Russia’s Currency Crisis: This Is So 2008!
October 16, 2014
(This item originally appeared at Forbes.com on October 16, 2014.)
Are you getting that “it’s kinda like 2008 again” feeling? I am! In November of 2008, the Russian ruble was collapsing vs. the dollar, the Russian central bank was intervening in the foreign exchange market, Russian interest rates had risen to high levels, and I was writing an op-ed about it.
On the surface, it appears that Russia’s central bank is doing what it should to support the value of the ruble. Rubles are being purchased on the foreign exchange market, using foreign reserves. The central bank’s interest rate targets have been raised, with the main overnight credit rate now at 12%.
However, a closer inspection reveals that the central bank — like most central banks in these sorts of situations — is neglecting to address the most important factor, the number of rubles in circulation. The supply of rubles is largely unchanged. If the demand for rubles declines, and supply is unchanged, then a lower ruble value is the inevitable result. Indeed, once market participants notice that the central bank is not properly managing the supply of rubles, it is common for demand to fall even more.
The “supply of rubles” is known as base money. As of November 10, the central bank reported that ruble base money was 4,416 billion rubles. At 27 rubles/dollar, that is worth about $163 billion. On September 1, the monetary base was 4,508 billion rubles. We see that, despite the apparent frantic efforts of the central bank, ruble base money has barely changed.
Well, here we are six years later. The value of the ruble has fallen from 32/dollar at the start of 2014 to about 41/dollar today. The central bank’s policy rate is at 8.00%, and the central bank has intervened in October by buying a total of $9.262 billion of rubles (about 370 billion rubles at 40/dollar). It hasn’t accomplished much.
And the monetary base? Unfortunately, we don’t have data yet for what has happened in October, but it was 9.351 trillion rubles on 1 February 2014 and 9.947 trillion on 1 October 2014.
There is a certain amount of seasonal variation in the monetary base, but particularly in a crisis situation, what should have happened is that the monetary base should have contracted by about the same amount as the amount of forex intervention. The forex interventions before October should have resulted in a shrinkage of the ruble monetary base by about 1.54 trillion rubles, a contraction of about 15%. But, that didn’t happen. Instead, the monetary base actually expanded by 6% over that time. The “too many rubles” problem got worse, with the usual consequences. I’ll guess that the same thing has happened during October as well, as we should see in the statistics soon.
Here’s what I wrote in 2008:
When the central bank sells dollars, it receives rubles in return. To support the value of the ruble, these rubles should disappear from circulation. In other words, base money should decline by an equivalent amount. If this had been done, base money would have declined by about 60%, or 2,646 billion rubles. Only 1,770 billion rubles would remain. If necessary, the central bank could buy every last remaining ruble in existence with an additional $66 billion.
A 60% decline in base money is very large. In practice, it would hardly take such a dramatic effort to support the currency’s value, if the central bank is properly addressing the problem. A 20% reduction should be more than enough. That would require the use of about $33 billion of foreign reserves, a relatively small sum.
At least until the crisis passes, base money should not be allowed to expand via some other open-market operation, such as an interest-rate target. In technical terms, the ruble-buying operation should be “unsterilized.”
I don’t know if anyone in the Russian government read this, but I do know that, in early 2009, they took exactly the measures described. In February 2009, the monetary base shrank by 22%, with an exactly corresponding quantity of sales of foreign currency. And it worked: the ruble rose in value, and the crisis passed. I documented it in my 2013 book Gold: the Monetary Polaris, which is available in free eBook (.pdf) version here. The part about Russia begins on page 133.
So, we know it works.
The appalling thing is that Russia’s central bank should know this, because they are the ones that did it, and it worked for them. But, they seem to have forgotten. (Presumably there are new people there now.) Monetary affairs, today, is in the hands of doofuses, in Russia and everywhere else. People don’t believe this when I say it. But, what else would you call it?
The central bank has a number of options here. It could sell foreign reserves, and reduce the monetary base by the equivalent amount – as it did in early 2009. But, it could also sell domestic assets (government bonds), and reduce the monetary base by the same amount. This way, they wouldn’t have to give up any foreign reserve assets at all. I suggest starting with a 10% contraction in base money, and going to 20% or even 30% if necessary. It doesn’t really matter what kind of asset you sell. The important thing is that there are less rubles in existence than when you started.
Eventually, I hope that Russia will show some leadership in the creation of a new monetary order based on gold. However, before then, they are going to have to learn a few things about how to manage a currency correctly. You can’t manage a currency based on gold, or anything else for that matter, if you act like a doofus.