Tuesday, November 04, 2008

International Monetary Fiddling

Tough times for developping economies. The Ukraine hass seen its currency sink 20%, it stock exchange fall 70% and seen its trade deficit explode because the demand for steel (a major export product) is falling fast. The government spent $2.9 billion buying hryvnas to support the currency in october alone.

Now the IMF has come to the "rescue" by lending $16.5 bln. The conditions are not yet clear but wil include a balanced budget and support for banks.

The question is whether this is any better than past IMF conditions that often nearly destroyed the economy of the receiving nations. I think not.

The Ukraine (and many other rising economies) had an economy driven by foreign investment. This foreign investment financed a hugh trade deficit that allowed a florishing consumer economy. It led to an artificially high currency that was detrimental to autonomous export-led growth.

Now foreign investment and foreign credit has stopped abruptly and the currency is falling fast. Many local companies that had lent in foreign currencies find themselves in trouble and put pressure on the government to support the local currency. The government is complying and spending a lot of money on this. I think it is wasted money.

Nonody knows how long the economic crisis will take. But very probably it will take years before foreign investment in the Ukraine and the other developping countries picks up again. There is no chance that the local governments can keep up supporting their currencies that long at levels that are untenable given the economic fundamentals like the trade balance. So for the local companies it is just a delay of the inevitable. In the mean time the government is wasting money by subsidizing speculators.

In my opinion it would be a much better option to drastically lower the currency at once and spend the money that would be spent on supporting the currency instead on supporting those local companies with foreign debts that get into trouble. It will be a shock for the local consumers, but it is the only way to position the economy for a fast recovery.

Unfortunately the IMF is supporting exactly the opposite policy.


pierre said...

It sounds to me like you have been reading Ron Paul's writings on monetary policy and sound currency.


Wim Roffel said...

Hi Pierre,
No, I don't agree at all with Ron Paul. Contrary to what Paul says the US does not have a problem to get more loans. Some people may think that the US has borrowed too much, but the international markets still think differently. The international aspect of the crisis actually makes investors flock to the US because they see it as a safe harbour with few risks.

America's only problem at the moment are the housing loans and their derivatives. It is a bit similar to the Savings and Loans crisis around 1990. It is more difficult because those insolvent are not a few hundred banks but millions of home owners. But it can be managed.

Serbia is in a different position. Its balance of payments is so bad that it would get a financial crisis in a few years anyway. It is trying to plug the holes by attracting more foreign investors, but in the present situation it is very unlikely that it will attract enough of them to solve the problem.

In the mean time the bad financial news from the region continues - with the Ukrains the worst at the moment. And even Serbia - that does not face an acute crisis - has felt the need to go to the IMF. So you can only expect that foreign creditors will be more reticent to lend to Serbia too.

Serbia's central bank sees that there is a problem. But they pretend that they do their work when they warn the government not run a deficit. But that is not how it works: it is the government that determines what happens and the central bank has to do its work within that context.

pierre said...

It seems Serbia's central bank is different from the USA. The Federal Reserve Bank (a mostly private entity)doesn't have to take orders from the government and indeed has a secrecy component. They are not even identifying the recipients of 2 trillion dollars in loans to banks. What else are they not saying? I believe it is difficult to comment based on this policy.


I do not like referring to wikipedia, but in this case, they have a moderately competent page on the Federal Reserve Bank.

As to making loans to the US. Do you think it is low risk because the Federal Reserve can print money at will? On the other hand, could the US be so far in debt that to allow the US markets to fail will have a domino effect on other countries, and thus they are required to loan money so they can have any chance of recovering prior loans? Just look at the deficit spending of the USA as well as their overall national debt. They are trying to dig themselves out of a hole by borrowing and spending more and more, but in the end they are just getting deeper.

It is my belief that US problems go far beyond housing loans and derivatives.

And, as for Serbia and Ukraine, they will hurt in the short term, but they are learning valuable lessons not to rely on foreign investment that too often comes with strings attached.

Anonymous said...

Ron Paul is also known for a racist and ignorant foreign policy. He's a joke, and got laughed off the stage of United States political culture. I'm glad that Wim changed the subject back to something relevant.

Wim Roffel said...

The US has a 14 trillion dollar economy and a trade deficit of 800 billion. That is 5.7%.

Serbia has an 40 billion dollar economy and a 10 billion dollar trade deficit. That is 25%. Even if you take the Serbian GDP on purchasing power parity - what in this situation makes no sense - you get only an 80 billion dollar economy and a 12.5% deficit.

Add to that that in times of trouble the US is one of the places where people with money go to, while Serbia is one of the places that they leave.

pierre said...

Let's just say I agree with you on Serbia and ukraine, but not the US. I was commenting on a more basic level regarding monetary policy. The figures you mention are attractive and make sense, but when one can't examine core monetary policies, I can't comment on economic successes. That policy will not make the US an attractive place to invest because of the value of the dollar.

Anonymous, than you for your constructive comment which is, as usual, made without any factual basis.

Wim Roffel said...

Well, if you mean to say that the US can't go on forever like it does now I agree with you. But I don't think the US is about to break down now and I expect the next government to follow more sensible policies so that the US won't arrive at that point.

Anonymous said...

Pierre: As usual, I know more about it than you do. If you want me to post some links about Ron Paul's racism and atrocious foreign policy, I will.