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As if Russia did not already have enough worries, with the security issues associated with the Sochi Olympics and the growing unrest next door in Ukraine, it now faces severe downward pressure on its currency. Any currency crisis flirts with economic opportunity and political disaster at the same time. The falling ruble can address some of Russia’s structural economic shortcomings, but only if other financial resources are made available in the process.
Russia is not alone in seeing its currency plunge. Turkey, South Africa, Argentina and Thailand have all experienced precipitous declines in their respective currencies since the beginning of 2014.
A common refrain runs through all these cases. The end of the U.S. program of quantitative easing and foreign investors’ rapid retreat from emerging markets has jolted the currency market, creating uncertainty in its wake. Throw in Russia’s low growth rate, high levels of capital flight and endemic corruption and one has all the conditions for a perfect currency storm.
January was a particularly bad month for the Russian ruble, with the currency falling more than 6 percent against the euro-dollar basket. The ruble rebounded a bit in early February, but it has again resumed its downward trend, with many experts speculating that the currency has yet to find its bottom.
The currencies of Russia’s post-Soviet neighbors also are in freefall, most notably in Ukraine, where currency controls have been introduced to save the hryvnia from total collapse. Kazakhstan, meanwhile, preemptively devalued the tenge by 19 percent in an attempt to keep its economy—and its exports—competitive.
To date the Russian government’s response to its currency woes has been reasonably restrained, unlike during the 2008-09 crisis when the Central Bank quickly went through $200 billion in reserves to defend the ruble. Russia currently possesses almost $500 billion in foreign exchange reserves. So to the extent that Russia has a rainy day fund, it is not raining hard enough, from the Central Bank’s perspective, to justify a major intervention to slow the ruble’s slide.
A falling ruble, in fact, solves several problems for the Russian government while setting the stage for a potential economic recovery. President Putin made several big campaign promises in 2012, especially in terms of increased social spending, that put significant strains on the Russian budget last year. Since the Russian government can make these payments with cheaper rubles, the burden on the budget has shrunk.
The decline in the ruble’s value also presents opportunities for Russian exporters, since their products naturally become more competitive abroad as the ruble declines. Though it appears unlikely that most Russian companies are in a position to profit from this changing dynamic, Russia’s wheat exports are up dramatically thanks to the declining ruble.
Russia brings other advantages to this crisis as well, including a balanced budget and a steady stream of hard-currency earnings that are not tied to value of the ruble, thereby allowing the state to replenish its coffers at a consistent rate. So one can clearly identify the scenario where Russia not only survives this devaluation but theoretically comes out in a better place than where it started.
But not all currency crises have happy endings. A weaker ruble portends a lower standard of living for many Russians. The specter of inflation further hovers over Russia as its citizens invariably will now chase after imported consumer products with cheaper rubles.
But the big unknown is whether Russia is flexible enough to benefit from the current financial crisis. As the ruble weakens and the price of labor and other inputs fall, Russia should be in a position to replace expensive imports with more affordable Russian-made goods. Such substitution occurred after the 1998 currency crisis and ultimately contributed to Russia’s sustained recovery.
Yet today, it remains an open question whether Russia possesses adequate financial and human capital to spark such business investment. Over the past decade, Russia’s entrepreneurial spirit has been snuffed out through excessive government regulation, corruption, and the steady rise of state-owned enterprises. The legal environment is so suffocating that Russia may not have sufficient reserves of entrepreneurs willing to assume the risk and invest in the Russian market.
Russia also still suffers from disastrous capital outflows. More than $60 billion dollars left the country last year for various destinations in the offshore banking system—and this money is exactly what Russia requires to buy equipment and otherwise invest in domestic business in order to take advantage of the falling ruble. Yet there is no sign that this money is returning onshore any time soon, especially if the government continues to talk about taxing Russian offshore companies doing business in Russia.
No supplemental investment means no sustained economic turnaround and the growing likelihood that a falling ruble will mirror a weakening economy, as opposed to reversing it. And as recent events in Argentina and Turkey suggest, such a development is a recipe for political failure. In both of these countries, a collapsing currency has fueled speculation as to the long-term prospects of their leaders. President Cristina Fernandez and Prime Minister Recep Tayyip Erdogan are floundering, in part because to address the currency crisis means to question the very economic policies that have sustained their popularity during their many years in power.
President Putin has not had to face this choice as of yet, but that day of reckoning may be approaching if Russians realize that basic Western consumer goods, foreign travel, and other perks of Russian capitalism are now beyond their reach.
Russians have weathered several currency crises over the past thirty years; so far, no one is shouting that the sky is falling. However, a currency crisis that is not contained could easily spill into politics, something that Putin wants to avoid at all costs. If the latter occurs, then it will be officially raining in Russia, and money will be no obstacle in any attempt to stabilize the ruble.
Will Pomeranz is the acting director of the Kennan Institute for Advanced Russian Studies at the Wilson Center in Washington D.C.
Image: RIA Novosti archive, image #978876 / Alexey Kudenko / CC-BY-SA 3.0
It has gone from being one of the world’s wealthiest nations to a serial defaulter, but can it get back on track?
Counting the Cost Last updated: 08 Feb 2014 04:56
|Argentina was once the world’s seventh richest country. But economic mismanagement by successive governments has left the country looking down the barrel of another default.
Since the 1980s, Buenos Aires has defaulted three times on its debts – most famously, perhaps, in 2001 when it refused to pay the creditors of its $95bn debt. Since then it has essentially been shut out of international markets.
To service its debt, Argentina started using central bank reserves. But the peso has been devalued by almost 20 percent, leading to spiralling inflation as a toxic cocktail of uncertainty and speculation drives prices through the roof. And Argentinians are feeling the pinch:
“We are in bad shape,” says mother of six Cynthia Cabrera. “With what my husband makes loading trucks at the vegetable market, we can’t survive. I have to ask the grocer to give us credit. We live day to day. Here we either eat at midday or at night; I can’t afford two meals now.”
So, what will it take for the government to get the country’s economy back on track? And can it come soon enough?
A double-edged economic sword
When a central bank raises interest rates, it increases the value of its currency, curbing inflation, cooling the economy and attracting investors seeking higher returns.
Lowering interest rates, on the other hand, devalues a currency, making it less attractive to investors, but easier for businesses and consumers to borrow money and spur economic growth.
Some forces, however, are beyond the control of central bankers, especially those presiding over emerging economies vulnerable to sudden shifts in foreign investment. Political unrest or disappointing economic news at home or in key trading partners can trigger a flight of capital from emerging markets.
For six years, the Federal Reserve’s low interest rate policies have pushed investors into emerging markets such as Turkey, Brazil, Argentina and South Africa where they could earn more for their money.
Many have profited handsomely from fast-growing industries feeding China’s insatiable demand for raw materials, but a slowdown in China’s manufacturing combined with Fed stimulus unwinding has spooked emerging markets investors. In recent weeks, they have cashed in their chips for dollars, leaving a glut of devalued local currencies and while that makes exports more attractive, it also raises the frightening spectre of runaway inflation.
Counting the Cost examines this double-edged economic sword.
Europe’s lost generation?
Unemployment is the millstone of this financial crisis, and particularly so amongst 15 to 24 years old. About one-in-four young people in the European Union are unemployed. In the US it is only slightly better at 16 percent.
In the UK alone, youth unemployment cost almost $8bn in 2012, and according to consultancy firm McKinsey, 27 percent of employers have left ‘entry level’ jobs unfilled because they could not find anyone with the necessary skills.
So, how can youth unemployment be tackled? And has it created a lost generation?
This time, the Federal Reserve has created a truly global problem. A big chunk of the trillions of dollars that it pumped into the financial system over the past several years has flowed into emerging markets. But now that the Fed has decided to begin “the taper”, investors see it as a sign to pull the “hot money” out of emerging markets as rapidly as possible. This is causing currencies to collapse and interest rates to soar all over the planet. Argentina, Turkey, South Africa, Ukraine, Chile, Indonesia, Venezuela, India, Brazil, Taiwan and Malaysia are just some of the emerging markets that have been hit hard so far. In fact, last week emerging market currencies experienced the biggest decline that we have seen since the financial crisis of 2008. And all of this chaos in emerging markets is seriously spooking Wall Street as well. The Dow has fallen nearly 500 points over the last two trading sessions alone. If the Federal Reserve opts to taper even more in the coming days, this currency crisis could rapidly turn into a complete and total currency collapse.
A lot of Americans have always assumed that the U.S. dollar would be the first currency to collapse when the next great financial crisis happens. But actually, right now just the opposite is happening and it is causing chaos all over the planet.
For instance, just check out what is happening in Turkey according to a recent report in the New York Times…
Turkey’s currency fell to a record low against the dollar on Friday, a drop that will hit the purchasing power of everyone in the country.
On a street corner in Istanbul, Yilmaz Gok, 51, said, “I’m a retiree making ends meet on a small pension and all I care about is a possible increase in prices.”
“I will need to cut further,” he said. “Maybe I should use my natural gas heater less.”
As inflation escalates and interest rates soar in these countries, ordinary citizens are going to feel the squeeze. Just having enough money to purchase the basics is going to become more difficult.
And this is not just limited to a few countries. What we are watching right now is truly a global phenomenon…
“You’ve had a massive selloff in these emerging-market currencies,” Nick Xanders, a London-based equity strategist at BTIG Ltd., said by telephone. “Ruble, rupee, real, rand: they’ve all fallen and the main cause has been tapering. A lot of companies that have benefited from emerging-markets growth are now seeing it go the other way.”
So why is this happening? Well, there are a number of factors involved of course. However, as with so many of our other problems, the actions of the Federal Reserve are at the very heart of this crisis. A recent USA Today article described how the Fed helped create this massive bubble in the emerging markets…
Emerging markets are the future growth engine of the global economy and an important source of profits for U.S. companies. These developing economies were both recipients and beneficiaries of massive cash inflows the past few years as investors sought out bigger returns fostered by injections of cheap cash from the Federal Reserve and other central bankers.
But now that the Fed has started to dial back its stimulus, many investors are yanking their cash out of emerging markets and bringing the cash back to more stable markets and economies, such as the U.S., hurting the developing nations in the process, explains Russ Koesterich, chief investment strategist at BlackRock.
“Emerging markets need the hot money but capital is exiting now,” says Koesterich. “What you have is people saying, ‘I don’t want to own emerging markets.'”
What we are potentially facing is the bursting of a financial bubble on a global scale. Just check out what Egon von Greyerz, the founder of Matterhorn Asset Management in Switzerland, recently had to say…
If you take the Turkish lira, that plunged to new lows this week, and the Russian ruble is at the lowest level in 5 years. In South Africa, the rand is at the weakest since 2008. The currencies are also weak in Brazil and Mexico. But there are many other countries whose situation is extremely dire, like India, Indonesia, Hungary, Poland, the Ukraine, and Venezuela.
I’m mentioning these countries individually just to stress that this situation is extremely serious. It is also on a massive scale. In virtually all of these countries currencies are plunging and so are bonds, which is leading to much higher interest rates. And the cost of credit-default swaps in these countries is surging due to the increased credit risks.
And many smaller nations are being deeply affected already as well.
For example, most Americans cannot even find Liberia on a map, but right now the actions of our Federal Reserve have pushed the currency of that small nation to the verge of collapse…
Liberia’s finance minister warned against panic today after being summoned to parliament to explain a crash in the value of Liberia’s currency against the US dollar.
“Let’s be careful about what we say about the economy. Inflation, ladies and gentlemen, is not out of control,” Amara Konneh told lawmakers, while adding that the government was “concerned” about the trend.
Closer to home, the Mexican peso tumbled quite a bit last week and is now beginning to show significant weakness. If Mexico experiences a currency collapse, that would be a huge blow to the U.S. economy.
Like I said, this is something that is happening on a global scale.
If this continues, we will eventually see looting, violence, blackouts, shortages of basic supplies, and runs on the banks in emerging markets all over the planet just like we are already witnessing in Argentina and Venezuela.
Hopefully something can be done to stop this from happening. But once a bubble starts to burst, it is really difficult to try to hold it together.
Meanwhile, I find it to be very “interesting” that last week we witnessed the largest withdrawal from JPMorgan’s gold vault ever recorded.
Was someone anticipating something?
Once again, hopefully this crisis will be contained shortly. But if the Fed announces that it has decided to taper some more, that is going to be a signal to investors that they should race for the exits and the crisis in the emerging markets will get a whole lot worse.
And if you listen carefully, global officials are telling us that is precisely what we should expect. For example, consider the following statement from the finance minister of Mexico…
“We expected this year to be a volatile year for EM as the Fed tapers,” Mexican Finance Minister Luis Videgaray said, adding that volatility “will happen throughout the year as tapering goes on”.
Yes indeed – it is looking like this is going to be a very volatile year.
I hope that you are ready for what is coming next.