...they hurt financial planning, create easy profits and easy losses...
In Fall 2011, the €1 euro was worth CHF 1.2 Swiss francs and the franc had the tendency to climb further towards parity. The Swiss Central Bank decided to protect its domestic importers and pegged the currency to the euro. For 15 months or so, the euro was worth CHF 1.2.
Leonhard Euler (not Gauss, LOL, thanks) only appeared in the seventh series of the banknotes, one printed in 1984. The current eighth one, printed in 1995, contains no mathematician or scientist whom I can recognize. Am I overlooking someone?
Some lucky-yet-realistic folks must have known that the peg wouldn't last forever. They bought lots of francs – or shorted the euro against the franc. They waited – and they were vindicated today. The peg was abolished, the Swiss franc jumped over 15 percent within minutes. Due to some instability, the CHFEUR exchange rate was up to 30 percent stronger than yesterday at some moments.
In similar circumstances, people who have the "right currency" benefit a lot and quickly – and those who have the "wrong currency" lose. It's wrong for numerous reasons.
First of all, there is always a potential for foul play. The central bankers knew in advance what would happen today. Even if they can't easily abuse their position, they can tell their friends who make the profit and this profit may partly get back to the bankers. I am not able to prove the accusation against any particular banker and her pals but I would be shocked if such things weren't occurring. It's OK to respect presumption of innocence while dealing with individual people and their possible acts in the past but it's very unwise to design policies that assume that people will act as saints in the future.
Second, if we assume that no one has the insider information, these jumps act as a form of a "mandatory lottery". Whether you like it or not, your choice of currencies in your savings, mortgages, and contracts affects your fate. Lotteries may be fun but mandatory lotteries are harmful because they effectively force people to reserve some extra resources for similar events that may turn against them.
Don't get me wrong. Of course that I think that it was right that the peg was removed today. What was wrong was the peg itself. But even the way how the peg was removed was wrong. They should have designed a more complex way to fix the exchange rate that doesn't admit any "totally easy and safe profit". For example, a random walk connecting 1.2 and 1.03 should have been computed by a random generator as the preplanned evolution for the next month, and they should have enforced this exchange rate as a function of time, announcing that they would be gradually allowing the currency to strengthen again.
The Czech National Bank has been a player in weird and dirty games meant to devalue the local currency, too. On the anniversary of the Great October Socialist Revolution, on 7th November, 2013, they did something similar as their comrade Vladimir Lenin. They announced that they are no longer able to guarantee the inflation target 1-3 percent by adjusting the interest rates (which are basically zero) and they need to weaken the crown by playing with the exchange rates. For years, the crown would be rather stable relatively to the euro but it was instantly weakened by 6 percent or so. Due to the strengthening U.S. dollar, the crown would lose over 20 percent relatively to the dollar since November 2013.
But the euro-crown exchange rate was standing close to 27.7 for most of the year 2014. Last week, the crown weakened again, to 28.4, after new inflation data showed that the inflation was still zero or so, increasing the risk that the madmen at the Czech National Bank will move their arbitrary target again and print the crown and buy the euros to push crown towards 29 per euro or something like that.
Because the market was well aware of the symptoms of the psychiatric disease of our central bankers, it immediately decided that the price of the euro should go closer to 29 as soon as possible.
If you realize how devastating and seemingly unstoppable the fall of the Russian rouble was weeks ago, you should agree that this decline of the domestic currency is by far the most serious threat that a country whose currency doesn't enjoy the status of a major world currency is facing. You know, a central bank may always weaken its own currency. It may print it in an unlimited amount and sell lots of it to the market. But it's much harder to strengthen your currency. Beyond a certain point, you may very well run out of your foreign currency reserves! And this outcome becomes more likely if you have previously worked to undermine the currency's trustworthiness.
Most of the drop from 27.7 to 28.4 was undone yesterday, after President Zeman verbally intervened and criticized the Czech National Bank for these exercises, saying that they should stop. Crown returned to 27.9 or so per euro today, less than a percent weaker than when it was a month ago (and many previous months). According to the constitution and the Bill on the Czech National Bank, the words of the president may matter because these documents assert that the president appoints and fires the members of the ČNB banking board. While the central bank is "independent", it's not "quite" independent, you know, and the central bankers could be afraid of their being fired.
Meanwhile, the Czech National Bank replied that they haven't intervened against the crown for a very long time. They have simply trained the market to get used to the new value around 28 per euro. The intervention-free exchange rate would be about 25 per euro and I think that according to some sustainable objective benchmarks, even that rate was exaggerated and the euro could "fairly" be just 20 crowns if not less.
So it is rather unlikely that the Czech National Bank will escalate its distortion of the exchange rate. Not only they may be afraid of the president's powers. The Czech economy returned to the growth, about 2%, so one may argue that the interventions are no longer needed. At least, that was the logic that canceled the peg in Switzerland today.
What ČNB exactly targets
They want to keep the inflation rate – based on some basket of common enough products – near 2%. My understanding is that they really care about the core inflation, one that removes the volatile food and energy prices from the basket. At least, a few years ago when the food and energy were getting more expensive, they would say that this part of inflation didn't matter. Now, so far, they seem to be consistent and argue that the dropping prices of oil, gasoline, and perhaps food are no reasons to be concerned (about deflation).
Despite this good sign, I find it obvious that in the long run, the bank overshoots its declared inflation target. The inflation was 4% several times and they would say that it didn't matter because some of it could have been attributed to the increase of the value-added-tax or something like that which was a one-time event.
This is a highly problematic excuse. While it's true that the increase of the tax shouldn't be expected to be repeated next year and every other year, I don't think that it should be fully subtracted and ignored, either. The increase of the tax was very likely to be "irreversible" for quite some time so one shouldn't treat it in the same way as the volatile food prices.
The point is that the bank should protect the long-term predictability of the value of the currency – how much a citizen will be able to buy for X crowns in the year Y. The increase of the prices due to a higher tax is just another increase of the prices affecting this planning and shouldn't get an exemption.
Five years ago or so, I would have a private lunch with Mojmír Hampl, now (and then) a vice-governor of the Czech National Bank. We met because we agreed about some libertarian principles in the international economics or something like that. Some of the discussions would be about the right way to target inflation. At that time, he looked reasonable but because of the events that happened in November 2013 and the way how the ČNB board defended it, I no longer think he is reasonable.
I think that he is blinded by some technicalities (like whether cars or houses should be in the basket) and fails to understand why it is actually a good idea to have a target.
Again, targeting is a good idea because it allows the users of the currency to financially plan – to imagine what their savings or loans will be worth in the future. There are many baskets one may use for targeting. One may also target the nominal GDP – to make it grow by 4 percent every year, for example. There are many different options. One has some experience what the prices of a basket or the GDP were doing and one may extrapolate some ideas about the future value, too.
But the key rule is that one must stick to these conditions and be consistent about them.
From the viewpoint of the monetary expectations, a one-time increase of prices due to some increase of a tax or something like that is a self-evident violation of the predictability. It is a clear mistake in the planning and targeting. Even more seriously, an artificially engineered jump in the currency exchange rate is absolutely harmful.
If you weaken your currency by 6 percent relatively to everyone else (and only our crazy bankers did such a 1953-style thing, not the Swiss ones, to be sure), it means that even short-term planning becomes harder. Exporters – the employers – benefit. But the importers, travel agencies, and especially employees lose. Czechia is already close enough to the bottom of the purchasing power in the EU. And of course, competing producers in adjacent countries lose and have a good reason to be upset, too. (For example, owners of Slovak hotels have lost lots of Czech tourists due to the weakened Czech crown – Slovakia uses the euro.) One may talk about the right balance between the interests of all these folks. And of course, the right balance is dictated by the free markets, not by intervening banks.
I think that even the Chinese officials have largely understood these things. One may increase the overall GDP figures by artificially weakening the yuan but the Chinese workers will be able to buy less foreign products for their income – which is why the higher GDP won't directly translate to a "good thing". Increasing GDP by these mindless interventions means that you have forgotten what the quantities mean and failed to realize that only the undistorted GDP, and not a distorted one, may be linked to the well-being of the people. Too bad that our "seemingly libertarian" central bankers haven't gotten these points yet. Time to learn how to think in a more pro-market way from the Chinese, Gentlemen!
At the end, I think that in a healthy world, the currency exchange rates would be pretty much the right numbers that bring a balanced current account or zero trade surplus/deficit to each country (each currency area). Roughly speaking. Now, I can agree that the right expectation shouldn't be "zero" but a "different constant" in various special situations. For example, a country with a currency used as the main world reserve currency may afford some trade deficits. At the end, I think that this imbalance is counterproductive for the world and it would be good for the world to get rid of this special role played by the American currency – and therefore America – but this distortion isn't a real game-changer.
If you forget about details, things are simple. Countries may have different currencies. Their exchange rates are adjusted so that the trade of each country is balanced. (I don't want to discuss too carefully whether it's better to expect the trade balance or the current account to be zero. I actually think that the trade balance is better. For example, when German companies get their Czech crowns as dividends from their Czech daughters, and these dividends only reduce the current account, not the trade balance, that should lead to the increased usage of the Czech crowns outside Czechia, and should therefore not be considered on par with the potential trade deficits.)
To conclude, I think that it's right for central banks to have targets and some quantities may be better for targeting than those that are used today. But I think that a civilized management should avoid discontinuous jumps in the currency exchange rates – and perhaps avoid discontinuous jumps of the rate of the previous quantity and/or discontinuous jumps in the exchange rates.
In my opinion, this condition of continuity is much more important than a modern choice of the basket (or nominal GDP) used for the targeting. Whatever the exact rules of the game (e.g. the inflation basket and target) are, the market is able to adapt to these rules of the game. However, one-time violations and discontinuities always create havoc – they're a form of earthquakes. And a sequence of earthquakes – one-time violations of the rules of the game – that affect the prices and rates in the same direction have an increased damaging power.
Civilized currency exchange rates are basically continuous functions of time that are determined by the free markets and if central banks do something about these features, they should make them even more continuous, not less so!
Also, central banks shouldn't be panicking about one year or two years of zero inflation – or very mild deflation. The idea that people will postpone their consumption (e.g. the dinner?) for a year is preposterous. Most things people are buying are to be "consumed" in a rather short time scale and people need to "consume" them soon, so whether they will be cheaper next year is completely irrelevant. It's simply not true that deflation of any kind is always harmful.
The central bank was "generous" when the inflation rate was around 4 percent several times in recent years. So I would expect the same generosity when the inflation is low. But if they're so obsessed about the bogeyman of (tiny) deflation, they should still prefer more gradual tools. Even negative benchmark interest rates could be healthier than interventions to the currency exchange rates.