Tuesday, 16 December 2014

Russian Roulette

The Russian authorities are following the neo-classical, 'sound money' playbook by the letter right down the drainpipe.

It didn't work for Argentina.

It didn't work for Turkey

So let's do the same thing all over again and expect a different result. What was that definition of insanity again? Something about truth by repeated assertion and thereby constantly misattributing a quote.

Currency markets are very simple. It's raw supply and demand. There are no market makers and every open trade has to be settled with delivery of the currency at 10pm GMT every day.

That means you have to get hold of the real thing and give it to somebody else or get out of the market. So the actual final liquidity in the market that allows things to move comes from people actually changing what they hold over a daily basis. Those playing Contracts for Differences and throwing 'forward next' are just greasing the daily wheels with liquidity. Overall net short positions from an aggregator still have to be delivered. You have to supply roubles and take US dollars. That means getting the roubles in the first place and is an obvious control point in the system.

The overall effect of the current crisis is that the rouble currency area is shrinking. Currency areas are not necessarily the size of the country that owns the currency. They can be bigger or smaller than an individual country. What size they are depends upon how the country uses the monopoly power of the currency to influence activity.

In Russia you are getting 'dollarisation' where people are giving up their rouble savings to hold USD. That expands the USD currency area into Russia and shrinks the Rouble currency area. And it is also the supply of those roubles the shorters need to cover their delivery positions.

As usual jiggling around with interest rates will not sort this situation out. This is now a quantity and qualitative situation that requires you to make the rouble more scarce. Paying people more interest from the central bank or issuing more bonds is not the way of making something more scarce. I find it bizarre that central banks cling to the jiggling interest rate myth when the evidence around them is clearly demonstrating that that particular lever is not connected to anything useful, and probably never has been.

Shrinking currency areas need to either stop shrinking or have less currency in them. You need more demand or less supply.

The insights from MMT show that exports are a real cost and imports are a real benefit. The sanctions in place are stopping imports coming into the country. So there is no need for the exports. Russia should just turn the taps off, which would bring Europe to its knees in a second. That they haven't done that suggests that Russia has the same problem as Argentina - the country is actually run by an Oligarchy that prefers to operate their export industry mostly in a foreign currency. So actually you can discount the entire oil and gas industry as a different country almost - operating largely outside the Russian currency area.

The shortage of food and basic items brought about by the sanctions should be solved using a simple wartime approach - rationing. If there isn't enough buckwheat to go around, then you can't use price to resolve the distributional struggle. You'll end up with starvation and riots and stockpiling of food. So assuming you care, then you'd ration the real goods for which there is a shortage and work at relieving the supply shortage. Set a price limit and a quantity limit. Start issuing ration coupons. And ban imports of Leah Jets, etc. You don't need luxury goods when the country hasn't enough food.

In terms of financing the Russian Central bank has to narrow the scope of Russian banks. Any lending to settle currency transactions in roubles should be banned. The Central bank should bar itself from directly intervening in the currency markets. And it should not be doing swaps into USDs, but offering to settle foreign debts for needed commodities - like buckwheat.

In addition it should be offering financing in roubles to pre-pack administration proposals for any important business crippled by foreign currency debt. That forces losses onto foreign creditors in foreign currencies - as well as Russian USD holders. If you get moaning from foreign creditors blame the currency war. Then perhaps they'll put political pressure on their own central bank to act and stem the losses.

Beyond that the fiscal authorities need to start taxing in Roubles more - preferably the oil and gas pipelines. And then turning them off if they don't get paid. The power play in Russia determines whether that is viable. Beyond that taxing USD accounts held at Russian Banks in roubles would help eliminate balances in those accounts as would a financial transaction tax on roubles (offsetable against real activity).

Get the supply of roubles down, and the demand up - using the monopoly power of the government over the currency area. There are probably other things that could be done just as soon as you take the correct viewpoint.

And please let's can this idea that if you just set the interest rate at a particular level everything will magically calm down. People are not robots.