Tuesday, December 16, 2014

This Year’s Crisis

Usually I wait until the advanced macro class starts in January before posting about this year’s macroeconomic hot spot.

But Russia seems to have jumped the gun by a few weeks. The best way to follow this sort of thing is to find a legacy media outlet that is running a live blog of the crisis. Typically, the European newspapers are a good source: here’s the link to The Guardian’s live blog.

The market signals about the Russian economy have been bad since mid-summer: about the time Russia got more serious about supporting separatist rebels in eastern Ukraine … who also happened to shoot down a passenger jet at an altitude that can only be hit with actual Russian military hardware.

So I posted about interest rates on Russian bonds about 60 hours ago.

But the news all day has been the dramatic decline in the value of the ruble today. This sort of thing happens when people and firms who have rubles decide they need to get that wealth into another currency … and find out no one wants the rubles at the current market price.

The Russian central bank tried to combat that by raising interest rates. This is bait to get international investors to choose to buy rubles so as to earn that rate in Russian banks.

As of right now, it seems like they have enticed enough new investors to offset the other people abandoning the currency.

But, at what price? Here in the U.S., we talk about movements of interest rate targets of a quarter or half point, perhaps several times a year. In Russia, they raised the interest rate by over 7% today. So that’s gigantic.

Russia is sitting on a huge amount of foreign reserves. What exactly does that mean? Basically, it’s a big pile of foreign currency that the government has collected through international trade. Russia has about $400B. That is used to keep the value of the ruble from depreciating: if investors are dumping their rubles at low prices on foreign exchange markets, then the Russian government can buy it with the foreign exchange they already own to keep its value up. The problem with this is that doing so makes the big pile smaller. Eventually it may dwindle to nothing, and that’s when the crisis will get far worse. Here’s the chart from Vox:

This number is important, but it’s only measured monthly. There’s so much traffic on the website of the Bank of Russia (looking for better data) that I wasn’t even able to connect.

Backtrack a little though, to where I said “dwindle to nothing”. It doesn’t actually work like that. Instead, the total may start accelerating towards nothing. What happens then is that the government will start to get the message that it’s going to lose it all … and will stop using those reserves. What then? That’s when the real crisis hits, because that policy choice is basically one to screw your own citizens so that you can keep the big pile of cash. That never ends well.

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