It's Official: Elvira Nabiullina Wins
the Tall Pointy Hat Award for Mismanagement of the Ruble
December 19, 2014
(This item originally appeared in Forbes.com on December 19,
in October, I wrote that
Russia’s central bank was
apparently making the same mistakes that most all central
banks make when they get into trouble with a falling
currency. It’s the same mistake that the Central Bank of
Russia made in 2008 (until they amended their ways in early
2009), the same mistake that Thailand, Korea and others made
in 1997-98, Mexico in 1995, and the United States in 1971.
That is: the central bank is “intervening” in markets to
support the value of the currency, either by selling foreign
currency, or, as was the case for the last days of the U.S.
gold standard era in 1970, by selling gold bullion. Perhaps
interest rate targets are also raised. However, the monetary
base is not contracting as it should, but is stable or even
What is supposed to happen in these situations, and what
does in fact happen in the case of currency-board-type
automatic systems, is that the monetary base is contracted
by the same amount as the sale of foreign currency reserves.
So, if the central bank sells $100 million of dollars and
purchases the local currency, the monetary base of the local
currency should contract by the equivalent of $100 million.
The local currency received in the sale of foreign currency
is absorbed and disappears.
I’ve been documenting that this was not happening in the
case of Russia, just as it didn’t happen in 2008, until the
Russian central bank changed course in early 2009. I
described this episode, and several other similar ones, in
my 2013 book Gold: the Monetary Polaris
, which you
in free eBook format here
The ruble had been stable around 30/dollar for some time. In
early 2013, the value began to slip a bit, and interventions
began in modest size. However, despite this, the monetary
base continued to grow. The supply of rubles was getting
larger, even as the sagging value indicated that the supply
was already more than sufficient.
In March 2014, there were some large interventions. Then,
the central bank was inactive until more large-scale
interventions in October. (Figures for December 2014 are
month-to-date to 17-Dec.) However, these sales of foreign
reserves were again not matched by equivalent contractions
of the ruble monetary base. The ruble monetary base
continued to rise, at roughly a 6%-7% rate compared to the
same month a year previous. (There’s a bit of yearend
The last graph shows what the monetary base would have
looked like if each sale of foreign currencies was
accompanied by an equivalent reduction in the ruble monetary
base. (This is called “alternative” in the chart.) Including
interventions in the first half of December, the ruble
monetary base would have been 4.244 trillion rubles,
compared to 9.950 trillion actual as of December 1.
In other words, the monetary base would have contracted by
57%. That is a lot! In practice, such a large contraction
would not likely be necessary. A contraction of about
10%-20% over the course of a month, with the promise to do
more if necessary, is enough. (The Central Bank of Russia
records its “broad definition” monetary base at the first
day of the month. I find this confusing, so I relabeled it
as the last day of the preceding month.)
Heck, even video
game central bankers know this
Such a contraction does not have negative economic effects,
because the central bank would be absorbing what amounts to
“excess” rubles. Or, to put it another way, it would be
supporting the ruble’s value – a good thing – not forcing it
dramatically higher, to 20/dollar for example, which could
have some negative economic consequences.
In the short term, there could be a rise in overnight
interbank lending rates. This is a natural market effect
caused by a reduction in the quantity of bank reserves, not
an interest rate policy target. In practice, these increases
in short-term rates tend to be quite short-lived, and often
overnight rates return to low levels within only a few days.
The broader economy suffers no ill effects.
I know what you are thinking. You are thinking: “Ummm, this
seems rather obvious and simple. I can understand it from
this brief description. Are you telling me that the people
managing currencies today, who are supposed to have years of
experience in these matters, and are supposedly at the top
of their field, don’t understand this? And are you telling
me that enormous disasters – including the Asian Crisis of
1997-98, and even the end of the world gold standard system
in 1971 – happen as a result? And that, for some reason,
people haven’t figured this out properly yet?”
Yes, that’s about right. That’s why we make them sit in the
corner and wear a tall pointy hat
“Are you then suggesting that, by reading this one-page
op-ed at Forbes.com, I might now know more about this than
the people heading the world’s central banks? And that this
knowledge could be used to make the world a place with a lot
fewer monetary disasters?”
I can almost see the light bulb light up over your head.
What then happens, for 97 out of 100 people, is that the
idea makes them so uncomfortable – it just can’t be so
– that they put it out of their mind.
The remaining 3 out of 100 are the ones who have the
potential to build the great monetary systems of the future.
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