Great Moderation 2.0: The Russian ruble, Sri Lanka's tea and rubber: Bellwether
Feb 05, 2015 13:57 PM GMT+0530 | 2 Comment(s)
COMMODITY BUBBLES: Though commodity bubbles had occurred before, including during the British Railway bubble, after paper money central bank were created, prices of food and energy have gone up to very high levels.
COLOMBO (EconomyNext) - Oil prices are plunging, the Russian ruble is crashing, the free floating Aussie and Loonie is also falling and Sri Lanka's Maithripala Sirisena camp is promising price support for anything from tea to rubber.
The link is the US dollar.
With US monetary policy becoming less dangerous, the dollar is appreciating against other currencies and real commodities, just like the opposite happened during the bubble days of the 'food crisis' shortly before the 'Great Recession; began in 2008.
While floating currencies like the Aussie Dollar fell from 1.07 to the US dollar in September 2014 to 1.22 levels now, the Russian ruble fell from 37 levels in September to below 60 before stabilizing.
If there is an inherent strengthening of the US dollar due to better monetary policy, naturally all free floating currencies should weaken.
The problem with countries like Russia is that they get into cycles of interventions - or sterilized foreign exchange sales where foreign reserves are sold and money is printed to prevent interest rates from going up - precipitating crises and panic.
Russia's central bank eventually raised rates to 17 percent. That should help, but the economy will be in shambles as interest rates hit all businesses, and bank defaults rises.
A country with a true free floating currency where the central bank does not intervene if forex markets therefore does not print money to control rates when dollar sales mop up domestic money, would not suffer a similar economic collapse.
Currencies of countries like Malaysia and Korea have also fallen in relation to the dollar. Some investors sell out at these times, worsening the trend, and people talk of an 'emerging market sell-off.'
Commodity powered authoritarianism
The Russian ruble gets into trouble much more than other countries when oil prices fall for yet another reason. The aggressiveness of people like Vladimir Putin, or most authoritarian states and rulers who ride on natural resources is directly related to their prices.
When commodity prices fall and state revenues fall, countries with authoritarian rulers print money and get into trouble, whether in Europe, South America or the Middle East.
Iran became powerful during the 1970s great inflation period. They lost their fire in the 1980s and 1990 after the US and Britain tightened monetary policy and brought prices down from 1980.
The Soviet Union eventually collapsed, during this so-called 'Great Moderation' period.
In the September 2014 issue of Echelon magazine, this column warned that when the Fed ends the expansion of its balance sheet and an eventual rise in policy rates would help the poor and the hungry but will hurt mining companies, the oil rich Middle East, Russia and Venezuela. (Toxic gold loans, Fed actions and Sri Lanka's policy conundrum)
Great Moderation 2.0
Now some analysts are predicting the arrival of what has been labeled the 'Great Moderation 2.0' with better US monetary policy.
It is during such times that farmers scream for price support. The so-called 'butter mountains' of the Europe in the 1980s were a result of that phenomenon.
Falling rubber prices is good for makers of rubber goods but not for plantations. Agricultural subsidies were first brought in the aftermath of the great depression in the US.
When credit bubbles burst, commodity prices fall, and it was only the extraordinary deadly US quantity easing after 2008 that kept prices up, giving profits to the Middle East and hurting the recovery of other industrialized countries, which are not so resource-rich.
US free enterprises eventually came up with deep oil and fracking, but some of these industries will also face trouble when prices fall.
In the latter stages of the Great Moderation in the 1990s oil prices fell below 20 dollars a barrel. It was the 'mother of all liquidity bubbles' fired by the Greanspan-Bernanke duo from 2001 that precipitated the recent global economic collapse.
Global milk powder and sugar prices are now at a record low. In Sri Lanka import duties have been used to keep prices up.
It is one thing to force the domestic consumer to buy at high prices but when commodities are exported it is a different game.
The common opposition candidate is offering price support for rubber at 350 rupees, and green leaf tea at 80 rupees. For a long time the formula for paying green leaf suppliers had worked relatively well. That money will also have to come from the domestic tax payer, if he is serious about it and he wins the election.
Sri Lanka can no longer take the risks with fiscal and monetary policy, it did in the past. Now the country is exposed to international capital markets, both in rupees and dollars.
This is based on a column in the January issue of the Echelon Magazine which was published before the Presidential elections. To read the February column by Bellwether subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.