The economic impact of the 2018 currency crises are now being felt

This morning has brought yet more developments in the ongoing currency crises of this summer. An early morning economic salvo was fired by the Turkish central bank the TCMB.

Recent developments regarding the inflation outlook indicate significant risks to price stability.
The Central Bank will take the necessary actions to support price stability.
Accordingly, in line with the previous communication, monetary stance will be adjusted at the
September Monetary Policy Committee Meeting in view of the latest developments.
The Central Bank will continue to use all available instruments in pursuit of the price stability
objective.

The press release was in response to this from the Turkish Statistical Institute.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.30%, on December of the previous year by 12.29%, on same month of the previous year by 17.90% and on the twelve months moving averages basis by 12.61% in August 2018.

What we are seeing here as inflation accelerates is a consequence of the fall in the value of the Turkish Lira as it had been around 10% in the early months of this year. If we look back to last year as well the inflation boost has been ~7%, and if we look at the producer price data also released today we see that there is more to come.

Domestic producer price index (D-PPI) increased by 6.60% on monthly basis, by 25.32% on December of the previous year basis, by 32.13% on same month of the previous year basis and by 18.78% on the twelve months moving averages basis in August 2018.

We get the clearest guide to the driver here when we note what has happened in August alone to goods which are priced across the world in US Dollars.

The highest rates of monthly increase in D-PPI by sub divisions of industry were index for coke and refined petroleum products by 25.11%, for metal ores by 15.33%, for basic metals by 12.07%.

What we are seeing here are the economic consequences of a currency crisis on the real economy, as we see inflation not only considerably up but heading higher as well. This will impact directly on consumers and workers via its impact on real wages. There are other consequences as well.

7 local newspapers in İzmir all cut their Sunday editions this week due to the price of imports like paper ( @06JAnk)

Another is more sinister as there are reports of an investigation into companies which have raised prices. Also the state bank which sold some incredibly cheap US Dollars last week might wish it had not.

But returning to the TCMB it has trouble ahead as we note the last sentence of its press release as of course President Erdogan has publicly stated he is no fan of interest-rate increases. So after a rally the Turkish Lira has been slipped backwards and is at 6.61 versus the US Dollar.

The economic situation

The last few days have given us signals that the economy is not only heading south but it may be doing so at a fair old lick. Here is the Hurriyet Daily News from Saturday.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

Trade Minister Ruhsar Pekcan said in a statement that the trade deficit of $2.48 billion last month was the lowest monthly figure in the last nine years…….She added that Turkish exports amounted to $12.4 billion in August, with a yearly fall of 6.5 percent, while the country’s imports declined by 22.4 percent to $14.8 billion.

Care is needed on two counts as there was a longish national holiday in these figures and they are just for merchandise trade. But it is hard not to note the fall in imports which is more of a plummet, and it comes on the back of this reported in the full trade figures for July released last week.

while imports decreased by 9.4% compared with July 2017.

We are seeing a large contraction in purchases of foreign goods and services and this is where initially national accounts let us down. This is because the fall in imports improves the trade balance and via that GDP ( as imports are a subtraction from GDP), so it is a bit like when in the cartoons someone runs straight off the edge of a cliff and hangs in the air before gravity takes over. It takes the national accounts a while to record that people are worse off. On the other side of the coin I think that some help will be provided by export rises and that the August fall was driven by the national holiday.

Looking ahead

The manufacturing survey of the Istanbul Chamber of Industry released this morning was rather pessimistic.

August was a month of challenging business
conditions for manufacturing firms in Istanbul.
Weakness of the Turkish lira led to strong inflationary
pressures, and contributed to slowdowns in both
output and new orders.

They also follow the Markit PMI methodology.

After posting above the 50.0 no-change mark at
51.0 in July, the headline PMI dipped back into
contractionary territory during August. At 46.3, the
PMI signalled an easing of business conditions for
the fourth time in the past five months and the most
marked moderation since July 2015.

The only flicker of good news was from exports.

There was positive news
with regards to new export orders, however, which
increased fractionally and for the second successive
month.

Cots however were reported as rising at a record rate ( since 2006) which after the inflation data should surprise no-one.

Argentina

In Argentina there has been a different response as the central bank has tried to battle a declining Peso with interest-rate increases of which the latest came only on Thursday. Those of a nervous disposition might like to sit down before reading this from the BCRA.

the Monetary Policy Committee (COPOM) of the Central Bank of the Argentine Republic (BCRA) resolved Unanimously after meeting outside the pre-established schedule to increase the monetary policy rate to 60%. Likewise, to guarantee that monetary conditions maintain their contractionary bias, COPOM undertakes not to reduce the new value of its monetary policy rate until at least December.

This is a new form of central bank Forward Guidance in that not only were interest-rate raised by an eye-watering 15%, which is only a couple of percentage or so less than even Turkey, but there was also a promise they would stay there until December. A consequence of such interest-rates was noted this morning by the Financial Times.

One of the bond market’s biggest investors has seen its flagship funds battered by the turmoil in emerging markets unleashed by Argentina’s spiralling financial crisis ………Franklin Templeton funds have lost $1.23bn in the past two weeks on just three of its biggest Argentine positions, according to FT calculations.

Those of you who have a wry sense of humour might like to mull how quickly things can change.

Argentina, which increased interest rates last week by 15 percentage points to 60 per cent, emerged as one of the hottest stories in emerging markets two years ago after the centre-right reformist Mauricio Macri came to power.

Or as David Bowie put it.

Fashion! Turn to the left
Fashion! Turn to the right
Oooh, fashion!
We are the goon squad
And we’re coming to town.

Meanwhile Argentinians will be facing soaring interest-rates for any mortgage or business borrowing rather I would imagine in the manner of their rugby team as it faces up to playing the All Black this weekend.

Comment

There is a certain irony in the war that the “currency wars” described by Brazil’s Finance Minister some 8 years ago have hit its neighbour Argentina. But of course Argentina has long had a troubled path, although we return to the concept of fashion as we recall that it was able to issue a 100 year bond in June of last year. The Vomiting Camel Formation for its likely price that I noted on the third of May performed really rather well.

However as we look at Turkey and Argentina in particular we see that the currency crises are causing inflation which will create a recession. How large and deep depends on where their currencies eventually settle as right now things could hardly be much more volatile. Yet they are far from alone as we note that the Indian Rupee has fallen to 71 versus the US Dollar and impacts on Russia, South Africa, Brazil and Indonesia. It should get more attention than it does as after all that is quite a bit of the world’s population. Also we see the power of the reserve currency the US Dollar.

 

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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 )

How to deal with a foreign-exchange crisis

This week has seen at least a couple of examples of currencies that appear to have gone into free fall. Let us open with the Argentine Peso which was singing along to “Down,Down” by Status Quo yesterday. From the Argentine newspaper Clarin via Google Translate

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.

The abrupt movement of a variable as sensitive as the exchange rate alters the nerves of investors, the general public and -although they deny it- of the Government itself, the last thing it wants is that in the middle of the hard fight to lower the inflation, the price of the dollar occupies large spaces in the media and in public conversation.

What they do not tell us is that this was a new low for the Peso. Actually we get an unusual perspective in that the paper gives a link to exchange rates on the front page  of its website. The situation so far this year is shown later as is a major factor in it.

Is that almost all currencies -especially those of the emerging world- are being devalued against the dollar. 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%).

How can a central bank respond?

Interest Rates

From the Argentine central bank or BCRA. You might like to sit down before you read it.

Buenos Aires, April 27, 2018. Given the dynamics acquired by the exchange market, the Monetary Policy Council of the Central Bank of the Argentine Republic met outside of its pre-established schedule and decided to increase its monetary policy rate, the center of the corridor of passes to 7 days, in 300 basis points to 30.25%. He made this decision with the aim of guaranteeing the disinflation process and is ready to act again if necessary.

This is perhaps the most common response and in my view it is the most flawed. The problem is twofold. 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? Unlikely in my view as we note that the currency has fallen 5% this week.

On the other side of the coin interest-rates in one place in particular are expected to have an effect. From a speech by BCRA Governor Federico Sturzenegger on the 23rd of April.

This week at the Fund meetings, for example, I saw scenarios with 9 hikes in the FED policy rate over this year and next. But most people did not believe that was the most likely scenario. Yet, whatever form monetary policy normalization takes, certainly such a move will have ample repercussions on the rest of world.

Next comes the way that markets discount this in terms of forward exchange rates which now will factor in the higher interest-rate by lowering the forward price of the Peso. So against the US Dollar it will be of the order of 28% lower in a year’s time so the expected return in each currency is equal. This should not matter but human psychology and nature intervene and it turns out often to matter and helps the currency lower which of course is exactly the wrong result.

So what should you do? Well respond to inflation changes are per your mandate as per this but then hold your nerve.

The Central Bank will continue using all the tools at its disposal and will conduct its monetary policy to reach its intermediate target of 15% in 2018.

Otherwise each currency fall you will be raising interest-rates and again a downwards spiral can result.

Foreign Exchange Reserves

This is often the first line of defence or can be combined with an interest-rate rise. From Clarin again.

plus the almost 5,000 million dollars of the reserves that sold in the last week of April and the start of May,

The catch is that it is not working although until the interest-rate rise last week it was not helped by the last move being a cut in interest-rates. Also if we return to the speech by the BCRA Governor Argentina was in a really bad place only a couple of years ago.

As we took over from the previous government, our international reserves were reaching very low levels. In fact, what we called net reserves, that is, our reserves net of our obligation in foreign currency, were negative.

In fact it was a real mess.

To make things worse, the previous government had sold USD futures for about the equivalent of a third of the monetary base at off market prices.

In fact it bought its new reserves from the Argentine government.

The combination of the need to accumulate reserves, plus the fact that the government had an excess supply of dollars, as it was financing abroad its gradual fiscal convergence, implied a natural agreement by which the Central Bank would buy these excess dollars to the Treasury, sterilizing afterwards the pesos issued by issuing short-term Central Bank debt.

Okay so now it has some reserves but there is a catch which is that whilst they are getting more valuable in Peso terms of course that is only for the amount left as they are being used up. This is the problem here as people focus on the amounts used and the rate of attrition. Even Russia suffered from this if you recall and it had and has ready sources of foreign exchange from its oil and commodity exports. The IMF estimated at the end of last year that Argentina would have US $50.7 billion of foreign exchange reserves this year and that they would grow in subsequent years. Mind you they also forecast a rising Peso so it was far from their finest hour.

Capital Controls

Argentina did have these but scrapped them. From the Governor’s speech.

The third change occurred at the beginning of 2017, when the government released the remaining capital controls

They can help but problems do arise of which the worst is the development of an official and unofficial exchange-rate. I am sure you can figure out which will be higher than the other. Or the US Dollar becomes the currency most used.

Comment

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis. The Swiss Franc has taught us that this is true in the case of currency strength where the central bank in theory at least is in a much stronger position. Oh and by temporary I mean the definition used by the ordinary person not the perversion used by central bankers.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one. As to building up foreign exchange reserves by borrowing it is hard not to think of this. From City-AM last June.

About a year after emerging from default, Argentina has surprised investors by offering a 100-year bond.

The US-dollar-denominated bond is offered with a potential 8.25 per cent yield.

Actually it feels like everyone lost there which cannot be true. Argentina has to pay the interest with increasingly devalued Pesos and the price of the bond has to give you a clue been described like this.

Of course Argentina did gain on the initial transaction.

Moving onto Turkey which this morning has joined the club with a new low for the Lira I note this from the editor of the Financial Times Lionel Barber.

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

Which got this reply from Henry Pryor.

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

Which gives me another question. Is London property considered to be the worlds safe asset and please note I typed considered to be?

Oh and helping with this sort of thing was the original role of the IMF as opposed to the way it intervened in the fiscal crisis in part of southern Europe.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.