Sunday, August 21, 2011

Czech koruna as another Swiss franc

According to Record PLC, a London-based currency manager overseeing $31 billion, the Czech crown (CZK or Kč in Czech) may supplement (if not replace) the Swiss franc (CHF, Corporation Helvetia Franc) as the top safe haven currency:
Bloomberg, Business Insider, San Francisco Chronicle

CNBC: Czech Republic, Switzerland of Eastern Europe (new!)

Bloomberg: Czech Market Is New Haven on Low Debt, Stable Koruna, CNBC Says (echo)
Well, they eliminated other currencies whose financial systems suffer from large debt or other problems; and those that don't but the currencies are already overvalued "to the limit". (The much stronger CHF relatively to USD is an unpleasant detail for the Americans working at CERN.)

Of course, the strengthening of CZK since 2000 has already been huge. The USD/CZK exchange rate went from the record high above CZK 44 per USD in 2000 or 2001 to the low point around 14.5 in 2008 (factor of 3 change: very bad for people like your humble correspondent) but it stabilized near 17 in recent years.

A CZK 50 (now: USD 3) coin

During the recent recession, the Czech crown was mindlessly treated as a risky form of investment (it dropped whenever people were more nervous) - a point I found crazy because the Czech economy has been immune against the financial risks - collapsing banks or other companies - and it is also going to be safe for some decades against the sovereign defaults - the public debt is 40% of the GDP.

The traders have learned a lesson and during the recent hysteria, the EUR/CZK exchange rate no longer reacts to the hysteria, at least not dramatically. But I still agree with Record PLC that it should react oppositely because CZK is a safer haven than EUR.

A comparison of the Swiss economy (7.5 million people) and the Czech economy (10.3 million people) may be helpful. Of course, the GDP per capita is much higher in Switzerland - main for obvious historical reasons. The PPP-based GDP per capita is $46,000 in Switzerland, way above the figure of $26,000 in Czechia.

A CZK 2,000 (USD 120) banknote.

However, the nominal GDP shows how CHF is overvalued and CZK is underpriced. It's 1.45 times higher than the PPP GDP in Switzerland, but 1.35 times lower than the PPP GDP in the Czech Republic. Clearly, 1.45 times 1.35 is almost exactly 2, so if all other things were equal, the Swiss franc would be overpriced relatively to the Czech crown by a factor of two.

Things are not quite equal but they're not that infinitely far. The public debt is 40% of GDP in both cases, unemployment is low, exports are somewhat larger than imports. CZ is producing motor vehicles, metallurgy, machinery and equipment, glass, beer, and weapons, among other things. CH is producing machinery, chemicals, Swiss watches, textiles, precision instruments, CO2 hot air into the bubbles in the Swiss cheese, and top quarks. And let's hope that the Higgs bosons and maybe superpartners will also be added to the mix soon. ;-)

Business partners of CH are Germany, Italy, France, and U.S.; in the CZ case, they are Germany, Slovakia, Poland, France, U.K., Italy, Austria etc.

Based on some observations what's happening with the trade deficits and surpluses when the exchange rates move, I am inclined to think that at least a 30% strengthening of CZK would lead to no substantial nation-wide problems - in fact, it would be viewed as a beneficial thing by most players in the Czech Republic. Czechia is an export-oriented economy but it also has to import lots of things (which is easier if these things look cheaper) and the labor itself (the added value) is still cheaper by a factor of 4 relatively to Germany despite the fact that the country is de facto a part of the greater German economy. For this reason, even the strengthening by a factor of 4 (assuming no differential growth in nominal salaries) can't really be excluded.


  1. CZK is linked to EURO, so if EURO falls, CZK will follow. The independence of CZK is much lower than in the case of CHF. Germany is the key to EURO. If the grow stops in Germany, the currency will fall, despite the short term moves of the czech government.

  2. Dear Kamil, what you say is not true in any nontrivial sense. You deliberately used a non-standard and seemingly neutral word "linked" which is meant to mean "pegged". But the crown isn't pegged in any way. It's a totally freely convertible currency whose rate is affected not only by "objective" factors such as the account balance but also by subjective feelings of the market players. During the recession, the subjective feeling was that CZK was a part of Eastern Europe so its exchange rate dropped whenever the anxiety drew and vice versa. Today, it no longer behaves in this way. In the future, it may behave in the opposite way.

    You're also emitting fog when you mention "moves of the Czech government". The Czech government doesn't intervene into the exchange rate of the currency - and really can't do it all. Only the Czech National Bank has tools to influence similar things but its reach is finite and as a matter of principle, the Czech National Bank never tries to target exchange rates. Ask anyone in ČNB.

    Shortly after the revolution, we could have a mark-dollar basket and similar things but this is a very distant history. No similar instruments are being used today. There is no peg and there are no interventions of the government. What you write shows that you don't understand these questions at all.

  3. By linked I ment that if German economy falls, also czech export will fall and that will cause a fall in CZK value.
    By government move I ment taxes on trade, and other legislation targeting trade, banking sector and so. Also government borrowings.

    During the recession the trade was lower and that caused the loss of jobs and increase of money value.

    If Klaus is gone of power and the Eurozone solved the crisis, Czech republic might want to adopt EURO (or other German currency) and that might require pegged exchange rates.

  4. Dear Kamil, I don't believe that the Czech Republic will ever voluntarily adopt the euro. This is not just Klaus - you're completely misrepresenting the picture. Prime minister is working on an official exception from the euro, the Czech National Bank is against the introduction of the euro, large parties are gradually inclined to be against the euro, and about 70+ percent of the public is against the euro entry now. This is no idiosyncratic opinion of Klaus.

    Your comments about a falling German economy show that you misunderstand the whole logic of the justification by Record PLC.

    The worry in the markets that is crippling the euro is *not* about the health of the German economy. It's about completely different thing. Indeed, if a currency is linked to the health of the German economy, it's a highly promising currency. The primary, urgent worry is about totally different things than the health of the German economy.

    The point is that the euro is not such a proxy because it's related to many other economies that are in a nearly tragic shape. Koruna is a proxy of the health of the German economy, which is exactly a top reason why it's so safe - more than the euro is.


  5. Well, you have a point. But I still think, that German economy qurantees the EURO. Of course the collapse of other economies might break the banks and the banks might break Germany. Plus there is a lack of qualified work force in Germany and they import workers (~300 000 a year). So Germany might get too old for a growth.

    The social benefits are the real killers of the economy, and also the dumbness of the people, who vote for big government. Not to mention rotting monetary policy in the direction of banks and their role. Insurances, etc. You can buy a house from a banks promise to pay - non cash transaction, the bank might never had that money. Capital adequacy 8% in some countries, insane.