Once again, I am flattering an entry with a picture taking here in Switzerland where I am currently entertaining courses at HEC Lausance. As you can see, it is a beautiful place and also, as it were, very interesting with respect to tail fume patterns from the enormous amount of airplanes moving back and forth over le Lac Léman (middle of Europe remember!). Posting is slim I know, but so unfortunately is time; I can assure that it is not out of lack of enthusiasm to write and opinion on current events.
Moving on to the topic du jour it is interesting to observe wow fast things sometimes change. We need not go back more than 5-6 months to observe how hawkish central banks across the economic edifice were busy scrambling to raise rates in order to quell inflationary pressures. Most notably, the price-hamping effect from a rising currency emerged as a key policy tool. Especially across the Eastern European edifice, at the ECB, and in some key Latin American economies this view was prevalent (arguably in New Zealand and Australia too, but the reversal has been very quick here).
However, as they say, this was then and this is now. In some cases and given the obvious severity of the incoming slowdown this policy was a mistake. In some cases, it may have made an otherwise dire situation worse, and in other cases it may, unfortunately, turn out be an extremely dear error. At this point it is still too early to say anything conclusive. Yet, as I point out in my recent installment the deflation ghost is moving closer and policy makers are positioning themselves accordingly. Just witness today's pre-December Christmas party at the European commission; I wonder how they are going to pay for it though.
Along the lines of the taxonomy described above I would, in particular, flag the economies in Eastern who are now confronted with some tough choices all at the same time as their real economies are heading straight to h'll. Add to this that the IMF and most notably the EU will be trying hard to pull the strings in the background and you end up with a great mess, both in economic and political terms. A small refresher might however be in order and although many examples would be illustrative here, Hungary and Ukraine are particularly telling. Let us thus go briefly back to May this year where Hungary's central bank decided to scrap the trading band against the Euro in an effort to quell rampant inflation by letting money come in to boost the currency.
A similar set of events was played out in Ukraine a couple of months later. Faced with a drastically changing market environment in which policy makers and market participants turned all eyes on inflation the Ukrainian monetary policy almost turned into a comic farce. Basically, Ukrainian monetary policy makers got caught, and understandably so, between market expectations on one side and economic fundamentals on the other side. As Edward so neatly put it at the time;
Does anyone happen to know offhand the "official" dollar rate of the Ukrainian currency, the Hryvnia? I am asking this question since clearly over at the central bank they are having difficulty deciding at the moment, since - like the legendary character Hydra - they seem to be speaking with two "heads" at the same time, and the only question I can ask is: would the real representative of the Ukraine central bank please stand up!
A lot of water has gone under the bridge since then and today we are, if only a very small bit, more knowledgeable of the dynamics at hand. In the case of both Hungary and Ukraine I was skeptical of the faith put in these aggressive inflation fighting policies through currency appreciation(1). Hindsight is of course always a cherished luxury and I am not suggesting that the decisions to depeg from the anchor currency (either the Euro or USD) were wrong; in fact this is an inbuilt necessity if these economies are to have a fair chance of "emerging" once again. However, I am suggesting that whatever faith we ascribe to the dictum of so-called rational expectations and the agents supposed to be imbued with these, we should always be careful taking knee jerk market discourses at face. The massive push to revalue Eastern European currencies in the context of the policy attempt to lower headline inflation was obviously such a reaction. As is clear now, it did not last long before the tide turned.
Forwarding our perspective to the present it is thus pretty clear that the shit has hit the proverbial fan. Once a clear and bright example of this is the events unfolding in Russia which is, if you remember, still a part of Goldman Sach's venerable BRIC group. That narrative is of course long gone now. We have all observed how Russia has been hit hardest from capital outflows amongst the emerging economies.
