Pulling the trigger

When does stability destabilize?


Since February 2009, when the national economy was in the throes of a slowdown, the central bank has held the value of the currency to about 150 tenge to the United States dollar. This stability has surely made Kazakhstan more attractive to foreigners intent on building factories. But it also comes at a cost.

By defending the tenge’s foreign value, the National Bank deprives itself of the power to defend the currency's domestic value. Inflation may result. For example, suppose that world demand rises for the tenge, strengthening its foreign value to 120 tenge to the dollar. To bring the exchange rate back to 150 tenge, the National Bank may have to create more currency in order to satisfy the new demand. We thus have more tenge chasing the usual amount of products. Domestic prices will rise. In fact, Kazakhstan had an inflationary spike in April 2008, when consumer prices momentarily rose by more than 10% over the previous April. Although inflation is usually lower in Kazakhstan than in Russia, the former’s economy remains vulnerable to it.

What should sharpen our sense of danger is that a small open economy like ours faces a relatively large global demand for its currency. Changes in that demand can rock the tenge. When world oil prices escalate, demand will rise for Kazakhstani oil – and the tenge will rise, too. This is not an immediate problem, especially since one of our largest oil customers, China, has seen its economy cool off this year. But oil prices are volatile, and their sudden surge may force the National Bank to act so quickly as to create uncertainty about domestic prices. This may lead consumers to cut back spending – creating for themselves a nest egg – until they are surer of where the economy is headed. Due to less spending, Kazakhstan’s economy may stagnate.

In this light, we may be troubled that the rate of spending a tenge – called “velocity” -- has fallen steadily since 2000 (see the Notes). Velocity equals total spending on Kazakhstan products divided by the number of tenge. Evidently, the supply of tenge (cash and checking deposits) has long risen more rapidly than total spending has. The possibility of steep inflation someday is hard to dismiss. If, in some episode, the National Bank suddenly prints tenge in order to hold down the exchange rate, then it may trigger the inflation that has long remained latent. –Leon Taylor, tayloralmaty@gmail.com


Notes

1. For the M1 money supply, annual velocity has fallen from 4.0 in 2000 to 1.9 in 2011. The raw data for this calculation is from the National Bank of Kazakhstan.