Turkey is facing the consequences of another currency collapse

Today we have an example of an exception proving the rule. Indeed it is something so rare in these days of negative interest-rates that I hope you are all sitting comfortably.

ISTANBUL (Reuters) – Turkey’s central bank raised the interest rate in its lira swap operation to 11.75% from 10.25% on Friday, continuing additional tightening steps in the face of a weakening lira after unexpectedly hiking its benchmark interest rate last month.

Following the rate hike in its swap transactions, the lira  rebounded to near 7.90 against the U.S. dollar from a record low of 7.9550 earlier in the day. It had eased back to 7.9375 as of 1010 GMT.

Today is full of hints or more interest-rate cuts in China and Europe but Turkey has found itself raising them again, albeit in an official way. But as you can see the initial reaction in terms of the Turkish Lira was along the lines of “meh”.Actually the Turkish Lira did rally later to 7.84, but that was from another perspective only back to where it was on Wednesday and this morning it is back to 7.89.

Turkish Lira Troubles

It has been a hard year as Bloomberg points out.

Turkey’s lira depreciated to a record against U.S. dollar, decoupling from other emerging-currencies amid mounting geopolitical risks in the region.

The lira fell as much as 0.9% to 7.8692 per dollar, extending losses this year to more than 24%, the second-biggest slide in emerging markets after Brazil’s real.

As you can see that level got replaced and in spite of the unofficial interest-rate rise we are below it now. Regular readers may well recall that the Lira was slip-sliding away and hitting new lows back in the summer of 2018 and the move through 6 versus the US Dollar was regarded as significant whereas now we are on the verge of 8 being the big figure.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

Whilst we are discussing big figure changes we see that the UK Pound £ now buys more than ten Turkish Lira.

Inflation Surges

This is the obvious initial consequence of an exchange-rate depreciation.

In August, consumer prices rose by 0.86% and annual inflation remained flat at 11.77%. While annual inflation rose in core goods, energy and food groups, it remained unchanged in the services group. Meanwhile, annual inflation in the alcoholic beverages and tobacco group declined significantly due to the high base from tobacco products

That is from the latest Minutes of the Turkish central bank or TCMB and in fact the impact is even larger in essential goods.

Annual inflation in food and non-alcoholic beverages increased by 0.78 points to 13.51% in August. The rise in annual unprocessed food inflation by 1.51 points to 15.36% was the main driver of this increase.

As important is what happens next and here is the TCMB view.

In September, inflation expectations continued to increase. The year-end inflation expectation rose by 64 basis points to 11.46%, and the 12-month-ahead inflation expectation increased by 45 basis points to 10.15%.

With the ongoing fall in the Lira that looks too low to me. On the other hand I think that Ptofessor Steve Hanke is too high.

Today, I measure #Inflation in #Turkey at 35.67%/yr.

I can see how goods inflation might have such influences but other prices will not respond so mechanically.

Trade Problems

You might think that an ever more competitive economy in terms of the exchange-rate would lead to a balance of payments triumph. However this morning’s figures tell a different story.

The current account posted USD 4,631 million deficit compared to USD 3,314 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 23,203 million. ( August data).

There are two highlights here. It is significant that the release is in US Dollars and not Turkish Lira. But we also note that Turkey has gone from surplus to deficit about which we get more detail here.

This development is mainly driven by the net outflow of USD 5,347 million in the good deficit increasing by USD 3,948 million, as well as the net inflow of USD 1,179 million in services item decreasing by USD 4,602 million compared to the same month of the previous year.

One factor at play in the services sector weakness is tourism. If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

The problem here is also what is called the reverse J Curve effect where imports have become more expensive but it takes time for volumes to shift as well as it taking time for more orders to come in for the relatively cheaper exports. At the moment that is exacerbated by the pandemic as for example if we stay with tourism international travel has fallen and with further restrictions possible it may not matter how cheap you are.

Staying with theoretical economics we should be seeing the J Curve effect from the 2018 devaluation but right now as we have noted with tourism practicalities are trumping theory.

Foreign Debt

We get some context here if we note this from Bloomberg.

Meanwhile, Turkey paid a premium as it sold $2.5 billion of debt to international investors on Tuesday, it’s first foray into global markets since February. The bonds priced at 6.4%, compared with 4.25% for similar-maturity notes issued in February.

We note the fact that we have another trend reversal here as most countries have seen lower debt costs whereas Turkey is paying more. The theme of borrowing in US Dollars is a Turkish theme though and in terms of the money raised each one has so far been a success as in it would have been more expensive later. The catch is when we get to interest payments and repayments which have got ever more expensive in Turkish Lira. So if your income is in US Dollars or other overseas currencies you are okay but if it is in Lira you are in trouble.

According to the TCMB here is what is coming up from its July data.

Short-term external debt stock on a remaining maturity basis, calculated based on the external debt maturing within 1 year or less regarding of the original maturity, recorded USD 176.5 billion, of which USD 15.9 billion belongs to the resident banks and private sectors to the banks’ branches and affiliates abroad. From the borrowers side, public sector accounted for 23.9 percent, Central Bank accounted for 11.4 percent and private sector accounted 64.7 percent in total stock.

August saw an outflow from the TCMB as well.

Official reserves recorded net outflow of USD 7,602 million.

They started the year at US $81.2 billion and are now US $41.4 billion.


So far we have noted a financial sector which is in distress with rising interest-rates a falling currency and overseas borrowing in a toxic mix. Let us now switch to the real economy where these will impact via general inflation highlighted by foreign goods and services being much more expensive. So living-standards will be lower. The normal mechanisms where a currency depreciation can help an economy are in many cases being blocked by the Covid-19 pandemic. Only on Friday we observed that the UK has been importing less which is pretty much a 2020 generic. This is added to be the fact that a Turkish economic strength ( tourism) has had an especially rough 2020.

There are other issues here as the continual foreign currency depreciation has led to a surge in demand for safe assets.

A significant part of the deterioration in the current account balance is due to gold imports. This year, gold imports will exceed $ 20 billion. ( Hakan Kara)

Gold of course exacerbates the US Dollar issue as it becomes increasingly important in Turkey. Actually the central bank has joined the game as its Gold reserves have risen by some US $17 billion so far this year and whilst some of that is a higher price it must also have bought some more.

Will more interest-rate increases help? I am not so sure as they are usually much smaller than the expected fall in the currency and they will crunch the economy even further. It would help of course if Turkey was not either actually in a war or acting belligerently on pretty much every border it has. Putting it another way government’s in economic trouble often look for foreign scapegoats.


The Central Bank of Turkey has voted for Christmas

Back on the 3rd of May I pointed out that yet another feature of economics 101 was not working these days. Here was my response to interest-rate rises from the central bank of Argentina or BCRA.

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?

Since then the BCRA  has indeed ended up chasing its own tail like a dog, as interest-rates are now an eye watering 60%. But the sequence of rises has been accompanied by further currency falls, as back then an exchange rate to the US Dollar of 21/22 ( it was a volatile day) has been replaced by 39.4. To my mind this has been influenced by the second factor I looked at back in May.

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.

Right now the forward price of the Argentine Peso will be heavily discounted by the 60% interest-rate. At least the Argentines got some welcome good news on the rugby front on Saturday when they beat Australia. Although they currently seem unable to avoid bad news for long.

The Argentine peso has lost more than half its value, but U2 frontman Bono is advocating for the economic well-being of the Argentine people  ( Bloomberg ).


As you can imagine the announcement below on the 3rd of this month from the Turkish central bank or CBRT made me mull the thoughts above.

monetary stance will be adjusted at the September Monetary Policy Committee Meeting in view of the latest developments.

On the day itself ( last Thursday) the water got very muddy for a while as President Erdogan again made a case for low interest-rates. He apparently has a theory that high interest-rates create high inflation. But the CBRT is not a believer in that.

The Monetary Policy Committee (the Committee) has decided to increase the policy rate (one week repo auction rate) from 17.75 percent to 24 percent.

The consensus was that this was a good idea as highlighted by the economist Timothy Ash.

Turkey – huge move by the CBRT, doing 625bps, taking the base rate to 24%. Respect. Difficult decision set against huge political pressure, but the right should set a floor, and gives the lira and Turkish assets, banks etc a chance.

I have more than a few doubts about that. The simplest is what calculations bring you to a 6.25% rise, or was it plucked out of thin air?  Added to that is the concept of a floor and giving the currency and banks a chance. Really? The words of Newt from the film Aliens comes to mind.

It wont make any difference

Initially the Turkish Lira did respond with a bounce. It rallied to around 6.1 versus the US Dollar on the day and then pushed higher to 6.01 on Friday. In response I tweeted this.

In the case of Argentina the half-life of the currency rally was 24 hours at best….

So as I checked the situation this morning I had a wry smile as I noted the Lira had weakened to 6.26 versus the US Dollar. I also note that the coverage in the Financial Times had someone who agrees with me albeit perhaps by a different route.

But Cristian Maggio, EM strategist at TD Securities, said the central bank did not go far enough, because inflation was likely to rise beyond 20 per cent, and “higher inflation will require even higher rates”.

On the day some speculators will have got their fingers singed as the comments from President Erdogan sent the currency weaker at first, so following that the CBRT move whip sawed them. If that was a tactical plan it succeeded, but that is very different to calling this a strategic success.

Another issue is that the currency may well be even more volatile looking forwards. This is because holding a short position versus the US Dollar has a negative carry of 22% or so and against the Euro has one of 24% or so. Thus there will be a tendency to hold the Turkish Lira for the carry and then to jump out ahead of any possible bad news. The problem with that is not everyone can jump out at once! Any falls will lead to a mass exodus or panic and we know from the experience of past carry trades that the subsequent moves are often large ones.

Foreign Debt

Brad Setser has crunched the numbers on this.

Turkey has about $180 billion external debt coming due, according to the latest central bank data. And most of that is denominated in foreign currency. The Central Bank of Turkey’s foreign exchange reserves are now just over $75 billion, and the banks may have about $25 billion (or a bit less now) in foreign exchange of their own. I left out Turkey’s gold reserves, in part because they are in large part borrowed from the banks and unlikely to be usable.

The total external debt is now a bit over US $450 billion. Very little of that is the government itself although the state banks are responsible for some of it. The problem is thus one for the private-sector and the banks.

How this plays out is very hard to forecast as we do not know how many companies will not be able to pay, and how much of a domino effect that would have on other companies. Also we can be sure that both the government and CBRT will be looking to support such firms, but we can also be sure that they do not have the firepower to support all of them! This is another factor making things very volatile.

The domestic economy

There are a lot of factors at play here but let me open by linking this to the foreign debt. If we look back we would also be adding a current account deficit to the problems above but this is getting much smaller and may soon disappear. From the third of this month.

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.

There should be a boost for exports which will help some but so far the main player has been a fall in imports which were 22.4% lower in the merchandise trade figures above. So a real squeeze is being applied to the economy which the GDP figures will initially record as a boost, as imports are a subtraction from GDP. So they will throw a curve ball as the situation declines.

Added to that is this which was before the latest interest-rate rise.

Switching to a year on year basis the impact so far of this new credit crunch is around three-quarters of the 2008/09 one. The new higher official interest-rate seems set to put this under further pressure as the banks tend to borrow short ( which is now much more expensive) and lend long ( which will remain relatively cheap for a while).


A major problem in this sort of scenario was explained by Carole King some years ago.

But it’s too late, baby, now it’s too late
Though we really did try to make it
Something inside has died and I can’t hide
And I just can’t fake it, Oh no no no no no

Regular readers will be aware that it is in my opinion as important when you move interest-rates as what you do. Sadly that particular boat sailed some time ago for Turkey ( and Argentina) and macho style responses that are too late may only compound the problem. Or as the CBRT release puts it.

slowdown in domestic demand accelerates

It must be a very grim time for workers and consumers in Turkey so let me end by wishing them all the best in what are hard times as well as a little humour for hard times.




Egypt is suffering from both the lower oil price and the currency wars

Today I intend to take a trip to a country which has a rich history. There are of course the Pyramids for starters but also the city of Alexandria which has been described thus in the Guardian today.

“Alexandria was the greatest mental crucible the world has ever known,” claim Justin Pollard and Howard Reid, authors of a book on the city’s origins. “In these halls the true foundations of the modern world were laid – not in stone, but in ideas.”

The lighthouse,library and museum went on to achieve great fame but the man whom it was all named after never lived to see it as Alexander the Great went off on other campaigns and met his own demise. However this rich history is clashing with a very troubled present as the groundswell of the Arab spring meet a lower oil price and both actual terrorism and the fear of it impact.

The Egyptian Pound

This morning’s news comes to us from Arab Economic News.

The Egyptian central bank devalued the pound by almost 13 percent at an “exceptional” sale of dollars on Monday.

The central bank said it sold $198.1 million to local lenders at 8.85 pounds per dollar. That compares with a previous exchange rate of 7.73 pounds. It wasn’t immediately clear whether the lower price is just limited to Monday’s dollar sale. Central bank officials weren’t immediately available for comment.

I do like the idea that you could devalue just for one day! Especially as we are immediately given a clue as to why this has happened.

Egypt is grappling with a dollar squeeze that is threatening economic growth in the most populous Arab country. Foreign-currency reserves have tumbled by more than 50 percent since 2011, though they have stabilized at just over $16 billion in the past six months.

When a country sees a rush for US Dollars that is invariably a sign of what Taylor Swift would call “trouble,trouble,trouble” and can end up in the sort of situation I have described in the past in Ukraine were it becomes a parallel currency for some anyway.If we return to the foreign reserves situation we see another familiar tale as Reuters take up the story.

Egypt’s reserves have dropped from $36 billion in 2011 to $16.53 billion at the end of February.

Over this time the currency has been falling as @RtrsAgAnalyst points out.

As you can see the period after the Arab Spring has seen both currency declines and foreign exchange reserve falls in a familiar pattern for a fixed exchange rate. According to Renaissance Capital it had the most overvalued currency in real terms of any of the Emerging Markets. That is no doubt related to pegging your currency against the strong US Dollar. In a way this from Gerry Rice of the International Monetary Fund in January confirms this.

We would like to stress the need to raise exports in order to promote growth and for exchange rate flexibility to support this, allowing the exchange rate to move to a market clearing rate where supply meets demand, would boost exports, and prevent foreign exchange shortages.

Those who have followed the disastrous policies the same IMF has applied to Greece may reasonably be wondering why a “market clearing (exchange) rate has been denied to it? Perhaps it might provide an antidote to the usually sycophantic media coverage of its Managing Director Christine Lagarde if style could be replaced by substance. After all the quote about is a clear critique and indictment of IMF policy in Greece.

Why are devaluations invariably too late?

I think that there are three major reasons for this. The first is that establishments and what are considered to be elites tend to be much less intelligent than they think they are. Secondly reality is rarely a friend of theirs. Thirdly and interrelated to all this is that they usually try to get their own money out first! In a way this news from China from Saturday highlights this. From Bloomberg.

China is tightening restrictions on the use of third-party payment providers to buy insurance products in Hong Kong as authorities move to stem outflows of the yuan.

I am sure we will find investment elements in these products as we note how inventive people can be. Personally I believe that sometimes the authorities are slow to close down such channels – after all some US $1 Trillion has reported fled China in the last year -because they want a slice of the pie!

The economy

Last September the IMF pointed out that it was not all bad news.

Macroeconomic figures also point to some improvement, with growth rebounding to 4.2 percent in 2014/15, and inflation has declined.

However we feel a chill down our spines as we see the word “resilience” applied to the banking sector as that usually means it is either going to need it or a bailout will be required. Also at a time of political disquiet we are reminded of “trouble,trouble,trouble” again.

At the same time, unemployment remains high notably among the youth

Only six months before Christine Lagarde had pointed out this.

Over the coming five years, there will be more than 600,000 new entrants to the labor market per year.

Have you noticed how according to the world establishment both growing and shrinking workforces are a bad idea?! Poor old Goldilocks never seems to have her porridge just right or in IMF speak.

This is a moment of opportunity.

For those of you wondering things are not as bad a being “on track”. Although perhaps the IMF will inform us as to how raising taxes such as introducing the same VAT which has cause so much economic pain in Greece will help the poor in Egypt.

What now?

The currency controls imposed a year ago had created a bit of a crunch on the economy according to Reuters.

At the same time, the central bank lifted caps on withdrawals and deposits of foreign currencies for individuals and companies importing essential goods, easing forex controls imposed a year ago that had all but paralysed trade……..Businesses who saw a devaluation as inevitable were holding back on investment.

Also there is the issue of lower receipts from tourism as the impact of the Russian plane crash in Sinai and as we mull lower figures for the Baltic Dry Index this consequence from the Middle East Monitor.

a decline in revenue from the Suez Canal

The latest economic growth numbers showed 4.5% but they are from the middle of last year and with the workforce growth we note that per capita growth will be less. Any slowing will only reduce progress on that front and reinforce Egypt’s long-standing problems with poverty and inequality. As to interest-rates some 15% is being offered to investors today on some 3 year bills as long as you can provide some foreign exchange and inflation is 9.1%. For a description of that mixture let me hand you over to Ms. Britney Spears.

Don’t you know that you’re toxic


Any economic woe poses its own problem in a country that is already so troubled. For example lawmakers have accused the European Parliament of being influenced by the Muslim Brotherhood which as far as I know not even Nigel Farage accuses them of. Meanwhile the economy is one of those being affected by the lower oil price as the US EIA indirectly highlights.

Egypt is the largest non-OPEC oil producer in Africa and the second-largest dry natural gas producer on the continent.

Also Egypt has relied on loans from Saudi Arabia and the United Arab Emirates to finance its balance of payments problems and such funds must be in shorter supply. Add the issues described above and 2016 will be hard going especially as the troubles have seen falling gas production in spite of new fields being found.

On the upside there is this from the IMF research although of course it is not clear how this can coexist with the spread of fundamental Islam.

For instance, Aguirre and others (2012) suggest that raising female labor force participation to country-specific male levels would boost GDP in the United States by 5 percent,
in Japan by 9 percent, in the United Arab Emirates by 12 percent, and in Egypt by 34 percent.

Oh and who always benefits from establishment moves?

Commercial International Bank surged 7.0 percent and investment bank EFG Hermes jumped 9.9 percent. Real estate developers Egyptian Resorts and Talaat Mostafa Group each climbed more than 8.0 percent. (Reuters)






The China financial crisis of 2016 is partly a reflection of the mighty US Dollar

We are not even out of the first week of 2016 and there is already a litany of financial and economic news out of China. We discussed several times in 2015 the issue of whether the Chinese central planners could make a better job of this sort of thing than the evil capitalist imperialists of the West and this week’s news suggests maybe not! Let us remind ourselves of one of the signs of trouble which I discussed on August 11th by looking at what the People’s Bank of China (PBOC) had done.

The bank then weakened the midpoint to 6.2298 per dollar on Tuesday morning, compared with Monday’s 6.1162 fix – the biggest-ever one-day adjustment to the midpoint.

So we saw that the Yuan ( which seems to have replaced the Renimbi again…) was seeing two things at once. Firstly it was continuing a journey from a fixed exchange-rate in the direction of a flexible or free once. Secondly it was being devalued/depreciated as the flexibility was downwards. At the time I pointed out that this was a new front in the currency wars of the time as we were already seeing the Bank of Japan and the European Central Bank push the Yen and Euro later. We know now that ( as I discussed yesterday) the Euro was about to take a dive.

This week

If we look back to August we see that the Yuan declined to around 6.4 versus the US Dollar quite quickly and then we saw a period of relatively stability as for example a month ago it was at 6.4. Actually it had rallied and dipped back. But since then we have seen a slow decline which has been replaced by faster falls this week. Central banks always have difficulties with a managed float of this sort and China has seen the same and now it finds the Yuan at 6.59 versus the US Dollar. Actually another sign of trouble is that the offshore Yuan is at 6.68 right now showing quite a gap and it was at 6.74 earlier until a fall back which looks rather like PBOC intervention to me. Thus we see that the managed float has proved problematic in 2016 so far with today the most difficult as an attempt to push the Yuan higher ended with it being fixed lower. We are back to levels seen in February 2011.

Currency reserves

This morning has seen news of trouble on this front too. I will let Reuters take up the story.

China’s foreign exchange reserves, the world’s largest, fell $107.9 billion in December to $3.33 trillion, the biggest monthly drop on record, central bank data showed on Thursday.

This backs up the picture for 2015 as a whole.

China’s foreign exchange reserves fell $512.66 billion in 2015, the biggest annual drop on record.

So it looks as though China has certainly been splashing the cash in 2015 to support its currency. As we have discussed monetary flows into China have become outflows and I note that RBS think that in the year to November 2015 outflows were of the order of one trillion US Dollars.

If we look at this in the style of the film “Airplane” then it looks as though the International Monetary Fund may have chosen a bad time to put the Yuan in its SDR (Special Drawing Rights) basket.

The strong dollar

A factor underreported in this is that China is at least partly suffering from its decision to at least partly fix its currency against the US Dollar. The trade-weighted Dollar Index is at 98.7 as opposed to the 80 or so of the summer of 2014 and this move has put the squeeze on quite a lot of currencies. If we look at 2016 so far ( h/t @BTabrum) then of 22 emerging market currencies the Yuan is in 11th place below the Singapore Dollar but above the Russian Rouble and its fall is small compared to the 6% of the Argentine Peso.

Trade-weighted Yuan

On December 11th the PBOC with interesting timing guided us towards a new trade-weighted index for the Yuan or Renminbi and here is the latest report.

According to the latest figures, on December 31, 2015, the CFETS RMB exchange rate index closed at 100.94, gaining 0.98 percent from the end of 2014;

In case you do not get the message then it is rammed home.

The mixed movements of the three RMB exchange rate indices are a reflection of overall stability of the RMB exchange rate against a basket of currencies in 2015…….The current conditions are supportive of relatively stable RMB exchange rate against a basket of currencies.

Actually in a way they have been proven correct today alone.

In 2016, the RMB exchange rate regime will continue to be based on market supply and demand and with reference to a basket of currencies. We expect that the exchange rate will move in both directions with flexibility.

So we move on having noted that at least some of the trouble right now has been caused by a sort of managed fixing versus the US Dollar. This has been exacerbated by the strength of the US Dollar which has put pressure on currency management. If we look at the other extreme of a free float even the previously firm UK Pound £ has been feeling the strain as it has been pushed below US $1.46. So the PBOC may be singing along to Brandon Flowers of The Killers.

And we’re caught up in the crossfire of Heaven and Hell
And we’re searching for shelter

Equity market pain

You can argue that there was only a very brief equity market in China this morning. There was only 29 minutes of trading as the market fell by just over 7% with the CSI 300 index falling 255 points. So much for a free market? Oh and where was the plunge protection team when it was most needed?

If we look for perspective we see that back on the 11th of August the Shanghai Composite equity index had a high of 3970 and today it closed at 3116. In the meantime we have had a barrage of moves to support the markets but technical and economic such as the interest-rate cuts. But like the evil capitalist imperialists discovered such moves struggle to reflate a deflating bubble. The falls have been particularly sharp this week so far as the Shanghai Composite closed 2015 at 3539 meaning there has been a 12% loss so far in 2016.

There has been an international impact too as we see that the UK FTSE 100 has fallen below 6000 today and as I type this is down 160 points at 5913. So central bankers around the world will be watching this – and in the case of the US Federal Reserve with sweaty palms and maybe a racing heartbeat – as they have targeted asset prices which includes equities. Spare a thought for Swiss taxpayers should this go on as of course the Swiss National Bank has become something of an equity investor in recent times.


A deeper analysis of the Chinese situation shows us that its own financial instabilities have been exacerbated by the strong US Dollar. This has been made worse by its decision to set its exchange-rate against it. Thus rather than drifting lower like virtually everyone else instead the pressure builds up, which it has tried to resist, but even with its sizeable currency reserves it has to give way every now and then. This then adds to the pressure as everybody concentrates on the decline in the reserves rather than the large amount left. Also I suspect that those in the “know” have been trying to get out of the Yuan before it falls further which only makes things worse.

The generated instability is also being seen in the stock market where it would appear that at least temporarily the plunge protection team has taken a holiday or perhaps a bath. As this crunches around the financial system we see consequences in many markets and not just other equity ones. For example Dr. Copper has nearly touched US $2 and Brent Crude Oil fell earlier to below US $33.

If we now move to the real economy we know that it had slowed down in China as highlighted by this week’s services and manufacturing surveys which indicated stagnation at best. The PBOC and Chinese authorities will be hoping for a disconnect between financial markets and the real economy but sadly for them this is usually an example of an asymmetric relationship. Falls hurt and rallies help little, or at least that has mostly been the picture in the West. Of course markets themselves are likely to be volatile as for the last day of trading this week it would hardly be a surprise if the plunge protection team was already doing some calisthenics and limbering up. For them there is only one song today courtesy of David Bowie and Queen.

It’s the terror of knowing
What this world is about
Watching some good friends
Screaming, “Let me out!”
Tomorrow gets me higher
Pressure on people – people on streets



The economic consequences of devaluing the Euro

One of the features of current world economic policy is the implicit effort of the European Central Bank to gain a competitive advantage by driving the value of the Euro lower on the foreign exchanges. Yesterday there was another effort via Reuters.

A consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said, a move that could weaken the euro and push up inflation.

Some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets, the policymakers said.

Actually after the recent speeches of Mario Draghi it was already clear that a deposit rate cut of more than 0.1% was being considered. Or perhaps more specifically they want us to think is being considered. Reuters did however touch on what I consider is the real game here.

The euro fell by as much as half a cent in response to the Reuters story

Draghi’s Currency Wars

Back at the last policy meeting for the ECB it had a problem. The Euro effective or trade weighted exchange rate was in the low 94s which is where it was when it implemented a major expansion of asset purchases back in January. To be specific the value of the Euro had fallen sharply initially and had continued lower until it dipped below 89 in mid-April. But from then onwards it had risen back to pretty much where it had begun. If you look at this in terms of bang for your buck then treading water does not seem especially good value in return for 60 billion Euros of QE a month.

Thus we saw Mario Draghi respond with a salvo of Open Mouth Operations which have involved hints and promises about taking the deposit rate which is already at -0.2% lower and either a fast rate of asset purchases or extending the term beyond the current end date of 2016. In response the Euro has fallen again and has done so most markedly against the US Dollar where it is now in the 1.07s but if we look wider we see that it is at 91.55 on the effective index. Accordingly Mario’s jawboning has been a success in financial markets terms as the Euro has dropped, however for the real economy we need to take care as if you think about it investment decisions are based on estimates of where they think an exchange-rate will be over a period of years not weekly or monthly fluctuations.

Mario has not always been a soft currency supporter

Back in July 2013 we were told a rather different story. From Reuters.

Noting that the currency’s recent strengthening on foreign exchange markets was a sign of renewed confidence in the euro, Draghi told a news conference:

So the current weakening is a sign of a lack of confidence in the Euro which Mario is encouraging? Anyway a year later Mario had decided you could have too much of a good thing. From CNBC in July 2014.

The recent rise in the value of the euro could stifle the flickering signs of growth in the euro zone,

Such reminders raise a wry smile but to be fair they also indicate that too much pressure is on central banks these days in terms of economic policy. Thus they have morphed into political style behaviour.

Competitive Devaluation

Here is something that rarely gets a mention so perhaps it is another example of the military dictum that it is best to hide something in plain sight. In today’s complex world how do you define a competitive devaluation and indeed exporting deflation. Well I would suggest that acting to drive your currency lower via monetary expansion when you are in the process of announcing a quarterly current account surplus of 53.8 billion Euros is a clear example. Indeed fuel is added to the fire by the fact that the surplus was over 20 billion Euros larger than a year before.

Now we get to something even more awkward if we look at the trade colossus which is Germany. In the first quarter of 2015 it announced a trade surplus of 56.8 billion Euros which means that the lower Euro is benefiting one of the factors which those who look at balance sheet balances think got the world into its current malaise. Also I have argued on here in the past that claimed defeats for Germany on policy such as over Greece might be considered a price to pay for a Euro value much lower than where a Deutschemark would be now. There has been an enormous competitive devaluation here which is being added to.

Just for clarity the German numbers include intra- Euro area trade so are not a like for like comparison with the overall Euro area ones.

What about QE?

Fans of the Matrix series of films will recall the bit when the Frenchman tells us about “cause and effect”. Sadly for his eloquent description we see that in the QE era the effect becomes before the cause. In the UK the UK Pound had its 25% or so fall in 2007/08 before QE began in 2009 and the Euro fell in 2014 ahead of the QE announcement in January 2015. Expectations of monetary easing lead to a currency fall before the easing happens or if you like we see yet another example of markets front-running central banks.

Take your pick as to where you think this began but back in April 2014 we saw the Euro top out in the mid-104s in trade-weighted terms but the acceleration began from 100 on December 16th 2014. Either date presents a much bigger move that what has happened since and makes any regression analysis problematic.

The economic impact

Back in March 2014 Mario Draghi told us what the ECB thinks the impact is.

 Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. So we can say that between 2012 and today about 0.4 or 0.5 percentage points of inflation was taken out of current inflation because of the exchange rate appreciation. Having said that, we have to be cautious, because there was a previous depreciation of the euro.

If we look at where we are and compare to the nice round number of 100 of mid-December 2014 then so far if we assume the Euro remains where it is now for long enough for Mario to consider the move “permanent” then the maximum impact on the inflation rate is 0.4%.

The ECB has been much more reticent about the impact on economic growth but if we used the Bank of England rule of thumb we have seen a move equivalent to to 2% fall in interest-rates. If we make a larger jump and look at the numbers established by the US Federal Reserve yesterday then the Euro area would get a 2.2% rise in exports and a 0.6% rise in economic output or Gross Domestic Product. Now I rush to say that America is not the Euro area and we are ignoring gains from falls in imports as the Euro is not the reserve currency but it does give an impression. Also you could choose different dates to compare.

Also we have to factor in that the Euro area has lost some of the gains from the falling oil price as it fell too. Over the past year it has taken away about a third of the gains that would have otherwise taken place.


I will leave that to the Swedish Riksbank which has rather intriguingly trolled the ECB in its monthly minutes which were published earlier today.

The markets have also interpreted the latest communication from the ECB as a clear signal that further stimulus measures are to be expected in December……. The ECB has indicated that it may make its monetary policy even more expansionary.

Indeed is the next bit trolling or a threat?

Expectations of a more expansionary monetary policy from the ECB have, together with an appreciation of the Swedish krona in September, contributed to the majority of analysts expecting further easing measures from the Riksbank before the end of the year,

So the Riksbank is trolling both the ECB and analysts now? Anyway the Financial Times reported it this way.

Riksbank head ‘would not hesitate’ to intervene in FX (Foreign Exchange).

This is obviously in itself a localised issue in the sense that Sweden is so near to the Euro area and is relatively small. But we are faced if we look at the countries looking to lower their currency as well (Japan springs to mind) with the issue of who is going to import the deflation they export? Meanwhile Paul Krugman searches for David Bowie on Spotify.

Is there life on Mars?

Or for Jeff Wayne.

At midnight on the twelfth of August, a huge mass of luminous gas erupted from Mars and sped towards Earth

China joins the Currency Wars as it devalues

One of the themes of this website has been that with other types of monetary policy being increasingly ineffective that exchange-rates have moved to the front of the pack. We have seen interest-rates cut to and sometimes below what was previously considered to be the lower bound but if such efforts were as effective as claimed we would not be where we are. Also I am reminded of the fact I noted yesterday which is that all 15 OECD countries which have raised interest-rates post credit crunch have since cut them! All sorts of extraordinary monetary policies have also been tried in some cases in the billions, in others in the trillions. However countries have increasingly tried to gain a relative advantage by lowering their exchange rate leading to this from Brazil’s Finance Minister back in September 2010.

We’re in the midst of an international currency war…This threatens us because it takes away our competitiveness.

The advanced countries are seeking to devalue their currencies.

Hence the Currency Wars theme which has seen an opening salvo fired this morning into the Pacific and perhaps the South China Sea.

China Devalues

Here is the statement for the People’s Bank of China or PBOC

Effective from 11 August 2015,the quotes of central parity that market makers report to the CFETS daily before market opens should refer to the closing rate of the inter-bank foreign exchange market on the previous day, in conjunction with demand and supply condition in the foreign exchange market and exchange rate movement of the major currencies.

It is a rather unwieldy statement to say the least! So this is what happened next according to Bloomberg.

The bank then weakened the midpoint to 6.2298 per dollar on Tuesday morning, compared with Monday’s 6.1162 fix – the biggest-ever one-day adjustment to the midpoint.

I note that Bloomberg has concerns over what this might mean going forwards.

Under the new method, market forces would have more ability to take the yuan lower in the weeks ahead,

As an aside there was for a while a fashion for calling the Chinese currency the Renminbi whereas the Yuan seems to have returned to some extent. So we have a lower currency and a new perspective from China.

Wasn’t it supposed to be appreciating?

This section is along the lines of this from Blueboy.

Remember me?

Let us go back to June 21st 2010.

the People´s Bank of China has decided to proceed further with reform of the renminbi (Yuan) exchange rate regime and to enhance the renminbi (Yuan) exchange rate flexibility.

Even for central bankers they are euphemistic! The Chinese currency was going to be allowed to rise against the US Dollar in response to arguments like this.

For those who do not follow the situation closely it has been considered for a while internationally and by the US administration that the Chinese Yuan is undervalued (estimates vary between 25 and 40%) and that this is one of the reasons for China’s Balance of Payments surplus and  a contributor to the American deficit.

Back then some 6.83 Yuan purchased a US Dollar and after today’s move to 6.23 we see that the total appreciation was just under 9% or nowhere near enough to correct the claimed undervaluation. However we need to think wider as the US Dollar has been rising meaning that an ever-growing list of currencies are undervalued against it. In May the Peterson Institute crunched the numbers resulting in this covering the year to April.

The most important changes were the large effective appreciations by the US dollar (about 12 percent) and the Chinese yuan (about 12 percent),

So we now find ourselves on a road where the Chinese currency is no longer undervalued and in fact on its way to correcting this has put a squeeze on the economy. If we switch to comparing it with its neighbours we see this.

Now we have rather a different perspective which is that China has been seeing a currency appreciation especially against its trading competitors as shown by the rise of the yellow line in that chart. Back in January 2014 FT Alphaville quoted this from Lombard Street Research.

But the situation now differs because the currency has become overvalued since 2011. The rebalancing from investment towards consumption given the overvalued yuan would be made easier if the currency is allowed to depreciate as capital flows are liberalised fully.

To put it another way China could not cope with the level of its exchange rate and there was trouble ahead. Since then the slow down in its economy has backed that up and now perhaps we are seeing an official response.

The currency devaluers

Another way of putting this is that devaluing or depreciating your currency is called exporting deflation. Now let us return to the Peterson data quoted earlier and see what it tells us about that.

and the large effective depreciations of the euro (about 11 percent) and the yen (about 8 percent).

If we take that a step further we see that two large currency blocs are devaluing from a position of strength in trading terms. The Euro area has a consistent current account surplus and whilst in recent times energy imports have pressurised Japan on this front it is hardly a serial deficit nation! So we are left with the thought that they and in particular Japan have exported deflation to China. When Abenomics turned Japan into a currency depreciation some 12.4 Yen bought one Yuan whereas this morning it took 20 of them. Quite a change is it not? It matters as the two countries trade together on a large scale.

Exports (referred to as China’s imports from Japan hereafter) increased by 0.3% to US$162.7 billion and imports also rose by 0.1% to US$181.0 billion. (Jetro).

Added to this is the fact that they will have more than a few industries that compete with each other for business around the world. So for China the plunge in the Yen caused by the policies of Abenomics have been a large issue and may well have been the straw which broke the camel’s back.

The International Monetary Fund

This has its own unit of currency called Special Drawing Rights or SDRs. These are based on the US Dollar, Euro, Yen and UK Pound £. An obvious issue is why not have China’s currency too and here are the thoughts of the IMF from last week.

The Chinese renminbi (RMB) is the only currency not currently in the SDR basket that meets the export criterion. Therefore, a key focus of the current review will be whether the RMB also meets the freely usable criterion in order to be included in the SDR basket.

There is much to consider here not the least that two of the current four ( Euro area and Japan) are indulging in large-scale Quantitative Easing operations to reduce the value of their currencies. Unless the basket is extended the UK may well find itself demoted.

For now the issue over the Chinese currency is the fact that it is plainly not “freely usable”.


It seems that a new front has been opened up in the currency wars campaign. The Chinese authorities will know that they have sent a signal here to the rest of the world and that there will be concerns that they are a new kid in town.

There’s talk on the street; it sounds so familiar
Great expectations, everybody’s watching you
People you meet, they all seem to know you
Even your old friends treat you like you’re something new

If we look at the recent signals from the Chinese economy we know that a depreciation of just under 2% is far shy of what might reverse that. So we see a potential game of pass the exporting deflation parcel where Japan has been joined by Euro land and China responds. Now who thinks that the UK and US will respond to that with interest-rate rises?

Meanwhile in a land down under christened on here as the South China Territories there must be real concerns about what is going on and how much they will be sucked into it. From Bloomberg.

The Australian dollar lost 1 percent against the dollar on China’s devaluation,

As to whether this will solve the problem the aptly and presciently named China Crisis have some thoughts.

And if I wish to comfort the fall
It’s just wishful thinking

After all unless there are Martians it is all a zero sum game.

Greece needs to grasp the nettle of default and devaluation now

Today begins with hopes of a new path for Greece where the people have been under the shackles of a Euro area imposed austerity programme which collapsed the Greek economy. It was not supposed to be that way as the future was bright according to the official forecasts and their apologists.

put the debt-to-GDP ratio on a declining path from 2013.


but from 2012 onward, confidence effects, regained market access, and comprehensive structural reforms are expected to lead to a growth recovery. Unemployment is projected to peak at nearly 15 percent by 2012.


As you can see that was a complete hoax call and a much worse one than the one troubling Prime Minister Cameron. Even at the end of 2012 rather than the promised “growth recovery” the Greek economy was instead shrinking at an annual rate of 5.7% on it way to losing around a quarter of its output overall. Even worse the unemployment rate which was supposed to peak at 15% climbed and climbed and as of the latest monthly numbers was still at an appalling 25.8% in October 2014. It is hard to imagine a worse failure especially as the apologists for this economic destruction regularly rubbished alternatives with the claim that they would lead to an economic Armageddon.

I consistently argued that there is another and better way I subject I returned to on the 30 th of December.

I am one of those who have consistently argued that Greece should default and devalue along the lines of the sort of programme that the IMF used to apply before it switched from plans based on economics to ones based on (French) politics.


So far the only rescue has been for the French and German banks which overextended and overexposed themselves in Greece. In return their taxpayers find themselves exposed to a threat of default by Greece via the various off-balance sheet mechanisms (EFSF and ESM) which have been used as bank errors were socialised.

A Fiscal Problem

The claim has been that the Greek public finances have been reformed but as we stand issues remain as the quote from Kathimerini below illustrates.

According to officials from the General Accounting Office, the lag in tax revenues compared to the targets set for January is greater than 1 billion euros. When this is added to 2014’s 1.3-billion-euro tax revenue shortfall, the fiscal gap in revenues amounts to 2.3 billion euros.


Added to this is the enormous debt burden which is Greece is now carrying. As of the end of the third quarter of 2014 it amounted to some 315.5 billion Euros or some 176% of Greece’s GDP (Gross Domestic Product). Here we see complete failure as the default/haircut of 2012 was supposed to reduce this ratio to 120% whereas it was saying “I’ll be back” just like the Terminator.

The interest payments have been cut and cut by the creditors who are now mostly taxpayers of other countries as organisations they support own around 4/5 ths of Greece’s national debt now. So interest payments have been contained for now but the capital issue or how this will ever be repaid was kicked into an undefined future. So the banking sector was bailed out but mostly Euro area and some of the rest of the world taxpayers (via the IMF) got what is called in rugby a “hospital pass” of the accumulated debt and losses.

Enter Syriza

Up until now the Greek political class has in essence supinely adopted whatever policies it has been told to implement by the Troika (European Commission, ECB and IMF) except for one major omission. This comes under the category of reform which of course would include removing themselves! Also if Greece had managed to tax its oligarchs the problem would have been reduced considerably in scale. So those presenting the solution were always part of the problem which is why that I hope that the new government that has just been formed by Syriza turns out to be a new boom clearing out the political and economic dust and cobwebs.

It is one of the tenets of this blog that I do not do politics and thus I will steer clear of the political debate. However I welcome this which is an excerpt from a Bloomberg interview with the newly appointed finance minister Yanis Varoufakis.

“extend and pretend was applied to a whole nation (Greece)”


To end this vicious cycle…….which is beating into a pulp a proud nation in the south-east of Europe.


According to Channel 4 in the UK he has presented himself as an economic reformer.

‘We are going to destroy the Greek oligarchy system’


Let us hope that there is genuine economic reform in Greece starting today as there is no time to lose. As Tears for Fears put it.

You can change


Let us also hope that this from The Last Resort by the Eagles will stop being prescient.

Some rich men came and raped the land,
Nobody caught ’em


Market Response

Initially the Euro fell on the foreign exchanges to an eleven year low but a bit like the Duke of York (ahem) it marched back up the hill to where is began! So it is now just above 1.12 versus the US Dollar. The Greek equity market  has dropped 2% but things seems calm although some care is needed as of course the ECB with its planned QE (Quantitative Easing) program which begins in March is sitting there as a back-stop. Although of course the QE program did in a way start very early in Greece as so much of its debt is in official hands.

There may have been action elsewhere however as rumours have been circulating that the Swiss National Bank has been capping the Swiss Franc against the Euro again. Well I guess it has intervened at almost every level on the way up! Whatever the exact cause the two currencies have returned to parity,for now at least.


The Greek election has ramifications for several other Euro area countries as for the first time a government has been elected on what we might call an anti-Troika vote. Should it hold its nerve and prove to be stable then it will be hard for the Euro area establishment to copy what it did to Ireland and play Gerry Rafferty from its loudspeakers.

Get it right next time


They of course will be hoping that the words from Hotel California remain true for the Euro.

“Relax, ” said the night man,
“We are programmed to receive.
You can check-out any time you like,
But you can never leave! ”


My advice is that of course Greece could and should leave the Euro and default. There are of course dangers in such a course but they are dwarfed by the economic and human catastrophe that has already taken place. I think that it is much more likely that Greece will reform itself and throw of the shackles of its establishment that is like an anchor on a ship in such a scenario. Actually you do not have to take my word for it you can instead read the words of the “on track” high priestess Christine Lagarde of the IMF.

‘Reforms Are Still Needed In Greece’ (Le Monde)


With apologies to the Bee Gees perhaps this can come true.

I saw my problems and I’ll see the light
We got a lovin’ thing, we gotta feed it right
There ain’t no danger we can go too far
We start believin’ now that we can be who we are – greece is the word