Monday, November 3, 2008

October Themes: Monetary Breakdown

Karl Marx's most famous contribution to the social-scientific lexicon is probably the notion of fetishism, the way in which a single moment of the social process comes to stand in for (and obscure) the others -- like an individual commodity and its market value for the total process of commodity production and value creation. There is no more substantial and enduring fetish than the monetary fetish: the tendency to treat media of payment as if they did not intermediate value but embodied it.

Some groups of people have always been relatively immune to this illusion: money-market traders, for instance, whose bread and butter is the spread between short-term and long-term money. But there are times -- like last month -- when more general stresses make the seams in the process of monetary intermediation obvious to a wider audience.

Black markets and informal currencies

Robert Mugabe's Zimbabwe is likely to replace Weimar Germany as the textbook example of hyperinflation. On October 13th, one Zimbabwe blogger was quoted a 9kg cylinder of white gas at USD27,000 (ZWD340mn) - as the total breakdown of monetary intermediation brought legitimate imports of necessary commodities to a halt. Taxes of up to 75% levied on imports -- in foreign currency -- mean that basic goods imported from neighboring South Africa can cost up to four times as much in Zimbabwe.

Trading in the Zimbabwe dollar, even for ordinary goods like loaves of bread, involves so much inflation risk that even street vendors are demanding payments in foreign exchange and salaries are being paid in easily negotiable basic commodities -- sugar, salt, mealie meal.

Since inflation expectations are constantly changing and foreign exchange risk is incalculable -- and unhedgeable -- basic accounting becomes impossible for businesses of any size and all planning for investment is put on hold. Businesses that demand payments in foreign currencies run the risk of sudden raids by the Reserve Bank of Zimbabwe, which confiscates forex and replaces it with ZWD at the official rate -- far below the real, black market rate. When the RBZ suspended the interbank payment system, ostensibly to limit arbitrage opportunities between the official and black market rates, aid agencies found themselves unable to make payments and provide the subsistence support most ordinary Zimbabweans now need.

Time deposits and liquidity

On October 15, when more stores in Zimbabwe were still pricing goods in ZWD, the UN's IRIN news agency reported that managers were repricing goods several times a day -- and posting three prices for each, one in ZWD, one in USD, and one for ZWD-settlement credit cards. Supermarkets in Zimbabwe have since begun refusing to accept checks and debit cards at all -- the currency depreciates too quickly during the time it takes the payments to clear.

Later in the month, in Russia, this phenomenon of double-pricing for credit resurfaced, with some Russian businesses refusing credit card payments, and at least one bank's ATMs (Sberbank) refusing debit cards from other banks.

In ordinary circumstances, consumers (and indeed most economic actors) behave as if time deposits like checking accounts and consumer credit like credit cards are equivalent to cash. But accepting payments in these media means incurring risk, however small it may ordinarily be -- payment risk (depending on the solvency of the card-issuing institution, or, in extremis, on the continued functioning of the settlement system) and time risk (exposing the payee to the risk that, in this case, the ruble might be devalued in the period between transaction and settlement).

Under pressure, monetary systems "delaminate," so to speak, as ordinarily interchangeable forms of payment -- cash, demand deposits, time deposits, repos -- start to trade separately and sometimes with very different risk premia, surprising even the most sophisticated investors. On a grander and more foreboding scale, the breakdown of the international market in trade finance -- letters of credit -- shows how ordinarily transparent, money-like credit instruments can breakdown in times of crisis. (In an important sense, letters of credit are a more basic kind of money than state-issued paper money, or even physical cash, like copper or gold: long-distance trade on any scale would have been impossible in the early modern world without flourishing markets engaged in the discounting of bills drawn on banking houses far away.)

Prices without money

And in times of crisis, national currencies can start to look more like letters of credit or commercial paper than the other way around. On October 24, credit-default swaps on sovereign debt for Ukraine (26%), Kazakhstan, Russia, Latvia, Indonesia, Argentina (38%), and Pakistan (32%) all traded above 1000bp, with CDS on a number of European sovereigns were trading above 100bp (Italy, Greece, Portugal, and Ireland), with most of the largest industrial economies' debt trading in the range of healthy or slightly stressed corporates. Some of this meteoric rise in CDS spreads is likely due to enterprising buyers expecting to be able to sell protection at even higher rates and take advantage of panic; but there is a very real sense in which, during a period of currency devaluations and debt defaults, obligations issued by a company like McDonald's are safer than obligations issued by a country like Pakistan.

And at the end of the month, Thailand announced it would barter rice directly for oil with Iran, as a shortage of forex (and Iran's political interest in doing as little dollar-denominated business as possible) incentivizes direct trade between countries -- the UN FAO says this kind of international trade may again become common as emerging countries' reserves shrink.

Currency areas and monetary hegemony

It's a general rule that within a single currency area (a loose enough term for a loose enough concept, indicating a qualitatively greater regional intensity of trading relationships) there is unlikely to be more than a single currency: a corollary of the definition of money that sees it as the commodity whose cross-elasticities with all other commodities are lowest. Every one of the vexed attempts by national governments to impose dual currency systems (one soft for internal exchange, one hard for external exchange) falls prey, in the end, to the reality of monetary hegemony. But what about local currencies that, when push comes to shove, turn out to be soft versions of harder neighboring currencies?

October saw the economies of a number of "Euro-margin" countries teetering on the brink of failure, and the provision of large dollar- and Euro-denominated bailout packages from European governments and the IMF. The collapse of the Icelandic economy is only the most spectacular illustration of the plight of a small (that is, relative to a larger, currency-hegemonic neighbor) open economy under pressure. Countries like Iceland and Hungary -- where most consumer debt is actually issued by Eurozone or Swiss banks and denominated in EUR or CHF -- need to stabilize their exchange rates in order to make sure trade necessary to their subsistence continues smoothly. But the costs to their citizens of standard, "Washington consensus" economic restructuring plans can be high: local austerity translating into large transfers of wealth out of the country.

Not that the monetary hegemons are themselves in great shape. The Federal Reserve this month vastly expanded its bilateral currency swap arrangements with G7 nations -- and also, for the first time, made dollar financing directly available to a selected group of emerging central banks. The dollar has remained the global currency of last resort and the Fed the global lender of last resort, as the only realistic competitors stagger under their own challenges: recession and retrenchment in Japan, and internal pressures in the Eurozone. Debt issued by individual Europena countries is trading at vastly different prices, as the market assesses the chances of individual governments still responsible for setting their own fiscal policies -- and bailing out their own banks. What would happen to European Monetary Union if a Eurozone country were to break its macroeconomic covenants is an open question. In the meantime, the lack of a centralized European debt issuer has made it hard for Europe to provide credible support to countries on its borders.

The IMF is, of course, the long-shot global monetary authority of last resort. But it may exhaust its capacity to lend to distressed countries in the near future, leading some commentators to punt the possibility it will issue bonds (which it has never done) or Special Drawing Rights, an exotic international currency based on a weighted basket of major national currencies (1 SDR = $1.48) not issued since the fall of the Soviet Union, in order to fund its operations. But without substantial policy-making independence from Washington, the bank, whose operations have always been funded by its members' quotas, is unlikely ever to be able to shoulder the responsibilities of a genuinely global central bank.

1 comment:

Anonymous said...

Strong summary.