All posts by Lars Christensen
Posted by Lars Christensen on March 10, 2014
I have long been a proponent of what I have called the Export Price Norm (EPN). The idea with EPN is that commodity exporting countries can ensure stable nominal spending growth by pegging their currency to either the price of the country’s main export good or to a basket of the export product and a foreign currency.
The case of Russia is illustrative. Hence, one could imagine that the Russian central bank (CBR) implemented a variation of EPN by including oil prices in the basket of euros and dollars, which the CBR has been “shadowing” in recent years. I believe that this in general would lead to a stabilisation of nominal GDP growth in Russia.
The graph below, I believe, illustrates this well.
We see that over the past 10 years there has been a very high and stable correlation between Russian NGDP growth and (the growth of) the price of oil measured in roubles. As the oil price in roubles seems to lead NGDP growth by 1-2 quarters it is clear that the CBR would have been able to stabilize NGDP growth by managing the rouble in such a way to ‘offset’ positive and negative shocks to the oil price. That of course would have happened “automatically” if the CBR had included the oil price in it’s EUR-USD basket – or alternatively allowed the rouble to float freely and communicated that it would allow the rouble to appreciate or depreciate to offset shocks to the oil price to ensure stable nominal spending growth in the Russian economy.
Nothing surprising about the slowdown in Russian growth
In the last couple of the years the Russian economy has slowed considerably. This I believe is due to the fact that the CBR effectively has been tightening the monetary conditions by keeping the rouble too strong relative to the development in oil prices.
Since early 2011 the oil price (in US dollars) has been declining moderately. This effectively has meant that the currency inflow into Russia has been slowing and not surprisingly this has put downward pressure on the rouble. This should be welcomed news, but the CBR has nonetheless kept monetary conditions too tight by not allowing a large enough depreciation of the rouble to fully offset the oil price shock.
As a result nominal GDP growth has slowed quite significantly and as prices and wages are sticky in Russia (as everywhere else) this has also led to a slowdown in Russian real GDP growth.
Why the EPN ‘prediction’ might be wrong this time around
However, things have been changing over the past year. So while the oil price has continued to “stagnate” the rouble has weakened significantly over the past year – as has been the case for most other Emerging Markets currencies in the world.
Hence, as the drop in the value of the rouble has been significantly larger than the change in the oil price (in USD) the oil price measured in roubles has increased somewhat.
As the graph above shows this de facto monetary easing has already started lifting NGDP growth and given the historical relationship between the oil price measured in rouble and NGDP growth then one should expect NGDP growth to pick up from well-below 10% to 13-14% y/y.
However, this “prediction” strictly based on the Export Price Norm is likely to be far too optimistic. The reason is that the Export Price Norm only ensures nominal stability if all shocks come from the export price – in the case of Russia from oil price shocks.
Historically it has been a reasonable assumption that nearly all shocks to Russian aggregate demand are shocks to the oil price (remember in the case of Russia an oil price shock is a demand shock and not a supply shock). This is why we have such a good fit in the graph above.
But over the past year the Russian economy has been hit by another external shock and a lot of the outflows from Russia has been driven by other factors than oil prices. Hence, the general negative Emerging Markets sentiment over the past year has undoubtedly own its own contributed to the currency outflow.
Furthermore, and more importantly the sharply increased geo-political tensions in relationship to Putin’s military intervention on the peninsula of Crimea has clearly shocked foreign investors who are now dumping Russian assets on large scale. Just Monday this week the Russian stock market fell in excess of 10% and some of the major bank stocks lost 20% of their value on a single day.
In response to this massive outflow the Russian central bank – foolishly in my view – hiked its key policy rate by 150bp and intervened heavily in the currency market to prop up the rouble on Monday. Some commentators have suggested that the CBR might have spent more than USD 10bn of the foreign currency reserve just on Monday. Thereby inflicting greater harm to the Russian economy than any of the planned sanctions by EU and the US against Russia.
By definition a drop in foreign currency reserve translates directly into a contraction in the money base combined with the CBR’s rate hike we this week has seen a very significant tightening of monetary conditions in Russia – something which is likely to send the Russian economy into recession (understood as one or two quarters of negative real GDP growth).
This in my view illustrates a weakness in the very strict form of an Export Price Norm. If the central bank pegs the currency directly to the export price – for example oil prices in the case of Russia – then other negative external shocks – would effectively be monetary tightening.
CBR should implement a 40-40-20 basket with an adjustable +/-15% fluctuation band
Given this weakness in the strict form of the EPN I believe it would be better for the Russian central bank to implement a less strict variation of EPN.
The most obvious solution would be to include oil prices in the CBR’s present operational basket. Overall I think a basket of 40% euros, 40% dollars and 20% oil prices would be a suitable policy basket for the central bank. Furthermore, the CBR should allow for a +/-15% fluctuation band around this policy basket.
The reason I stress that it should be a policy basket is that the ultimate target of the CBR should not be that basket but rather to achieve a stable growth rate of nominal spending in the Russian economy – for example 8-10% NGDP growth.
I believe that under most circumstances the CBR could maintain composition of the policy basket and maintain the fluctuation band unchanged and that would to a large degree ensure nominal stability without changing the basket or the “parity” for this basket and long as the CBR communicates clearly that the purpose of this policy is to ensure nominal growth stability. Then the market would take care of the rest.
Unfortunately Putin’s Russia has much bigger (self-inflicted) problems than monetary policy these days…
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Posted by Lars Christensen on March 7, 2014
March 5th is my birthday (yes, I am turning 43 today)
In 1953 Stalin died on this date. Last year on this day Hugo Chavez died. This year my nephew’s hamster died.
And in 1946 on this date Churchill made this important speech, which unfortunately these days seems more important than at anytime since 1989.
Update: Also on this date – today – Liz Wahl did this. Bravo Liz.
Posted by Lars Christensen on March 5, 2014
As geo-political tensions continue to increase and all eyes are on Ukraine I have been very busy analysing and talking about the impact on the markets and the global economy.
This is from an interview I did with Radio Free Europe today:
Lars Christensen, head of emerging markets analysis at Danske Bank in Copenhagen, says a big reason for the fall is foreign investors’ perceptions of Russia are changing as the Ukrainian crisis deepens.
“There is a fear among investors that Russia is moving away from the West. Whether or not that should be called a new Cold war is controversial but, at least, investor sentiment is influenced by the fact that we are seeing a cooling down of relations between East and West. And obviously in such an environment you would see less foreign direct investment into Russia,” Christensen says.
…But the pressure of the Ukraine crisis could make it even harder now for Russia to decide where to stop the ruble’s slide.
Christensen notes that the farther the ruble falls, the more expensive it becomes for the central bank to protect it.
“We saw in 2008, in connection with the Georgian conflict and the financial crisis, that the ruble came under significant pressure and that when the Russian central bank at that time intervened heavily and spent $200 billion to defend the ruble and failed that it had very significant costs for the Russian economy in terms of high interest rates and significantly lower growth,” Christensen said.
“So, I think the Russian central bank is aware of those risks and is therefore likely to allow the ruble to continue to depreciate but will from time to time step in and try to curb that sell-off.”
…But if the Ukraine crisis is not solved, much greater economic troubles for Russia — and for the West — could lie ahead.
As Moscow maintains a threatening posture toward Ukraine and the West responds with warnings of possible sanctions, the exchanges sound increasingly like echoes of the Cold War.
And any real slide back toward Cold War risks weakening the infrastructure of trade agreements that today underpins much of the global economy.
“If we were to move to a new Cold War-style scenario, then we would see more fundamental negative impacts that would mean higher defense spending, a less open, global economy, and trade barriers coming up between East and West,” Christensen says.
“I think we often forget how beneficial the end of the Cold War has been for the global economy and it would be terrible from a global economic perspective to see us moving in the other direction.”
I wish I had a more positive message to talk about, but unfortunately geo-political risks in Europe overshadows everything else at the moment.
Posted by Lars Christensen on March 4, 2014
I just found a reference to this sensational new Working Paper – “Stock Picking Skills of SEC Employees” – by Shivaram Rajgopal and Roger M. White. This is the abstract:
“We use a new data set obtained via a Freedom of Information Act request to investigate the trading strategies of the employees of the Securities and Exchange Commission (SEC). We find that a hedge portfolio that goes long on SEC employees’ buys and short on SEC employees’ sells earns positive and economically significant abnormal returns of (i) about 4% per year for all securities in general; and (ii) about 8.5% in U.S. common stocks in particular. The abnormal returns stem not from the buys but from the sale of stock ahead of a decline in stock prices. We find that at least some of these SEC employee trading profits are information based, as they tend to divest (i) in the run-up to SEC enforcement actions; and (ii) in the interim period between a corporate insider’s paper-based filing of the sale of restricted stock with the SEC and the appearance of the electronic record of such sale online on EDGAR. These results raise questions about potential rent seeking activities of the regulator’s employees.”
What can I say – or rather what should I say other than WAUW!
Posted by Lars Christensen on March 1, 2014
I have waited for this book for a while, but yesterday it finally arrived in the mail. It is Fragile by Design by Charles Calomiris and Stephen Haber.
This is the book description:
Why are banking systems unstable in so many countries–but not in others? The United States has had twelve systemic banking crises since 1840, while Canada has had none. The banking systems of Mexico and Brazil have not only been crisis prone but have provided miniscule amounts of credit to business enterprises and households. Analyzing the political and banking history of the United Kingdom, the United States, Canada, Mexico, and Brazil through several centuries, Fragile by Design demonstrates that chronic banking crises and scarce credit are not accidents due to unforeseen circumstances. Rather, these fluctuations result from the complex bargains made between politicians, bankers, bank shareholders, depositors, debtors, and taxpayers. The well-being of banking systems depends on the abilities of political institutions to balance and limit how coalitions of these various groups influence government regulations.
Fragile by Design is a revealing exploration of the ways that politics inevitably intrudes into bank regulation. Charles Calomiris and Stephen Haber combine political history and economics to examine how coalitions of politicians, bankers, and other interest groups form, why some endure while others are undermined, and how they generate policies that determine who gets to be a banker, who has access to credit, and who pays for bank bailouts and rescues.
Recenly Charles and Stephen talked to the legendary EconTalk host Russ Roberts about their new book. Listen to the interview here.
I do not agree with everything Charles and Stephen are saying, but I fully agree with the general idea that we cannot understand banking crisis without understanding the politics of banking – or what they call The Game of Bank Bargains.
Anyway, since I have only read a small part of the book this is not a review and I am sure I will return to comment more on the ideas in the book.
PS Of course I would stress the role of monetary policy in banking crisis. That is another issue…
Posted by Lars Christensen on March 1, 2014
It has been a busy couple of weeks for me. It is events in particularly Ukraine, Turkey and partly Venezuela that have kept me very busy so there has not been much time or energy for blogging.
My blog is mostly about monetary issues, but the most important thing going on in the global economy and markets right now in my view is not monetary affairs, but rather the escalation of geo-political risks or what Robert Higgs in the most general sense have called “regime uncertainty”.
So let me quote myself. This is from EMEA Weekly – a Weekly produced by my hard working colleagues in Danske Bank’s research department and myself. This is on the recent developments in Ukraine:
Centre of attention moves to Crimea
This week there has been a sharp increase in geopolitical tension on the back of the violent in recent weeks and particularly since the Ukrainian parliament voted to oust President Viktor Yanukovych at the weekend and appointed a new caretaker president and a new government ahead of presidential elections, which are now scheduled to be held in May.
As we pointed out in Flash Comment Ukraine – geopolitical risks increase, the events over the weekend sharply increased geopolitical risk and we expected the focus of the markets to turn to eastern Ukraine and the peninsula of Crimea. The events this week have confirmed this.
We also note that most of the population in Crimea is ethnic Russian and many hold a Russian passport. During the Russian-Georgian conflict in 2008, fears about increased separatist sentiment in Crimea increased tensions between the then Ukrainian government and Russia. These concerns have now returned. This morning a group of apparently pro- Russian armed men seized Crimea’s regional parliament and the government headquarters of the Russian-majority region.
Yesterday, Russian President Vladimir Putin ordered tests of the combat readiness of Russian armed forces in western and central Russia and today the Russian Ministry of Defence said it had put its fighter jets on ‘combat alert’ on its western border.
The new Ukrainian government has reacted angrily to recent geopolitical events. Hence, Ukraine’s interim President Olexander Turchynov has warned Russia against any ‘military aggression’ in Crimea.
The clear escalation of the geopolitical situation is now having a very clear impact on not only the Russian and Ukrainian markets. Hence, over the past couple of weeks there has been some contagion – so far fairly moderate – to other central and eastern European markets but, as of today, it seems that we are seeing an even broader spillover as fears of an armed conflict have increased.
The Ukrainian hryvnia has fallen sharply this week and today alone it is down around 10% against the US dollar. The Ukrainian central bank has effectively stopped defending the hryvnia as it has more or less run out of foreign currency reserves. Furthermore, it is very clear to us that the banking sector has effectively stopped working in Ukraine and the country is close to default. Indeed, we think it is impossible to avoid a sovereign default unless the Ukrainian government receives foreign financial assistance. This is also reflected in the pricing of Ukraine’s credit default swap.
The Russian rouble has also come under additional pressure. The rouble, which has been under pressure for some time and has lost some 20% in value over the past year. yesterday hit the weak end of the official fluctuation band against the basket of the euro and the US dollar.
This morning USD/RUB reached 36.11 – a five-year high. The dual currency basket hit a record high of 42.11. The Russian central bank Bank Rossii has refrained from significant support of the rouble, intervening by around USD300m per day and shifting repeatedly up the rouble’s trading band. We do not expect any significant turnaround in the rouble’s rate this year or any significant support from Bank Rossii as the authorities believe the rouble’s weakness helps the domestic economy.
As a direct consequence of recent events, we have changed our already very bearish forecast on the Ukrainian hryvnia to 15 against the dollar. This implies an almost 70% devaluation of the hryvnia compared with pre-crisis levels. We are also considering whether to revise our rouble forecast and it is obvious to us that there is considerable downside risk for the rouble if the geopolitical situation worsens further.
It is also obvious to us that these events have significant negative ramifications for both the Russian and Ukrainian economies.
I normally like to tell my stories within a simple AS/AD framework. If you want to understand the economics of what is going on right now in both Russia and Ukraine think of recent events as a negative aggregate supply shock to both economies. So we will have lower growth and higher inflation – as well as weaker currencies in both Ukraine and Russia as a result of these events.
This is how it looks – the geo-political shocks pushes the short-run aggregate supply curve (SRAS) to the left – from SRAS to SRAS’. This causes inflation to increase from p to p’ and real GDP growth drops to y’ from y.
From a monetary policy perspective the worst thing to do would of course be to tighten monetary policy in response to such a shock. Interestingly enough it seems like both countries despite initially tighthening monetary conditions to “defend” their currencies now have accepted that this is a foolish policy and both countries’ central banks are now moving in the direction of freely floating exchange rates. So at least here there is some common ground.
Lets hope and pray that peace prevalence.
Posted by Lars Christensen on February 27, 2014
Wolfgang Münchau has a good up-ed on the risk of deflation in the euro zone, while I do not agree with everything Wolfgang says I think he is 100% right about the significant risk of deflation in the euro zone and that bold policy action is urgently needed to curb deflationary pressures in the euro zone.
I particularly find this paragraph interesting:
Remember what happened in Japan? Once its economy settled to a new steady state with negative inflation and zero growth rates during the 1990s, it got stuck in a hole. There is still a dispute over whether fiscal or monetary policy is the more suitable instrument in such a situation. But there is no dispute that a policy mixture that consists of fiscal rigour, excessive monetary tightness and a refusal to deal with the zombie banks is not going to work. The ECB always says Europe is not Japan. Indeed, it is not. Europe’s position is potentially worse.
The only tools strong enough to stem deflation are unconventional. These could include purchases of sovereign and corporate bonds, bank bonds or even company shares. They could also include funding-for-lending schemes, support for small company loan securitisations or, in extremis, direct lending to companies. But the longer one waits and the longer deflation festers – the more it affects wage settlements and prices for goods and services – the harder and more costly it will be to get rid of.
Posted by Lars Christensen on February 24, 2014
My readers have to excuse me, but these days I can’t think about monetary policy. What is on my mind is the terrible events in Ukraine. I have for the past 15 years spend a lot of time in Central and Eastern Europe. I have seen the miracle of a country like Poland. But I have also seen how the people of Ukraine have been cheated by their corrupted and criminal politicians from seeing the same kind of progress as their neighbours in Poland.
I could write a lot about how I feel about this, but you have to excuse me because today I am not able to express my sadness about the terrible events in Kiev. I fear things will get even worse in the coming days. I pray it won’t.
Today I am an Ukrainian. Please watch this.
Posted by Lars Christensen on February 20, 2014
Back in October 2012 I wrote a blog post on what I called “My favourite Chinese monetary graph“. In this post I am returning to this topic as I think the monetary developments in China has become increasing worrying.
My focus was on the development in M1:
Imagine a 4% inflation target – this year’s Chinese inflation target – trend real GDP growth 10-11% and money-velocity growth between -1% and 0% then the money supply (M1) should grow by 15-16% to ensure the inflation target in the medium term. This is more or less a description of Chinese monetary policy over the past decade.
Over the past decade People’s Bank of China has been targeting M1 (and M2) growth exactly around 15-16% (give and take a bit…). Overall the PBoC has managed to hit its money supply target(s) and that has more or less ensured nominal stability in in China over the past decade.
I find it useful to track the growth of M1 versus two idealized targets path of 15% and 16% going back to 2000. This is my favourite graph for the Chinese economy.
This is how the updated M1 graph looks today:
Back in October 2012 the actual level of M1 had just broken below the 16% trend line and since then M1 has kept inching downward compared to both the 16% and 15% trend lines and recently we have broken 15% tend line. This is obviously a very crude measure of monetary conditions in China, but I nonetheless think that the indication is pretty clear – monetary conditions are clearly getting tighter in China and I think it is fair to say that monetary conditions are disinflationary rather than inflationary.
Since my October 2012-post distress has clearly increased in the Chinese money markets and growth worries have certainly increased. Furthermore, given it is hard to ignore the connection between the continued tightening of monetary conditions in China and the turmoil we have seen in Emerging Markets over the past 6-12 months – after all China is a global monetary superpower.
It is time to ease Chinese monetary conditions
I think that is totally appropriate that the People’s Bank of China (PBoC) initiated monetary tightening in early 2010 and overall the tightening has been warranted – even though it has had negative market implications for particularly some Emerging Markets. However, it is obviously not the task of the PBoC to conduct monetary policy for Brazil or Turkey for that matter. However, I think it is now pretty clear that Chinese monetary conditions has become too tight for China.
However, the PBoC has been extremely reluctant to step up monetary easing. In my view there are overall two reasons for this. First, PBoC obviously is worried that it could “reflate the bubble”. Second, the Chinese policy makers clearly seem to think that Chinese trend real GDP growth has declined and I would certainly agree that Chinese trend growth likely is closer to 7-8% y/y than to 10%.
So there likely has been good reason for a more cautious monetary policy approach in China, but if we indeed assume that Chinese trend growth has declined to for example 7-8% and money velocity on average decline 0-1% per year and the PBoC wants to hit 2-4% inflation over the medium-term then M1 needs to growth by at least 9-13% (7+0+2 and 8+1+4).
Since October 2012 – when I put out my original post – Chinese M1 has actually averaged 9%, which is in the lower end of the range I think is necessary to avoid monetary policy to becoming excessively tight. Furthermore, it should be noted that the increased financial distress in China over the past year likely is pushing down both money velocity and the Chinese money multiplier, which in itself is disinflationary.
Concluding, I think there is little doubt that Chinese monetary conditions are becoming excessively tight – so far it is probably not catastrophic, but I can’t help thinking that the risk of nasty credit events increase significantly when economies go from a boom to a disinflationary weak growth scenario – said in another way I really fear is a “secondary deflation”.
PS A look at M2 growth would likely paint a slightly less scary picture.
PPS The growth rate of M1 in January 2014 was extremely weak (1.2% y/y). I am not certain what to make of the numbers, but it was what really got me to write this blog post.
Posted by Lars Christensen on February 17, 2014