RON depreciation cannot be avoided

Last week I looked in detail at the NBR statement after the decision to cut the key policy rate by 25 basis points. To refresh, my conclusions there were that due to a badly damaged credit channel to relax monetary conditions NBR will have to depreciate the currency in nominal terms or lower the minimum reserve requirements (MRR)  for RON and EUR.

Last night Deputy Governor Cristian Popa was on TV and among other topics he mentioned the monetary conditions. His talk confirms my estimate that the only way to relax monetary conditions is by depreciating the RON.

Just here me out.

First, let’s look at the credit channel again, but very briefly. Let’s assume I am totally wrong. And that the post I wrote few days ago about the NBR statement is just total non-sense. I will give the benefit of the doubt to anyone and let’s assume the people at NBR know better and are closer to the real world than I am. Let’s assume that a 0.25% cut in the key policy rate is enough to lower lending rates in Romania. Let’s assume NBR is right and I am dead wrong and the credit channel works. Even better, it works faster than research at NBR shows.   In the best scenario let’s assume that the whole 25 basis points cut get instantaneously transferred to lending rates. Does anyone honestly believe that a 25 basis point cut can increase demand for credit while real income has fallen by 2.9% until August this year relative to the same period last year?  I do not.

Second, let’s look at the minimum reserve requirements (MRR)  – implicitly a tax imposed by NBR on banks’ liabilities to control credit growth. Last night Mr. Popa provided new information regarding the evolution of this tax.  In his view MRR for both EUR and RON will remain unchanged due mainly to fear of capital flight. Thus, Mr. Popa confirms what I have been saying all along –  two days after I said it was also mentioned by one CEO of a branch of a Dutch bank in Romania – that currently there are no barriers to capital into or out of Romania.

Third, a tricky central bank can push money in the economy via the budget deficit. I have not mentioned this channel in my previous analysis but it is an important one these days and in almost market economies. This is how it would work. Surprise budget deficits need to be finance via local banks. Local banks will finance it and then use the t-bonds/bills to get cash from the central banks two or three days later at the same price or even a discount. This will not be your normal primary market deal but a deal done via few preferred banks. Banks will go to the NBR to cash the bonds and this is how money get pushed in the economy, i.e. money supply growth. But Mr. President Basescu, the IMF and the NBR assured us of a small budget deficit in 2012. Thus at least in theory this channel is also eliminated.

To me these are the three main ways through which the central bank can currently inject cash in the Romanian economy. Unless there is another way by which the central bank can push money in the economy by process of elimination we are left with RON depreciation, even orderly if that makes the NBR comfortable, but depreciation nonetheless. This does not mean that RON will fly into the sky tomorrow. It does mean, however, that if central bank is serious about relaxing monetary conditions will have to leave with RON rates against EUR constantly higher on average. The depreciation should continue until Romanian economic growth will be above potential for some time. Also, should any of the other channels show signs of recovery then depreciation of RON could take the back seat. Until then there is no way to avoid a weaker RON.

 

P.S.: I am not sure why everyone is so afraid of depreciation. I had to buy some EURO today from my RON account at ING Bank. The exchange rate used was 4.41 RON/EUR. In the real economy we are already there. All we need is for the “official” rate to close the gap.

20 thoughts on “RON depreciation cannot be avoided

  1. 1. 0.25% is obviously not enough to encourage crediting, just perhaps to lower deposit rates. These will go down in the first stage, except for Greek banks. I also think your analysis ia accurate regarding the other channels. And the yield for 10yr Italian bonds this morning does not comfort me too much either.

    2. “one CEO of a branch of a Dutch bank in Romania”? Niceeeeee🙂

  2. I don’t think that monetary policies can actually improve the economy by themselves, at least in the long run. I’m damn sure that they can do a lot of harm.

    This is because things, especially in the economy, are easy to destroy and hard to build. For most people, it’s really hard to add more value than the next guy.

    And real economic growth is based on the principle of added value. Without added value, there’s no point in doing anything because there’s no improvement for anybody. It’s like spinning our wheels. It’s like wishing for the future to be better without actually doing anything(work related) about it.

    Measures like:
    * deficit spending – spend other people’s money on credit to improve the GDP numbers
    * swaping t-bills between banks and NBR in order to make a buck for the banks and to get more credit on the market
    * printing money
    * manipulating the exchange rate

    are in one way or another creating money from thin air. That’s like doing magic!

    It’s nothing wrong with creating things from thin air unless those things are paper money. I would personally want a boat created by means of magic by Isarescu. Trust me, I wouldn’t refuse it.

    *****

    My point: those measures don’t actually improve anything. Growing the economy by manipulating the prices doesn’t really work.

    Here’s the formula to actually grow the economy:
    1. spend less than you make(i.e. don’t borrow)
    2. work harder and smarter
    3. don’t even talk about deficit spending, just don’t do it
    4. transfer public jobs to private firms. And get the state out of the economy.

    Henry Ford was worth $188.1 billion in 2008 dollars. He said:

    “Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services.”

  3. I also don’t think that cheaper credit would do much good to the today’s economy.

    In today’s economy, there are millions of Romanians in debt. Romanian companies are more in debt than the population.(read some statistics about it)

    What happens when you borrow(take other people’s money) to fund your business? Because you have cash, you think that you are doing well. And you are less conscious about it.

    When you invest your own money and your own resources, you are much more motivated to make it happen. You have that fire in the belly that tells you that you have to make it now with what you have.

    And when you have less resources at your disposal, it’s much harder to waste them. Your mind adapts to the situation and improvises and comes up with creative solutions.

    *****

    One of the strengths of Romania is actually having less resources. This is because people are habituated with having less and needing less. For this and other reasons, Romanians are in general inventing spirits.

    Living in a culture of abundance makes you lose sense of your limits. You think that just by trying harder you can get ahead in life. This is unsophisticated and there’s nothing strategic about it.

    Dinu Patriciu said that Romania could get economically in the next 15 years in the top 5 countries of the European Union. I actually agree with him especially if you consider the power of the compounding interest. 5% more than other countries per year translates to much more than 5%*15years.

    *****
    Here are a few pragmatic measures:

    1. lower the taxes.
    The income tax should fall from 43% to 30% at most. VAT should fall to 10% or even less. How do you avoid creating a huge deficit? You sell all unprofitable state-owned companies. And you fire 1 million people from public service.(see the 4th point)

    2. get the tax on profit at ZERO. Basically, investors or anyone with surplus money will keep all of the money they earn.
    And the mindset of the investor is different from the mindset of the average person. This is why these kinds of people wouldn’t buy for themselves an Island. They will reinvest a large percent of their money in lucrative businesses that generate even more profit in the long run.
    And he will hire more people. And those people will spend their money on frivolous and sometimes necessary things. And the entire economy will spin faster and thus create more prosperity for everyone.

    3. Get rid of 95% of the fiscal system.
    One person working part time should be able to keep the evidence for a company of 100+ employees.

    4. 1 million people working in the public sector should go and start working in the private sector.
    How do you get rid of these people? You give them a small wage for the next 6 months while they can find a job. And you give them 2-3 training courses per person so they get some real marketable skills.
    This will also lower the price of hiring someone. Which is a good thing especially in the long term.

    There are many more things that can be done. It’s not that complicated. These are ideas are based on pure math and human psychology.

    1. These ideas are NOT based on any sort of math.

      Your post is too long for me to try to even start dissecting it, but anyone who suggests eliminating 1 million people from the public services when that’s about how many they are in total, excluding the armed forces, needs a reality check.

      Your other numbers are equally ridiculous.

      1. @Florin Bejan
        Attack the message, not the messenger.

        The public services in Romania are really poor. They should be done by businesses and for a profit.

        There’s no point in wasting resources in keeping this people on payroll.

      2. @Adrian T. – I’m pretty sure that’s exactly what I did, where do you see me saying anything about you?

        And I don’t share your opinion that privatizing a service will automatically solve the quality issue: faced with a serious medical problem and being given the option, would you go to a French hospital or a Romanian private clinic?

        What next on your list? Give up public education? Yep, let’s really make all the efforts to go back to the 19th century.

      3. Guys and gals,
        Let’s keep the debate focused on arguments. There are good points on all sides but sometimes they just need to be articulated. It is hard to prove your point in economics but sometimes real world stories help. here is a good example, although I am sad to see how it turned out in the end.

      4. @Florin Bejan
        “I’m pretty sure that’s exactly what I did, where do you see me saying anything about you?”
        You said: “anyone who suggests eliminating 1 million people from the public services […], needs a reality check.”

        “And I don’t share your opinion that privatizing a service will automatically solve the quality issue: ”
        I didn’t say that. I said that it’s a better choice in the long run. The quality will improve over time and based on the needs of the people who make up the market.

        “faced with a serious medical problem […], would you go to a French hospital or a Romanian private clinic?”
        Your example is a logical fallacy. You are talking about the exception, not the average scenario. Most medical problems that people have are average health-related problems that can be dealt with in Romania.

        If there’s a need on the market for complicated health-related problems, entrepreneurs will create solutions for the people who have these problems.

        “What next on your list? Give up public education?’
        You don’t give it up. You transform the system. I was exposed to both the Romanian and the French educational systems. They are both wasteful.

        Let’s say that a company wants java programmers. And entrepreneur talks with those companies. He hires people and creates teaching materials based on what the companies want.

        And the company publicly approves his courses. And then the entrepreneur advertises these courses to people who want to get a job.

        in this way, you don’t need to spend 4 years in school. You just learn the basic skills for the job. Then when you want to advance in the company, you take another course during the spare time. In this way, you get better at what you during a life time.

        “Yep, let’s really make all the efforts to go back to the 19th century.”
        Actually, the public educational system that we have right now was created in the 19th century. Now, in 21th century with the help of the Internet, you can do most of the school related things online and much cheaper.

      1. @Florin Bejan
        That means to eliminate 95% of the rules and regulations + 95% of the things businesses need to do for the state excluding paying their taxes.

        That’s unproductive work. It doesn’t add to anything. It should be 100% eliminated.

  4. @Adrian.

    You are making some confusions, and you don’t take into account some elements.

    For instance, don’t confuse people with companies. In order for people to spend less than they make, first they need a job, and second they need a wage to allow them to save. This is not out of thin air.🙂 It has much more to do with financing, including loans, but not only, than people unaware of what a company is are ready to accept.

    Ford did all his fortune and built up it’s company relying on debt, also. He created goods and sold them, using creditors money.

    Small rates are not only a question of new credit, but also a question of old credit, as the most part of the loans in Romania, and everywhere, bear a variable rate, not a fixed rate. Don’t expect you’re employer to increase your wage while he pays more for his loan (short term or long term) at the bank, and in the same time he doesn’t actually sell more. As you can see, smaller rates have a lot of sens, and helps the economy much more, mostly during economic downturns, then you supposed in your comment.

    In the whole history there exist no example of grate invention or progress achieved without enough money. For you to have a computer and surf on the internet, today, in the US, about a decade, tones of debt flowed into this industry, injected by the venture capitals. There was a big waste of money, and a lot of debt, until you and I had the chance to read Florin’s views on a blog, over the internet🙂. I’m sure lots of people those days considered the venture capitals to have lost their limits. An idea worth nothing without the money to implement it, and life is not mathematics, is a question of trial and error, which by definition imply waste and excess. And most of the people having an idea don’t have the money to make it marketable, in the same time. Including Ford.

    Nobody has enough, so this is why the debt has been around since Mesopotamia. The NBR and the unrealistic people are the only ones who believe that you can develop a country without enough money. Again. There’s no such example in the whole history of humanity. Poor get poorer, until they understand the trick.

    Debt is not always speculation, let’s not confuse things.

    I agree with you that consumer loans should be treated a little bit different🙂.

    I totally agree on taxation and firing in the public sector. I think the state should decrease, from all points of view, almost proportional to the economy increase.

    I don;t think the budged deficit itself is a problme, it depends on what is the state spending for, why do we have a deficit. And, of course, we should have a breakeven above which we should stop.

    Of course, it’s just my view.🙂 >:D<

    1. @Lavinia
      “For instance, don’t confuse people with companies. In order for people to spend less than they make, first they need a job, and second they need a wage to allow them to save.”

      What’s the difference between people and companies? A company brings together people and resources towards common objectives.

      The only difference is in terms of scale and complexity. The same rules that apply to an individual, apply to a company.

      A person doesn’t need to go in debt in order to produce something valuable and sell it to other people. An employees also sells a product: his time and skills. A company doesn’t need debt in order to buy his time and skills. The company had to have money saved that were being generated from profit.

      What is money? By itself, it’s a piece of paper. It doesn’t have any value. It’s not valuable.

      Money represents value which is something else entirely. Money is like a beautiful menu in a restaurant. It looks awesome but you can’t actually eat the food that’s being displayed. To actually eat the food you need to mix the ingredients and prepare it.

      *****
      @Florin Citu
      Offtopic regarding debt.
      On this page, there’s a featured book called Debt: The first 5000 years. It’s an awesome book. It solved my dilemma regarding the relationship between money and trading.

      I couldn’t figured out why people would invent money because of trading. Trading doesn’t come naturally to most people. That’s because of certain cognitive biases that all people share.

      Thanks for your recommendation.

      *****
      “Ford did all his fortune and built up it’s company relying on debt, also. He created goods and sold them, using creditors money.”

      How do you know that?

      Here’s what Henry Ford said in his autobiography:

      “A business which can bring itself to the point where it attracts the attention of money should be able to continue on its own feet without being financed.

      Another rock on which business breaks is debt. Debt is nowadays an industry. Luring people into debt is an industry. The advantages of debt have become almost a philosophy. Possibly it is true that many people, if not most, would bestir themselves very little were it not for the pressure of debt obligations. If so, they are not free men and will not work from free motives. The debt motive is, basically, a slave motive.

      When business goes into debt it owes a divided allegiance. The scavengers of finance, when they wish to put a business out of the running or secure it for themselves, always begin with the debt method. Once on that road, the business has two masters to serve, the public and the speculative financier. It will scrimp the one to serve the other, and the public will be hurt, for debt leaves no choice of allegiance.

      Being in debt changes your focus. It makes you thinking about the wrong kind of things. You should be thinking on giving other people what they want: goods and services. Not worrying about paying back your loan.

    2. “In the whole history there exist no example of grate invention or progress achieved without enough money.”

      We were talking about debt not about money. Debt, which is borrowed money that has to be paid with interest, that’s the problem.

      “Poor get poorer, until they understand the trick.”
      My father has 10 brothers and sisters. He has more wealth(assets) than all of his brother and sisters put together. They took loans on mass. And half of them are in debt for the next 20+ years.

      While his relatives spent their money. My father deffered high style consumption and invested them in assets which grew at least 10 fold in 15 years. He has no debt. And he can buy them out together with their loans.:)

      They all earned much more money than he did. But they are still poorer, and envious I may add:P If you look at the numbers, debt and consumption took them to the road to poverty. It wasn’t production and savings that made them poorer.

      “Including Ford.”
      Read his autobiography.

      “For you to have a computer and surf on the internet, today, in the US, about a decade, tones of debt flowed into this industry, injected by the venture capitals.”
      Venture capitalists buy stakes new companies. They don’t loan money.

      “I don;t think the budged deficit itself is a problme, it depends on what is the state spending for, why do we have a deficit. And, of course, we should have a breakeven above which we should stop.”

      That’s not logical. If debt is so good, why not have more of it. Why is there a limit? The limit exists for a good reason.

      It’s like a poison. It may only make you sick in small doses. But it will kill you in big doses.

      I don’t say that people can’t benefit at all from debt. But it’s not the way to go for most people. There are better ways.

      Debt is something made up by people, it’s not something that exists in the real world. Most people don’t think really well in terms of debt, interest and long term.

      “Debt is not always speculation, let’s not confuse things.”
      Not borrowing the money is the speculation. What you do with it and the means to pay it back involve risk. And the bank always has a risk that the person is not going to pay it back.

      You may think that your product is the best out there. But your customers may think otherwise.

      Debt is not something you need or a company needs. Money doesn’t equal creating something of value.

      *****
      Trial and error in a market which is not leveraged by big money happens in obscurity. Not many people see the actual trial and error. And not many people have to suffer because of it.

      When these big financial swings happen, which are always leveraged by debt, the world becomes a poorer place. And the wealth is transferred from many unprepared to few prepared.

  5. @Florin

    I don’t think RON is depreciating :))))) I think RON was missed price ever since started to exist, so first it needs to come closer of the true level, and may be than we can talk about devaluation🙂.

  6. I also bought Euro today at 4.36 rate. The real economy of ING retail banking is already at 4.41🙂, the rest of us are still in 4.35 range.
    I mostly agree with this analysis, however it fails to evaluate which of the 3 channels to inject money into economy is more benign. I think a moderate RON devaluation would work best for our economy, so BNR is doing the right thing in the end, isn’t it?

  7. @Florin B

    I must admit I didn’t read your whole comment🙂 Sorry for this one.

    Do you have any idea how many prizes did romanian teams obtain at international invention fairs in the last 3-4 years? And some examples of them becoming marketable, or you hearing about them, or their owners becoming big romanian businessmen?! I think one of them was about to be produced and made marketable, some scanner for customs, but I don’t know if they finally started to produce it at mass scale, and mostly to produce it in Romania, and not selling the patent outside the country.

    Dreaming has always been easy🙂.

    I invite you to become a business man, and to produce A GOOD, without having a rich family, without corruption and other sort of stolen money, and without having a really very high end paid job a couple of years, before deciding to become a producer. Than come back, and we can further discuss on the topic.

    Florin will really got mad for what I’m saying, (I invite you to delete my comment, as a result, Florin!), but I’m afraid I will have to repete. We are not living on the same world, and dreaming have always been easy. The drama starts when you get into the position to step out of you imagination and logical rationing and face the real world, and you find out that being smart and hard worker is not actually enough, and that in the end is all about the money🙂.

    But, of course, we imagine that we can survive as being a country of book-keepers, and others alike. No, we can’t, actually. Some people have to produce goods in this country if we wanna get far away from the tent. And, we can’t actually do it without credit🙂.

    And the simple fact that you confuse a company, and a loan for a company, with the consumer credit, tells me that you don;t actually know very well what a company is. And I’m mad, not acting nice to you, I recognize this, because I realize that the authorities have the same primitive and unrealistic level of understanding and perception toward the reality of the business environment, mostly in Romania, but not also, and what a company is, and this is the reason why half of the romanians ar still using a horse for motion, after 20 years of … presuming free market.

    1. “And the simple fact that you confuse a company, and a loan for a company, with the consumer credit”
      I don’t confuse anything. I’m not that stupid. I have an IQ of 140+. It’s not that difficult. It’s a simple concept.

      Yes, I know that a company produces products and services. Let’s say that the profit is 10% and the interest is lower. Then it makes sense to borrow money.

      But there’s also an added risk and you have to carefully examine both faces of the coin. There’s no guarantee that your assumptions about the market is accurate. Risking your own money, that you have saved, it’s a much better way to go about it.

      Instead you should start things small and build one step at the time through profits. Your market will fund yourself based on results.

      Elan Schwartzenberg, and many others, didn’t borrow a dime for a bank and they are still worth tens of millions or even more. There are plenty million dollar companies out there who grew based solely on their resources.

      “we imagine that we can survive as being a country of book-keepers, and others alike. No, we can’t, actually. ”

      If what I’m saying would be implemented, there will be less need for bookkeepers. This explains your reluctance to these measures.

      “And, we can’t actually do it without credit’
      Why don’t you actually start your own company and bootstrap it? You could do it in your spare time and prove yourself wrong.

      “why half of the romanians ar still using a horse for motion, after 20 years of … presuming free market”
      It may be free market. But it’s definitely free market in their heads.

      You could also count the money they spend frivolously over the years and the hours they wasted doing pretty much nothing to better themselves.

      The people you see as poor are still poor for very precise reasons. It’s not that they had no opportunities. It’s not that they didn’t have enough money. It’s not even that they didn’t work hard enough.

      They have to change themselves in order to get to the next level. Any most people out there can at least double their standard of living and their wealth. But most of them don’t actually go in this direction. They are less industrious about it. There’s no reason to blame them.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s