What a zigzag... On 21 November, a very optimistic Krugman wrote:
Everyone’s talking about a new New Deal, for obvious reasons. In
2008, as in 1932, a long era of Republican political dominance came
to an end in the face of an economic and financial crisis that, in
voters’ minds, both discredited the [Republican] free-market
ideology and undermined its claims of competence. And for those on
the progressive side of the political spectrum, these are hopeful times.
But now Krugman is back to reality:
> 2008-12-01
> Paul Krugman
> ...
>
> The first task is the harder of the two, but it must be done, and soon.
> Hardly a day goes by without news of some further disaster wreaked by the
> freezing up of credit. As I was writing this, for example, reports were
> coming in of the collapse of letters of credit, the key financing
method for
> world trade. Suddenly, buyers of imports, especially in developing
> countries, can't carry through on their deals, and ships are standing
idle:
> the Baltic Dry Index, a widely used measure of shipping costs, has
fallen 89
> percent this year.
However, instead of the New Deal and Keynesianism, he myopically turns
back to the right:
> ... the International Monetary Fund was providing loans to countries
> with troubled economies like Ukraine, with less of the moralizing and
> demands for austerity that it engaged in during the Asian crisis of the
> 1990s.
That's not how The Economist (1 Dec) reads it (see below).
> ...
> Even if the rescue of the financial system starts to bring credit markets
> back to life, we'll still face a global slump that's gathering momentum.
> What should be done about that? The answer, almost surely, is good old
> Keynesian fiscal stimulus...
> And once the recovery effort is well underway, it will be time to turn to
> prophylactic measures: reforming the system so that the crisis doesn't
> happen again.
>
> Financial Reform
>
> "We have magneto trouble," said John Maynard Keynes at the start of the
> Great Depression: most of the economic engine was in good shape, but a
> crucial component, the financial system, wasn't working. He also said
this:
> "We have involved ourselves in a colossal muddle, having blundered in the
> control of a delicate machine, the working of which we do not
understand."
> Both statements are as true now as they were then.
>
And he also said this, in 1933 (in The Yale Review):
I sympathize, therefore, with those who would minimize, rather than
with those who would maximize, economic entanglement among nations.
Ideas, knowledge, science, hospitality, travel--these are the things
which should of their nature be international. But let goods be
homespun whenever it is reasonably and conveniently possible, and,
above all, let finance be primarily national… [O]ver an increasingly
wide range of industrial products, and perhaps of agricultural
products also, I have become doubtful whether the economic loss of
national self-sufficiency is great enough to outweigh the other
advantages of gradually bringing the product and the consumer within
the ambit of the same national, economic, and financial
organization. Experience accumulates to prove that most modem
processes of mass production can be performed in most countries and
climates with almost equal efficiency. Moreover, with greater
wealth, both primary and manufactured products play a smaller
relative part in the national economy compared with houses, personal
services, and local amenities, which are not equally available for
international exchange; with the result that a moderate increase in
the real cost of primary and manufactured products consequent on
greater national self-sufficiency may cease to be of serious
consequence when weighed in the balance against advantages of a
different kind. National self-sufficiency, in short, though it costs
something, may be becoming a luxury which we can afford, if we
happen to want it… The decadent international but individualistic
capitalism, in the hands of which we found ourselves after the war,
is not a success. It is not intelligent, it is not beautiful, it is
not just, it is not virtuous--and it doesn't deliver the goods. In
short, we dislike it, and we are beginning to despise it.
Could the neoliberally-trained but Keynesian-touting Krugman engage a
political economy that is not pro-globalisation? I doubt it. If he
quotes Keynes, keep an eye on what he leaves out...
***
Currency collapse in Ukraine
Dec 1st 2008
From the Economist Intelligence Unit ViewsWire
The battle in Ukraine to stop the currency plummeting
Ukraine’s currency is plummeting in response to the country’s declining
economic prospects and financing difficulties. With the IMF now having a
major say in policy decisions, non-market solutions are improbable;
instead, the aim is to achieve an orderly depreciation rather than a
rout. Ultimately, a weaker exchange rate will be beneficial to the
economy. Yet the adjustment will be painful, and this may fuel political
impulses that run counter to IMF strictures.
Off a cliff
The hryvnya hit an all-time low of HRN7.38:US$1 on November 27th, a fall
of around 38% from the HRN4.60:US$1 rate seen in the first week of July.
The National Bank of Ukraine (NBU, the central bank) had been attempting
to defend the currency through interventions in the foreign exchange
market, but having seen reserves fall by 15% in October alone, to
US$31.9bn, it can ill afford to further defend the currency.
The lack of confidence in Ukraine’s currency is unsurprising. Inflation
has been sky-high this year, averaging just over 30% year on year in the
second quarter and 26% in the third quarter. Industry is going into
freefall. Monthly output growth fell by 0.5% in August and 4.5% in
September; nevertheless, the 19.8% year-on-year contraction recorded for
October came as an enormous shock. The economic slowdown and the weaker
prospects for export volumes and prices, as well as the global credit
squeeze, have focused attention on Ukraine’s large external financing
requirement. Financial inflows have all but dried up.
As good as steel
Russia too is experiencing strong downward pressure on its currency
versus the dollar. In Russia’s case, this reflects the the fall in the
oil price since July and uncertainty over short-term prospects. The oil
and gas industry is the main driver of the economy; it is also a major
determinant of sentiment; hence the Russian equity market has followed
the oil price downwards since mid-year.
For Ukraine, the commodity to watch is steel. Ferrous metals account for
40% of export revenue and 25% of industrial production. As with oil in
Russia, the revenues generated are vital to stimulating the broader
economy. From late 2007 until the middle of this year, the hryvnya was
generally on an appreciating trend. This was consistent with the surge
in the prices of Ukraine’s main steel products. Prices for steel billet
rose from around US$540/tonne in late 2007 to US$800/t in early March
and US$1,200/t in early July, according to data from Metal Bulletin.
Prices for steel slab and hot-rolled coil followed a similar trajectory:
from US$550/t in late-2007 to US$1,100/t in late July for the former,
and from US$620/t to US$1,130/t for the latter.
From August, however, prices started to collapse. The price of billet
fell by 25% in a month and as of November 24th its price is down
two-thirds from its mid-year high. Slab and hot-rolled coil prices have
suffered a similar decline. Even more damagingly, global demand for
steel has shrunk dramatically since July, hence the sharp downturn in
industrial output and the guaranteed contraction in export revenue (90%
of steel output is exported). One prominent Ukrainian mill expects
output in the first quarter of 2009 to be down 75% from a year earlier.
The hryvnya has tracked steel’s declining fortunes. On Bloomberg data,
the currency traded at HRN4.60:US$1 in the first week of July. By late
September it had broken through HRN5:US$1. Over the course of October it
moved unrelentingly towards HRN6:US$1, but the major slide has come in
late November. From HRN6.12:US$1 on November 21st, the Ukrainian
currency slumped to HRN7.38:US$1 on November 27th.
The current-account deficit was until recently estimated to be around
6.7% of GDP this year. With steel export revenue set for a sharp
decline, this will put widening pressure on the current-account deficit
from one side. From the other, the near-certainty of a sizeable increase
in the price of imported gas in 2009 threatens a further widening. Given
the sharp shrinkage in the availability of credit, it is not clear how
Ukraine could finance its current-account deficit in the months ahead.
The IMF, starkly, has forecast a current-account deficit of just 2% of
GDP next year--on the assumption that this is all the credit that
Ukraine will be able to attract.
Managed retreat?
In early November Ukraine agreed a US$16.4bn package with the IMF,
focused initially on reviving the banking sector and ensuring it could
service its large external debts. The programme also seeks to put
Ukraine’s public finances and exchange-rate policy onto a more
sustainable footing. With large budget surpluses not a practical option,
nominal depreciation is inevitable. The IMF and the NBU hope to engineer
an orderly retreat and so avoid a rout that could overshoot, causing
additional and unnecessary damage. Yet the IMF also wants Ukraine to
relinquish controls on foreign-exchange markets.
Now that the NBU has scaled back its efforts to arrest the currency’s
slide, the most pressing question is how much further the currency will
fall. On November 27th that NBU’s deputy governor, Oleksander Savchenko,
said that an exchange rate of around HRN7:US$1 was appropriate given
Ukraine’s financial circumstances. Yet just ten days earlier, the NBU
had said that HRN5.6-6.0:US$1 was sustainable through to mid-2009, after
which the currency would strengthen once again. Among banks and other
market-watchers, there is a growing sense that HRN7.5-8.0:US$1 could be
a more sustainable exchange rate.
In the firing line
The devaluation will cause considerable disruption. Importers find it
all but impossible to hedge against currency risk in the country. As a
result, in October some pharmaceutical importers put up prices to cover
their increased costs, only for the government to mandate that prices be
returned to their October 1st levels. As the impact of the November
weakening of the currency feeds through, many more enterprises that
import finished products or inputs will be inclined to raise prices.
This will either stoke inflation and suppress consumption or, if the
government opts for widespread price controls, threaten higher rates of
insolvency and a cutback on future investment.
Alongside business, Ukrainians with foreign-currency loans will feel an
immediate impact from the devaluation. According to the NBU, an
astonishing 50% of loans in Ukraine are US dollar-denominated. A slide
in the currency will put additional strain on borrowers, at a time when
growth is falling, unemployment is rising and real wage growth is about
to fall sharply (and may become real wage contraction). Monthly
repayments on a US$12,000 car loan taken out over 7 years in 2006 at
11.5%, for instance, will rise from HRN966 at the August exchange rate
to HRN1,460 if the hryvnya stabilises at HRN7:US$1.
The most realistic method of protecting those with dollar loans, aside
from seeking to lengthen the maturity of the foreign-denominated loans,
would be to hike interest rates in an effort to defend the currency. Yet
this would arguably make the overall situation worse. Already businesses
are facing lending rates of 30-50% when they approach domestic banks for
credit. The government would fiercely resist moves to increase interest
rates. According to Anatoliy Shapovalov, the NBU’s first deputy
governor, the government wants to cut the benchmark interest rate from
12% to 8%. However, higher interest rates are likely at some point to be
on the IMF’s agenda for Ukraine, if only to bring down inflation, most
likely once liquidity improves.
Unavoidable pain
A weaker exchange rate is inevitable given the balance of payments shock
that Ukraine is starting to experience. Eventually it should provide a
competitive boost to the economy, increasing opportunities for exporters
(when external demand recovers) and import-substituting producers.
First, however, Ukraine must undergo the pain of adjustment. How painful
this process will be depends on how much further the currency will fall;
the main risk now is that ordinary Ukrainians will lose confidence in
the currency, causing it to fall even further. The reported withdrawal
by residents of HRN9bn from banks in October suggests that this risk is
appreciable. It would not be surprising if Prime Minister Yuliya
Tymoshenko’s dirigiste government soon resorted to heavy restrictions on
withdrawals.
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