How
would a default in D.C. affect Astana – and Almaty?
One hates to be the gloomster in the season
of good cheer. But the chances that the United States
government will soon default on its loans -- or, what is just as bad, that
people will expect a default – are greater than Panglossians think. Fiscal conservatives in Congress – call them
the Tea Partygoers -- lost their T-shirts in the last bout over the
budget. One more whipping like that and
they’ll be out of business. So they may
resist pressure to continue the lift in the debt ceiling, which expires
February 7. And before then, the road
takes a couple of tricky turns: The deadline for agreeing on a long-run fiscal
plan is December 13, and funding for the government ends January 15. What would an expected default mean for Kazakhstan?
Global interest rates may soar. A security from the U.S. government
– a bill, note or bond – is essentially an IOU.
If you, the potential creditor, suspect that the borrower will renege,
then you will demand a higher return – the interest rate – to compensate you for
the risk of lending. Since Uncle Sam’s
bonds are among the world’s safest assets (at least, they used to be),
perceived risk for assets around the world will rise. There go the interest rates, including Kazakhstan’s.
Enthusiasm will fade for building plants
and homes here, since builders cannot afford to borrow at exorbitant interest
rates. They will cancel projects on the
drawing board. Output will fall, and unemployment
will rise.
This will pressure the National Bank of Kazakhstan to
try to resuscitate spending by printing tenge.
But the Bank has a new chair, Kairat Kelimbetov, who has yet to
establish his reputation. A sudden
increase in money supply on his watch may destroy his credibility as a foe of
inflation. Prices might not rise in the
likely recession, but they will later.
Let’s
do the tenge tango
A spike in interest rates will also affect
the tenge. In the foreign-exchange
market, you profit by buying and selling currencies until each pays off at the same
rate of return. Were this not the case,
then you could make money by selling a low-return currency (say, the Japanese
yen) in exchange for a high-return one (the tenge). But this would drive up the price of the
tenge – its exchange rate for a yen – and thus lower its rate of return.
Normally, the rate of return to the tenge
equals the global return plus an adjustment for risk. An American default would increase the risk
of holding currencies rather than safer assets like gold. The return to the tenge would have to rise,
or no one would want to hold it.
Most of this return consists of the
domestic interest rate, since assets denominated in tenge (like government
bonds issued by Astana) pay off at this rate.
But the return to the tenge has another component – the rate at which
the currency is expected to strengthen. If
you think that the tenge will appreciate, in terms of the amount of foreign
goods that it will be able to purchase, then you may decide to hold tenge
despite their mediocre interest rate. The
impact on Kazakhstan
of the American default may show up partly as a rise in our interest rate and
partly as a strengthening of our currency.
The latter cuts the tenge price of imports,
since each tenge can buy more of them than before. So, Kazakhstanis will demand more imports –
sedans from Germany, bottled
water from Georgia. Similarly, the world will demand fewer of our
exports; we’ll sell less oil. Our
“balance of trade” -- the difference between our exports and imports of goods --
will deteriorate. Although this is not a
fatal disease, it will shrink our economy for a while.
The
trade imbalance
But not right away. In fact, perversely, the immediate balance of
trade will improve. This is because most
exports and imports are delivered under contracts that fix the price and
quantity for a few months. Suppose that
an export contract of ours fixes the price of an oil barrel in tenge. Now strengthened, the tenge will be able to
buy more foreign goods than before, improving our trade balance. Here’s a hypothetical example. Before the tenge appreciated, we could buy
100 books from Russia
in exchange for a barrel of oil. Now we
can buy 200 books. In terms of goods,
our balance will look better.
(Economists call this the “real” balance of trade, because it is
expressed in terms of output rather than of money.)
As time passes, traders will update
contracts to reflect the new exchange rates, and our trade balance will finally
tip against us. As even more time
passes, firms will revise their product prices – increasing them for our
imports, decreasing them for our exports – in order to cope with the effects of
the strengthened tenge. The trade
balance will improve again – and will even return to its old position if
nothing fundamental has changed.
Meanwhile, the senseless default in Washington
will distort decisions about investment and foreign exchange around the world
-- even though it is just a political mirage, telling us nothing about the U.S. economy’s
capacity to produce. --Leon Taylor, tayloralmaty@gmail.com
Good
reading
Krugman, Paul R. The J-curve, the fire sale, and the hard
landing. American Economic Review, May 1989.
Reprinted in Krugman, Currencies
and crises, MIT Press, 1992. A
formal yet readable analysis of how risk affects the interest rate and the
exchange rate.
Weisman, Jonathan and Ashley Parker. Republicans back down, ending crisis over
shutdown and debt limit. The New York Times. October 16, 2013.
