How not to deal with a foreign exchange crisis

Just over three months ago on the third of May I gave some suggestions as to how to deal with a foreign exchange crisis using the hot topics at the time of Argentina and Turkey. Back then the Argentine newspaper had reported this.

On Wednesday, the US currency jumped again to reach $ 21.52 in the retail market and $ 21.18 in the wholesaler. It went up 5% in the week…….. And the Argentine peso is the currency that fell the most in the year against the dollar (12.5%) followed by the Russian ruble (9%).

Actually the R(o)uble is currently in a soft patch but it is slightly different due to its role as a petro-currency, But returning to Argentina the central bank had a few days earlier done this with interest-rates as they raised them by “300 basis points to 30.25%.”

I suggested that this was unlikely to work.

Firstly you can end up chasing you own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it?

Actually they did not even get out of that day as the dam broke quickly and interest rates were raised by 3% later that day. Of course that just provokes the same question if a 3% rise does not work why do you think another 3% will? Well my logic applied again as the next day the central bank announced this.

It was resolved to increase the monetary policy rate by 675 points to 40%.

Frankly they were in utter disarray as they proved my point at what was extraordinary speed. Such an interest-rate will have quite a contractionary influence on an economy if sustained and so far it has been as this announcement from Tuesday informs us.

the Monetary Policy Committee (COPOM) of the Central Bank of the Argentine Republic (BCRA) unanimously resolved to define the Liquidity Rate (LELIQ) ) to 7 days as the new monetary policy rate and set it at 40%.

They can have as many new rates as they like but reality is still the same.

What about the Peso?

If we return to Clarin to see what is being reported in Argentina then it is this.

After having closed stable in a day in which the Central Bank maintained the rates, the dollar rose this Wednesday 20 cents in the banks . The average of the entities surveyed by the BCRA showed a closing value of $ 28.23.

In the same sense, at wholesale level the currency increased 23 cents, to $ 27.63 .

So that is around 6 more Pesos per US Dollar. I am not sure at exactly what point a currency fall becomes a plunge but 56% over the past year is hard to argue against.

Along the way Argentina decided that is had to go to the International Monetary Fund or IMF. Although how they both think moving the goalposts will help I am not sure.

 In particular, the central bank has adopted a new, more credible path of inflation targets (for example, the inflation target for end-2019 moved from 10 to 17 percent).

Also this is one way of putting it.

The exchange rate regime is a big change. It is now floating, not fixed, so it’s working as a shock absorber.

Also as I understand it this is rather economical with the truth.

Banks and the private sector also operate without money borrowed in foreign currency, so their balance sheets are not at risk from a depreciation of the peso.

It seems that the Governor of the BCRA thinks so too if this from his annual speech in January is any guide.

As a result of these measures, interest rates in dollars went down from 5%-6% annually by late 2015 to 2%-3% annually today, and lending in foreign currency went up 379% since then, from a stock of U$S 2.9 billion to 14 billion dollars today.

Perhaps the IMF were trying to deflect attention from the foreign currency borrowings of the Argentine state that the central bank had been helping to finance. You may remember the Vomiting Camel Formation that some drew on the 100 year bonds that had been issued in US Dollars by Argentina.

Turkey

Yesterday brought an example of the opposite line of thought to mine as I note this from Bloomberg.

Turkey must hike rates to 23% as the crisis gets worse, Investec says

This was presumably driven by this from Reuters.

The currency had fallen as much as 5.5 percent on Monday to 5.4250 per dollar, an all-time low and its biggest intraday drop in nearly a decade, after Washington said it was reviewing access to the U.S. market for Turkey’s exports.

Actually the territory gets even more familiar because back on June 7th Reuters told us this.

Rates rise by 125 basis points, more than expected……..Turkey’s central bank ramped up its benchmark interest rate to 17.75 percent on Thursday, taking another step to assert its independence, two weeks after an emergency rate hike and just ahead of elections.

No doubt the cheerleaders would have proclaimed success as this happened.

The lira strengthened to 4.4560 against the dollar after the rate rise from 4.5799 just before. It was trading at 4.4830 at 1605 GMT.

However they would have needed the speed of Dina Asher Smith to get out of Dodge City in time if we note where the Turkish Lira is now. So an interest-rate rise that was more than expected did not work and of course it was on top of a previous failure in this regard.

So if we stay with Investec we are left wondering about the case for a rise to 23% or 4.25% more. Especially if we note that such a rise would not even match Monday’s fall in the Lira. The environment is very volatile and the Lita has hit another new low this morning although it is jumping around.

If you want a sense of perspective well if we look back to May 3rd some got ahead of the game.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency ( Lionel Barber)

Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year… ( Henry Pryor)

Comment

These are situations which were described rather aptly by the band Hard-Fi.

Can you feel it? Feel the pressure? Rising?
Pressure
Pressure
Pressure, Pressure, Pressure
Feel the pressure
Pressure
Pressure
Pressure

In that sense perhaps we should cut central bankers a little slack as after all the academics which are often appointed will hardly have any experience of this sort of thing. Then again that begs the question if they are the right sort of person? I recall when the UK was in such a melee back in 1992 that the establishment and I am including the Bank of England and the government in this was simply unable to cope with events as each £500 million reserve tranche disappeared even after promising interest-rate rises of 5%. What a day and night that was…..

In my opinion a combination of Bananarama and the Fun Boy Three gave some coded advice.

It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
And that’s what gets results

As to Turkey the official view is that it’s all fine.

*TURKEY SEES NO FX, LIQUIDITY RISK FOR COMPANIES, BANKS ( h/t @Macroandchill )

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6 thoughts on “How not to deal with a foreign exchange crisis

  1. ” I recall when the UK was in such a melee back in 1992 that the establishment and I am including the Bank of England and the government in this was simply unable to cope with events as each £500 million reserve tranche disappeared even after promising interest-rate rises of 5%. What a day and night that was….”

    That’s the problem facing sterling again, as once the dam breaks the selling completely overwhelms any policy response regardless of the size or extent, additionally you have the problem of those shorting the market having more money than the Bank of England when thay make purchases to defend it and using the leverage of the forex market to magnify that power.

    This is why Carney’s scamming of the market over the last few years by promising rate increases and then reversing the decision just at the last moment has been so irresponsible and dangerous as there are only so many times you can try and make fools of markets before the forces above are unleashed and when they are, there are virtually no weapons to counteract the downward forces.

    Additionally there is the fact that in 1992 the Bank of England were prepared to raise raise and aggressively -by 5%(to 20% if my memory serves me???) in the final move that was never enacted as we left the ERM beofre it could be implimented, this time the situation is magnitudes worse since Carney will refuse to raise rates until the falls are so massive the bank will be in the same position as the Argentinian Central Bank described by Shaun above, and of course, just as the BCRA found out it wouldn’t work, Carney will discover the same nighmare.

    And just to give a picture of the arrogance and incompetence of the Bank of England, the Treasury and the government at the time in 1992, and how out of their depth they were, someone told me that during one of their meetings on the freefall of sterling at the time they were tracking the drops v not via a Bloomberg terminal oh no……. but using A TRANSISTOR RADIO!!!!! tuned in to the news bulletins, if that doesn’t sum up the decline of the country then nothing will, and this time its even worse.

    I’m sticking with my prediction of sterling being replaced as our currency within five years, recent events only make it look more and more certain.

    • Kevin, that seems rather an extreme scenario and certainly would not fall into the category of “taking back control”. Maybe that post I made about London banks moving reserves to Frankfurt has gotten some traction.

      I think its fun that global elite folk in Turkey think London is the first place to escape with their cash. Makes us one of those welcoming light touch tax avoidance islands and recently we’ve had the Bemudan weather as well.

    • Agree, I’m beginning to believe the whole Brexit saga is a sham to force the Euro, Schengen and removal of rebates on the UK (high risk but no other way to break the log-jam on these as they are serious impediments to a United States of Europe). Also, once the UK is in the Euro, Sweden and Denmark would follow pretty quickly.

      Maybe a bit ‘tin-foil hat’ but what else can explain how things have panned out (the UK had a pretty good hand at the beginning of the negotiations and our politico’s have proceeded to throw the cards all away)

      • I think that Argentina and Turkey show how impossible events are to control once the legs are knocked from under a currency. 40% interest doesn’t seem that high when it is accompanied by a halving of the currency in six months…
        As to us joining the Euro, I am not so sure. I think that the Euro has a lot of pressures upon it (including the Italian leadership, Target 2 imbalances etc, potentially trouble in the May European elections). While the Euro grass may look greener to us right now, it still seems to me that the Euro is causing deep unemployment and impoverishment in Southern Europe, while Germany enjoys its relative weakness to a putative Deutschemark.
        Of course, it would be rather typical should we join at the very moment it starts to fall apart!

        • Agree but the EU cant resist roping us into the Euro system, they really need the UK to help shore up the system and take the pressure of Germany to a degree

          However (as we can see with Italy) once in there is no going back without extreme pain.

          • I absolutely agree that it would be the Euro’s greatest day in the minds of the Eurocracy were we to be forced to join and that the others would also then join, but the tectonic plates just seem to me to be moving away from the ever closer union mob.
            I am also sure that, if the UK asks to reverse the Brexit Aricle 50, the EU will ask us to sign up to the Euro.
            Interesting times. At least we are not Turkey/Argentina (yet…).

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