So Russia’s currency fell quite a bit yesterday, but today’s intervention by their finance ministry is stabilising things (so far, -ish) at around 70 RUB to the USD. For those keeping track, that’s about a 50% devaluation since the beginning of the year.
OK, 50% seems like a crazy number. What does it actually mean? For most of us living in places like the US or UK, the idea of a currency depreciation doesn’t come naturally; unless we travel a bunch or have an export/import business on the side, FX rates aren’t an everyday concern. But when your country imports 40% of food, for example, the situation isn’t pretty. The lady quoted in the article is already paying 20% extra, a week into this depreciation. People are worried what their salaries will buy. This is sounding like the early stages of hyperinflation, where loss in the faith of a currency as a store of value can get bad, fast.
This is perhaps a concrete reminder of what gold bugs and Tea Partiers and such have been saying is the inevitable fallout from the Fed’s quantitative easing: namely, a dollar worth nothing. They advocate buying real assets (such as gold, though I’ve already expressed my reservations there) to protect against a big dollar crash.
To be clear, however: the US and UK are very unlike Russia and other emerging countries. The main difference, in this context, is having wide and deep financial markets denominated in domestic currency. Let me explain:
- Who really has the power? Lenders. As much as we like to define power as military strength, in these days of relative peace the marginal power lay with the lenders. Pretty much all governments rely on borrowed money to function; even the US government went through a completely idiotic own-goal by refusing to allow itself to borrow (NB: Tea Party, I blame you).
- What do lenders need? Trust in borrower. Remember that a lender’s best-case scenario is to receive back his principal + interest. He can lose all of his principal. In the case of US or UK, lenders are just fine receiving an IOU; they have faith they’ll be fully repaid. With Russia and other emerging economies, lenders frequently require collateral; this frequently comes in the form of foreign exchange reserves, so lenders can seize ‘hard currency’ if needed.
- The key difference: domestic versus foreign currency borrowing. Keep in mind that countries like the US and UK (and Russia) have fiat money, which means the USD and GBP (and RUB) are worth whatever the government and users say it’s worth. Furthermore, all these governments have printing presses, allowing them to repay domestic currency debt with newly-printed money. As a lender, then, the question becomes how likely you will be repaid with domestic currency worth anything. If there’s doubt, the lender will only lend using (a more stable) foreign currency; for example, many emerging countries borrow in USD. Once the borrower goes the route of foreign currency, the government has lost control of his debt burden; if his local currency devalues, it’s bad news bears.
- An interesting contrast, then. Even with explicit repayment of government borrowings with newly-printed money (i.e. quantitative easing), the US and UK have rarely seen lower costs to borrow. In contrast, Russia can’t get enough faith in their currency to keep the ruble alive: they need to intervene in foreign exchange markets to convince lenders that the ruble can and will stabilise in order to obtain debt financing for their government. This is crucial, as with a low oil price Russia’s government has no hope of funding itself. The US and UK have adopted almost the exact opposite (indeed, Switzerland adopted the exact opposite) approach: trying very hard to convince folks all the newly-printed money should cheapen their currencies, thereby stimulating demand.
In sum: the life of everyday Russians is getting worse and worse as their currency goes down the toilet. Though the same problem could happen in the US or UK, in theory, the latter governments’ reliance on domestic-currency borrowings suggest nothing like the Russia situation in the foreseeable future.