Economic Policy in the 21st Century

Thursday, May 15, 2008

One of the inevitable outcomes of the Three Axioms is the rising importance of the new entrants/BRICs in global financial markets. However, as Macro Man has observed on and off since the creation of this space, these new entrants don't always follow the same rules and conventions as existing participants. Scanning the headlines over the past twenty four hours provides a couple of particularly egregious examples of this "21st century policymaking."

Yesterday, the central bank of Russia announced changes to its currency regime. Ostensibly, this was to "help fight inflation", a stated aim of the Putin government. Yet the measures, which involve the potential sales of roubles for foreign currency, are pretty clearly inflationary- both in terms of weakening the domestic currency and increasing the money supply. The Bloomberg story headline gets to the heart of thissue straight away; these measures were designed to screw speculators. And so they have....the Russian basket trade, a highly popular destination for spec capital over the past three weeks, has suffered a rather ugly reverse.
So the Russians want to prevent foreign currency speculators, even to the cost of increasing domestic inflation. Meanwhile, the CBR runs over the EUR/USD market on a daily basis, while Russian "private sector" banks (Kleptokratbank Nizhny Novgorod, Oligarkbank Arkangel) regularly treat currency markets like an orca treats a baby seal. So while the Russkies are more than happy to speculate in your currency, they'll shoot themselves in the foot to stop you from speculating in theirs.

The race for energy, meanwhile, is becoming more visible in developed economy equity markets. China, for example, has seen the price of its energy imports skyrocket, particularly coal. Despite attempting to apply heavy pressure to their Ozzie "partners", Chinese importers have been hit with price increases of several hundred percent. Although Macro Man cannot find a price series for Aussie coal export prices, the chart below (coal products in the PPI) give you a flavour of the trend.
So imagine the Chinese dismay at the thought that two of their main suppliers, Rio Tinto and BHP Billiton, might merge, thereby giving the combined firm even greater pricing power. So what's a 21st century Machiavellian to do? It's obvious! Take advantage of the relatively open markets of the developed economies and buy a stake in each company to prevent the merger.

Now in fairness, Chinalco was joined by Alcoa in buying a decent chunk of Rio. But Alcoa is a private company; Chinalco isn't. And it is only the word on the strasse is that it is Chinalco
buying up a stake in BHP. Still, it's hard to imagine China looking too kindly on, say, the Australian Treasury lending BHP A$50 billion or so to buy up resources in China. In fact, such a proposition is little short of preposterous. So it would be kind of refreshing if the new Aussie premier Kevin Rudd got his Chinese counterpart on the phone and said "kindly f*** off."

If only somebody would tell SAFE's FX trading desk (pictured left) the same thing....

Posted by Macro Man at 9:34 AM  


More morsels for the protectionists to feed on. How long before we see a counter-revolution in globalisation?

Adrem said...
12:03 PM  

I enjoy reading this blog, but from a position of profound ignorance. However, your comments on Russian FX intervention stir a question from long forgotten ??? (Well, so long forgotten that I don't even know what I forgot.)

Is it not true that the intervention creates exactly the sort of mispricing that speculators can feed on. To be sure, the Chinese get away with it, but only by having a financial system that is much more clamped down by the state than I perceive the Russian system is.

Why can't a speculator just find the hole that the Russians are shovelling money into, and sit at the bottom with his mouth open?

sargon TM

sargon TM said...
3:26 PM  


If Russia had an open capital account and a developed financial market, it would be easier to profit from this situation. As it is, the capital account is closed and CBR buys a shedload of USD to stop the rouble appreciating. Sound familiar?

The trade in a "normal" market would be a curve steepener, but that option just isn;t really there.

You can see the riches there to be had....sadly, they're ringfenced with electrified barbed wire, which makes 'em difficult to access.

Macro Man said...
4:08 PM  

No question about it: China is not playing fairly. How are Western companies to compete with state-owned Chinese firms? The Western firms are subject to the constraints of their balance sheets; the state-owned enterprises can tap into an almost limitless pool of capital (in the form of tax revenue). Well, maybe not limitless, but they definitely have a huge advantage over their counterparts.

But then again, according to the tenets of free market...the state-owned enterprises will prove to be grossly inefficient, and Western firms will come on top. In theory, anyway.

Besides, it was funds backed by foreign governments that came to the rescue of Western banks when the latter were running with their tongues sticking out earlier this year. Gotta take the good with the bad....


Anonymous said...
4:14 PM  

There was a well known corridor in rubble volatility, so the levels to buy or sell rubbles were too clear...

The level of appreciating of ruble for the year was a target for Russian CBR...

Several days ago official from Russian CBR, clearly warn against following recommendations from major investbanks to play up on rubble...

So, making money with RUB was too simple... with eurusd you couldn't do this...

Anonymous said...
6:39 PM  

I like what the Russians are doing. In a closed capital account as M-squared said the Mundell equivalence does not apply. You can control both FX and rates. One of the issues that can create problems is if you have a perpetually undervalued currency, but you do not interject enough volatility into the appreciation process. Then it seems almost like a free call option to own the currency, especially if you get paid in the forwards. This attracts huge speculation. Presumably policymakers are and should not be keen on that. So three cheers for the Russians, doing something ingenious, introducing volatility it was supposed to be lock for specs. It almost reminds me of my all time heroic play - HKMA taking on specs selling the HangSeng in 1998...

Mr. Prop said...
6:52 PM  

So for the sake of screwing over foreign specs, who are only engaging in the same genre of behaviour that the Russians themselves engage in with the foreigners' currencies, the Russkies are prepared to exacerbate an already ludicrous inflation problem? Colour me unimpressed.

At least when the Fed screws over foreigners holding dollars by slashing rates, it's supposed to be to the benefit of the US economy.

Vlad must suffer from "small willy syndrome" if he needs to get his kicks by attacking foreign specs for the sake of it....

Macro Man said...
7:33 PM  


Sounds like you lost some money with those Ruskie...


Anonymous said...
8:23 PM  

One should not think so parochially about structures, for they share common characteristics

1. They are systems of rules set up by [mostly] men.

2. These rules can be changed.

3. There may be a seeming logic or order to the rules, BUT this too can, and often does change according to whim, happenstance, and of course, corruption.

TCI violated one of these axioms in taking on MoF AND (I repeat AND) MITI. US Bond shorts have multiple contusions from betting against Voldemort. And go ask the Hunt Brothers about "rule changes". Even if Brian Hunter hadn't gotten obliterated by wrong-way price and predatory trading, he could have just as easily been torpedoed by say an extraordinary change in margin requirements. A few more days price action in oil like today, and one might wonder whether we'll see a demand from regulators for precisely this.

"Cassandra" said...
8:35 PM  


No, I actually resisted the siren call of the rouble basket trade because I thought all the risk premium had been squeezed out of it. It turns out that I was right. Still, over the years they (and my buddy Voldy) have cost me plenty with their shenanigans in developed market "floating" currencies. In general though, this post was motivated by the theme of the week, the impact of the brave new three axioms world.

Macro Man said...
10:11 PM  

Given that this is Russia, the death of a million specs is but a statistic. In any event why expect solicitude from a government which in other contexts is so willing to liquidate its own citizens?

However, Mr. Prop must clearly find an ally in the Vlad and Dmitry show. Their policy only makes sense if they expect an imminent and severe collapse in the price of crude oil. But if even the Russkies (and apparently the Saudis) are not betting on black in terms of monetary policy, perhaps a bearish consensus on crude is still too premature? Illuminati or not, the crude bull marches on...

Orca and baby seals! MM I am truly envious of your gift for metaphor.

Cheesehedge said...
10:21 PM  

I think you raise some very important points here and even though I also enjoy your posts about crude crack spreads and curve steepners :)I in particular enjoy when you take the time to do one of these birds' eye view.

I suspect that I will have more about the axioms later since they really cut across a whole gamut of global economic issues I feel. Yet, when it comes to the concrete question of the BRICs and their SWF/reserve muscles it is obviously one of the most important themes at the moment. I see two main issues ...

First of all, there is the need to aggressively deploy state backed reserves not only to earn yield but also to fulfill a policy objective to keep currencies within some arbitrary band. Of course, as we know too well ... we are debtors and they are creditors and the role of the latter does come with some privileges which I feel Voldy et al. are now more than happy exercising. However, if one or more creditors start scaling back new ones have to be found which may turn out to be difficult this time around. In the meantime it is indeed distortionary that speculation only works on one side of the table so to speak.

This brings us to the second point which of course takes us to those axioms of yours. Not only is their (the BRICs) net real economic edging towards inflationary but their impact on asset markets is likewise. Now, you could quibble with me here for distinguishing between asset markets and the real economy here but one of the important side effects here is (and thanks a lot for this MM) that central banks simply have no power anymore. Of course, they can guard against second round effects and try to reign in expectations but targeting inflation for policy reasons does not work. In such an environment the effect of raising interest rates is even counter intuitive since it just serves to pull in even more money in the search for yield. In this way, nominal yields are pushed down and real yields into negative in many cases since headline inflation is structurally high.

Ultimately, it is difficult not to see this as dance macabre between creditor and debtor. The real problem as I see it is that no matter how long Chinese retail sales grow at double digit numbers Voldy et al. will still (have to?) be looking elsewhere to find yield.


CV said...
10:36 PM  

CFMA 2000 loophole is being unwound...expect another pop in crude to draw in the dumb money thinking it's invincible.

After that, let the blood run.

D said...
11:57 PM  


Banker said...
12:37 AM  

Thank you Russian Central Bank for giving me a chance to enter this trade (buying Rubles and shorting the basket) at better levels. :)

Anonymous said...
11:55 AM  

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