Commodity prices, currencies and monetary policy
It has been a busy year for me - it has especially been the Russian-Ukrainian crisis, which has kept me busy. However, I thought that this week would be fairly calm - I didn't have any traveling planned, not a lot a meetings scheduled and I had not expected to be too busy. However, things turned out very differently thanks to the spectacular collapse of the Russian rouble and a massive rate hike from the Russian central bank. After 15 years in the financial markets this is absolutely up there among the wildest things I have ever experienced. So frankly speaking I am a bit tired and not really up to the task of writing a major blog post. However, I have a lot on my mind nonetheless so I want share a bit of that anyway. First, in relationship to what have played out in the Russian markets recently I must say that I actually have been impressed with the Russian central bank. Yes, Monday's 650bp rate hike in my clearly is a major policy mistake and the decision has brought more uncertainty and more financial distress rather than stability and the rate hike will just send the already badly damaged Russian economy into a even deeper recession. But one have to see the actions of the Russian central bank in the light of political pressures the central bank is under and that is the reason I am impressed. Russian monetary policy is far from great, but other Emerging Markets central banks would probably have made significantly worse decisions in a similar political and financial environment. Second, while Market Monetarists advocate NGDP level targeting we have been less outspoken on our support for (N)GDP-linked bonds (in fact I am not sure the other MM bloggers like NGDP linked bonds as much as I do). However, I think the logic of market monetarism also implies that we should be advocating that governments should issue bonds linked to nominal GDP. This would not only be a useful tools for monitoring market expectations for NGDP growth, but equally it would be helpful in "synchronizing" fiscal policy with monetary policy in the sense that fiscal policy would be automatically eased then the NGDP target is undershot and tightened when the target is overshot. This would also be helpful for countries where monetary policy is in different ways restricted for example by a fixed exchange rate regime. Third, the Russia crisis "story" and the topic of NGDP-linked bonds can be combined to a discussion of whether the Russian government should issue government bonds linked to oil prices - so when oil prices decline then debt servicing costs also decline. Just imagine what that would have done to reduce Russian default worries in the present situation. And this of course is linked to my favourite monetary framework for commodity exporters - the Export Price Norm. Hence, had all Russian government debt been linked to oil prices and had the rouble been pegged to a basket of US dollar (80%) and oil prices (20%) then I believe there would have been a much less spectacular crisis in Russia right now. I hope to return to all these topics in the coming weeks, but until then I want to draw my readers' attention to a recent blog post by my friend "Hishamh" over at Economics Malaysia on the topic of Commodities and Currencies. Here is Hishamh:
There’s quite a bit of gloom in the air these last few weeks. The plunge in oil and other commodity prices, capital pulling out of emerging markets, and currency turmoil, have people getting very worried about growth prospects next year. There doesn’t appear to be a bottom yet on oil prices, and it’s anybody’s guess where all this will end up. In Malaysia’s case, oil price depreciation and Ringgit depreciation seems like one piling on the other – the latter is making things worse (Malaysians feel relatively poorer), on top of the drop in oil and gas revenues. But conflating the two like this is wrong. The depreciation of the currency is in fact a required and necessary result of the drop in oil prices. If the Ringgit had stayed where it had been (about MYR3.20-3.30 to the USD), the full drop in oil prices would have been transmitted directly and with full force into the domestic economy. The approximate 8% depreciation of the Ringgit over the past few months partially mitigates that income shock. Since sales of oil (and gas) are denominated in USD terms on the international markets, a cheaper Ringgit partially cushions the revenue drop in local currency terms. Consider that oil & gas make up about 20% of Malaysian exports; commodities as a whole about a third. That means that the drop in oil prices and the depreciation of the Ringgit have been nearly symmetrical. If anything, the Ringgit hasn’t dropped far enough – my estimate is that it should be at least 3%-5% weaker. ...That suggests the last few months currency action has largely been a USD movement rather than weakness in the MYR. There’s also the flip side that the lower Ringgit should in theory provide a boost to non-commodity exports. In this case though, I’m a bit leery of depending on this as global demand growth outside the US and UK is pretty weak, and because again this is largely a case of Dollar strength more than Ringgit weakness. ...Some have been interpreting ...central bank intervention to support the Ringgit value...My view is a little more nuanced – the drop in reserves is just too small to make that conclusion. Contrasted with the pegged FX regime of the early ‘00s, reserve movements over the past four years are just too minor to affect the FX market. Rather, what I think is going on here is that BNM is simply trying to ensure that there’s enough USD (and other currency) liquidity in the interbank market to ensure, in their words, “orderly” market conditions. ...The bottom line is that BNM is not and will not be “defending” any level of the Ringgit. And if they’re not willing to spend reserves on it, you can forget the interest rate defense (which doesn’t work anyway).Said in another way - the Malaysian central bank (BNM) has moved closer to my ideal of an Export Price Norm and that is benefiting the Malaysian economy. This is in fact what I suggested back in 2012 that the BNM should do.