to a labour productivity study conducted by the Department of Statistics.The boom also shifted Bermuda’s labour force toward the higher paying IB sector. Both effects were inflationary. Residential and commercial rents, as well as wages and salaries rose unsustainably.The pathology of Dutch disease appreciates the real exchange rate. Unlike the nominal exchange rate, which is fixed at par, the real exchange rate appreciates because the Bermuda dollar price of wages, salaries, profits, fees and rents, rises faster than those of our competitors. More technically, the real exchange rate compares implicit price indices or gross domestic product (GDP) deflators of different countries in the same way that nominal exchange rates compare the prices of currencies.The problem is that the folks who buy our services tourists and international business people think globally. They have options; they are under no obligation to buy Bermudian.Bermuda residents, on the other hand, who work to produce those services, think in terms of the rent they pay and the food and energy they must buy. This disconnect between buyer and producer has grown over the last 20 years. Not a good thing for a place heavily dependent on the rest of the world to buy its services.Whilst the world’s leading economies are in a currency war to keep their exchange rates weak, Bermudians are happy to maintain an overvalued currency. Since the recession began, US policymakers have engaged in two rounds of quantitative easing (QE), a rapid and significant increase in the amount of US money in circulation, which has devalued the dollar relative to other currencies. Strictly speaking, it is the Federal Reserve’s balance sheet that has ballooned from approximately $870 billion in 2007 to over $2,800 billion presently.If successful, the depreciation will boost foreign demand for US goods, particularly manufactured goods, and services, such as insurance, health and consulting services, and tourism. The Chinese have kept the yuan cheap so that Chinese goods and services are cheaper for Americans and Europeans. Brazil, Mexico, Japan, Russia, South Africa and South Korea all fear an appreciation of their currencies. So it is odd that Bermudians don’t share this concern.What’s more, the market for offshore financial centres is more competitive today than it was in the nineties and noughties. The increased competition has created a price-taking environment for IB: either deliver the product in a certain price range or suffer the consequences. Our economy will continue to struggle until it is able to adapt to this new reality.Enter the recession. Salaries in the private sector along with rents have declined by double-digits since 2008. If the public sector follows suit, then the seeds for recovery will be planted. Once wages and salaries and business costs in general decline, the green shoots of recovery will come as new jobs and opportunities for budding entrepreneurs. In a best-case scenario, recovery would begin in 2013.On the downside are: rising food and energy prices; rising foreclosures, which will add to an already bloated supply of residential real estate; and $5 billion in private debt, $1.5 billion of which is in US dollars. For the next three years at least, indebted households’ spending will be diverted to paying off debt instead of helping to reverse a three-year decline in retail sales.According the United Nations Food and Agricultural Organisation’s food price index, food prices are today higher than at the previous peak in 2008. The global recession brought prices tumbling down, but as the recovery continues, expect food and energy prices to surge to dizzying heights. The Economist’s latest Food Price Index is up 50 percent over a year ago. This risks thwarting the recovery.Rising food and energy prices may bring populist calls for higher wages and salaries to cope with a rising cost of living, but this would be a mistake. It would prevent the necessary downward adjustment in the real exchange rate that will in turn make locally produced goods and services more affordable to both foreigners and Bermuda residents. The adjustment will not be easy.Bermuda’s deep integration into the global economy highlights the tension between parochial economic interests, on the one hand, the need to remain a competitive international business centre and tourist destination, on the other, and the needs of our democratic and national interests on the other. We don’t really have a choice of the interest rate applied to deposits and loans. That decision is the province of the Federal Reserve Bank in the US. Holders of government debt, who are foreign, have a say in how much our democratically elected government spends or taxes. Recall the Finance Minister’s reason for increasing payroll tax in 2010 was to placate ratings agencies.From a macroeconomic perspective, the way forward is clear. Find ways to lower business costs and raise productivity, as well as restructure the mountain of private debt in the domestic sector or risk the unthinkable, a depreciation of the Bermuda dollar.Craig Simmons is a senior lecturer in Economics at Bermuda College