Thursday, November 07, 2013

Currency interventions are immature assaults on free markets

Expletives appropriate after the insane war was declared against the Czech crown

A few hours ago, the Czech National Bank has done something insane that hasn't taken place for 11 years: interventions against the Czech currency. Within minutes, the exchange rate weakened by stunning 4 and 6 percent relatively to the euro and the U.S. dollar, respectively. Their stated purpose is to encourage inflation (they look like an arsonist who boasts that he set a big building on fire) and they expect this thing to add 1 percentage point to the inflation for the next 12 months.

CZK 2,000 was worth $104.8 in the morning and $99 now, a decrease by nearly 6 percent (contributed by the drop of the euro due to the ECB's lowering of the rate).

Sources differ about the amount of crowns that were sold to increase the euro reserves. Reuters said it was just EUR 0.5 billion, others say it was EUR 3 billion. The figure doesn't really matter. They have stated that they will print the crowns and sell them to reach the rate around CZK 27 per euro – it was just 25.7 a few hours ago – so the rate will be close to CZK 27 per euro whether they actually need to print the new crowns or not simply because they obviously have the potential to weaken their own (well, our) currency.

I have to emphasize that this is an extremely different procedure from quantitative easing in the U.S. that we recently discussed. In the quantitative easing, the long-term bonds are being repaid i.e. bought back i.e. liquidated and the same amount of money is printed. In the case of interventions, money is being printed and sold to the market and no bonds or other forms of debt are being absorbed at the same moment.

So of course that the intervention against the crown immediately contributes to inflation and has many other consequences.

According to the discussion forums hosted by Czech news servers, I think that most citizens disagree with such an operation. I disagree for many reasons, economic and ethical ones, too.

It seems virtually unthinkable to me that there are no people who have made profit (or at least who avoided the loss) because of some insider knowledge. In my opinion, the system in which individual people may decide about such big operations that don't need any sensible justification is defective, it is really corrupt.

I also completely disagree with the idea that the inflation rate near 1.5 percent is too low. The stated inflation target is said to be around 3%. The inflation rate around 4 percent was just OK with the central bank just a year or two years ago. But suddenly 1.5 percent is too low? These data are completely inconsistent with the stated target. If they wanted to be honest, they should raise the official inflation target to 3 percent because this is what they're targeting in the medium or long term (real interest rates are minus 1-2 percent in the last decade or so).

But with their "apolitical" status and the flexibility of the rules that determine their policies, there is nothing that would make them honest. The Czech consumers will have more expensive Christmas and at least the domestic consumption will be hurt as a result. Because of the Marshall-Lerner condition, one may doubt that the intervention will improve the trade figures.

Moreover, there is no good justification for improving the trade figures. The latest Czech trade surplus was CZK 35 billion per month. That would be CZK 0.42 trillion per year, not too much below 10% of the GDP! We don't need even larger surpluses. What we may need is to increase the domestic consumption and the intervention will do the opposite, especially because the savers will feel poorer and they're the essential contributors of the Czech domestic consumption. By any sensible market measure, the Czech crown is still significantly undervalued; the trade surpluses are one sign of that (the total current account is closer to zero or sometimes showing deficits but smaller deficits than the surpluses of the trade figures).

Markets determine the currency exchange rate wisely – more or less with the idea of making the co-existence of all the economies sustainable which pretty much means that markets move the exchange rates to keep the trade surpluses and deficits low (near zero). That's the right motion that should take place. The Czech Central Bank's openly declared goal is exactly the opposite – a way to see that the markets are much more intelligent than the manipulators in the central bank, to see that manipulations with the exchange rates are always wrong.

The potential for huge swings such as this one is an argument against the independent currencies of small enough countries like ours. With the situation in Greece etc. looking much better than a year or two years ago, my personal desire to join the eurozone has surely increased dramatically after the today's experience. The ability of a few individuals to manipulate with a currency in this way is just wrong. The right of a country to demand huge external injections just because they share a currency is also wrong but the today's procedure has decreased the Czechs' wealth more than all the hassle in Greece has.


I wrote these comments long before I saw the reaction by ex-president Klaus so I was only reassured that his opinions matched mine:
The intervention is a flawed and risky step that brings highly questionable benefits but indisputable costs such as more expensive imports and an upward push on the price level in the country.
He also criticized the justification of the intervention by the desire to fulfill the inflation target, something that the bank has imposed on itself. We don't need interventions, we need a sensible fiscal policy and the return to normal parliamentary politics, Klaus said.

In an article featuring these Klaus' comments, there is a poll and only 9% of respondents think that the event is a net positive for the economy, 83% think it is a net negative.

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