The champagne currency

Will the National Bank of Kazakhstan soon devalue the tenge?

Suppose that you are to meet another Almaty resident somewhere in the city.  You don’t know whom you will meet, or anything about him or her; nor do you know when or where.  Then where will you go, and when?  How will you identify yourself?

A favorite answer in this parlor game is that you will meet at midnight December 31 at Republic Square, perhaps at the pavilion of statues.  Probably you will carry a sign saying, “Are you looking for me?”   The point is that you will choose the most obvious time, place and identification, since your unknown partner will do the same.

Currency speculators look for focal points, too.  The word on the street is that the word on the street is that the central bank will soon devalue the tenge. To maximize profits from short sales, you must anticipate when others will close out their positions.  The most obvious focal point is:  Right after the New Year’s break, at a new exchange rate of 200 tenge to the dollar.  What recommends this point is not that it’s logical but that it’s easy to imagine.  (A second possibility is February, since the Bank devalued in that month on both prior occasions.)

If this reasoning is right – and I’m not sure that it is – then we should see a frenzy in the forex market for tenge in the next few days.  Keep your eye on KASE.  Of course, the short sales might compel the National Bank of Kazakhstan to devalue, whether it wants to or not, since the shorters will profit by purchasing dollars for tenge and draining the Bank’s dollar reserves.

Why does “everyone” expect devaluation?  Because she “knows” that the Bank intercedes when oil prices, the ruble, and forex reserves all fall.  Indeed, the ruble had weakened before the devaluations of 2009 and 2014; and oil prices and dollar reserves also fell in the run up to the February 2009 reduction of 25% in the target dollar value of the tenge.  This year, since June, the dollar value of the ruble has halved, and the peak-to-trough decline in the daily futures price of some oils has been something like 40%.  Ergo, devalue.

Shooting craps

If we could be sure that oil and the ruble would not recover until 2016, then devaluing the tenge might well make sense.  Historically, Russia has been Kazakhstan’s leading partner in trade; a weaker ruble would eventually reduce Russian demand for Kazakhstani exports and sharpen Russian competition with Kazakhstan in global markets.  Lower oil prices in the spot market reduce Kazakhstan’s export revenues for a while – say, for less than a year – because oil demand is not sensitive to the price in the short run.  That is, the lower price does not induce sales of many more barrels – not right away, at least; so Kazakhstan sells about as many barrels as before, but for less money per barrel.

The operative word in that paragraph is “if.”  The value of the ruble is contingent on the Western sanctions imposed on Russia for intervening in Ukraine.  They are painful for Europe’s largest economy, Germany, and it is hard to believe that Berlin will comply with them until 2016.  More important, a 40% decline in daily oil futures of 40% does not imply a concurrent 40% decline in annual spot prices, which are far more fundamental to production decisions than the speculative, volatile futures are.  At the moment, annual spot prices for Brent crude, the global benchmark, are down by about 12%, according to data from the United States Energy Information Administration.  If this rate of decline continues for another year, then -- judging from its performance since 2000 -- annual Kazakhstani GDP per capita may fall by 6% or less.  However, estimates of the excess supply in the global oil market have been running at one or two million barrels per day, or roughly 1% to 2% of global supply.  It is not evident that this can sustain a 12% reduction in price over all of 2015.

Bandwagon finance

In short, the Bank is in a gray area.  The ruble, and oil prices, may not continue to decline for long enough to enable a tenge devaluation to pay for itself.  Add to this the pernicious consequences of any devaluation for tenge holders, particularly the commercial banks.  When the Bank weakened the tenge this February, social-media rumors led to runs on three financial institutions in Kazakhstan.  Finally, devaluation would be inconsistent with financial reforms that the Bank is considering in tandem with the government, such as increased insurance for tenge deposits, a reduced rate of interest paid on dollar deposits, a rise in tenge liquidity for the banks, and a general move away from dollars and towards tenge (“dedollarization”). 

Were it not for the public pressure, the National Bank would not need to rush into a decision.  Its international reserves are, to say the least, ample.  Last month it held $7.1 billion of gold – slightly lower than in August, when it built its stash to $7.5 billion, but still a 29% gain since January, according to Bank data.  As of November, net reserves had been rising steadily since June to $27.9 billion, a 15% increase over January.  As if this wasn’t enough, the National Oil Fund, consisting mainly of royalties from exports, was nearly triple the Bank’s net forex reserves -- $76.8 billion in November, an 8% increase since January (despite the fall in oil prices).  Combined, the reserves and Fund could pay for merchandise and service imports for more than two years.  (Early this year, imports averaged $4.2 billion per month.)      

At this point, given these conditions and especially the uncertainty surrounding them, a second devaluation within a year is not logical.  However, we are moving beyond logic.  The word on the side of the bandwagon is “devalue,” and the bandwagon is filling up fast.  See you in Republic Square. –Leon Taylor tayloralmaty@gmail.com

Notes

Net reserves fell from $21 billion in October 2008 to $18.2 billion in January 2009, a 13% decline, according to Bank data.  They did not weaken so graphically in the run up to the devaluation last February.  They had fallen throughout most of 2013 but had been strengthening fairly steadily since November.  However, compared to January 2013, net reserves in January 2014 were down by about 9%.  In sum, the Bank sometimes devalues even when net reserves in prior months have been rising.       

References

     

Nikolai Drozd.  Svyazannii s dedollaryzatsyiy resheniya myagche syshectvovabshyx radykalnix ozhydanii.  Panorama.  December 26, 2014.

Slouching towards equilibrium

  

The Bank of Japan is struggling to ignite inflation.  “Central bank officials,” reports the Wall Street Journal, “have been putting a brave face on the slowdown in inflation resulting from the lower oil prices, saying that cheaper crude will stimulate demand, eventually adding to upward pressure on prices.”

If that quote is accurate, and if it refers to oil demand, then the Bank of Japan really is in trouble.  It’s confusing a market equilibrium with the lack of one.

In principle, the oil market tends toward a price that equates the quantity supplied to the quantity demanded.  If supply exceeds demand, then sellers will cut their price until they work off the excess.  Once they do so – that is, once supply again equals demand – the price will stabilize, lower than before.  It won’t rise in response to excess demand, because there is no excess demand.  The market is in equilibrium. 

Central Asian policymakers make this mistake, too.  The point is that the price doesn’t just change on a dime.  It responds to shocks – like international sanctions choking demand – that throw the market out of kilter.  Once it has brought the market back to equilibrium, it will stay put, until the next shock.

Maybe the Bank of Japan is referring to demand for all products, not just petroleum.  When oil prices fall, Japanese consumers save money.  They will spend much of the savings on a variety of goods, raising their prices.  That’s inflation.

Moral of the story:  The Journal should sharpen its blue pencils and edit for clarity.  –Leon Taylor tayloralmaty@gmail.com

Reference

Tatsuo Ito and Kosaku Narioka.  Japan inflation slows in blow to Abe.  Wall Street Journal.  December 25, 2014.

What a coincidence

 Last week, oil prices rose on the short-term futures market when traders cleared their positions, reported the Wall Street Journal.   A word of explanation: To profit from a falling price, a trader can borrow an asset and sell it at today’s high price, then purchase it at next month’s low price and return it to the lender.  Her profit is the price difference, minus transaction costs.  If, for example, the asset price falls from $100 to $60, then she clears $40.  If many traders clear their positions at the same time, then demand for the asset will rise, increasing its price.  So is this adjustment somehow mechanical, with no implications for the asset’s perceived value?

No.  Traders will choose to close their deals precisely when they expect the price to rise.  If I think that the price will be $60 on Wednesday and $65 on Thursday, then I will buy back the asset on Wednesday, profiting by $40 rather than $35.  Last week’s increase in price was not some mysterious happenstance; it reflected the belief of traders that oil prices are going north.  The prophecy fulfilled itself.

So, are oil prices finally rising for good?  Not necessarily.  The daily futures price is volatile, prone to temporary changes in what traders expect the market to do.  A more stable measure is the annual spot price.  (The “spot” market is where oil is bought and sold; the “futures” market is where traders speculate on future spot prices).  But this measure is backward-looking, since it is dominated by prices that occurred several months ago.  A reasonable compromise may be the quarterly spot price, which is a fifth lower now than it was at this time last year.  For September through November of this year, the European Brent spot price for a barrel was $88; for the same period in 2013, the price was $109, according to data from the United States Energy Information Administration.  In contrast, the annual spot price for Brent has fallen 12.4% -- $103 for December 2013 through November 2014, and $118 for the same period in 2012-3. 

In short, oil prices are still falling.  But the completion of short sales last week reminds us that the prices need not continue to decline for, say, two years.  Expectations may change and indeed may be changing.  –Leon Taylor tayloralmaty@gmail.com

Notes

I calculated the quarterly and annual prices as averages of monthly FOB prices.

References

Nicole Friedman.  U.S. oil prices bounce off multiyear lows.  Wall Street Journal.  December 17, 2014.

United States Energy Information Administration.  Data on prices and quantities of energy fuels.  www.eia.gov.

  

           

The Riyadh connection

Why did OPEC's decision rattle futures markets? 

In the last six months, during which oil prices on the futures market declined, they plunged most steeply immediately after the November 27 decision of the Organization of Petroleum-Exporting Countries (OPEC) not to reduce its supply, perhaps because of a prisoner’s dilemma. Brent prices fell by $6 to $71.25 per barrel, reported Reuters.  Why did speculators respond to OPEC by dumping oil securities?

The most reasonable explanation would be that they believed that the decision would create an excess supply of oil.  Either supply would rise or demand would fall.  Let’s consider each possibility.

Could OPEC’s decision have increased supply?  It’s hard to see how.  Non-OPEC producers (like Russia and Kazakhstan) would not respond by increasing their own supply since, given demand, this would create an excess.  They might have stepped up production had OPEC voted to cut back, for this might have freed up some demand for themselves.  Indeed, this very possibility might have led OPEC to maintain its existing supply.

Surely, then, OPEC’s decision would lead to a fall in demand.  But this doesn’t make sense, either.  Why would buyers cut back in response to a confirmation of the usual supply?

Seeing is disbelieving

In short, it is not reasonable to think that OPEC’s policy could increase excess supply and thus cut oil prices.  So why did investors immediately respond by selling oil short?

Perhaps they considered not the actual effect of the decision but the perceived effect.  If the typical investor believes, correctly or otherwise, that the policy would increase supply, then it makes sense to get out of oil.  With apologies to Robert Shiller, one might call this an “irrational lack of exuberance.”

The weakness of this approach is that an investor who focuses on actual demand and supply will eventually profit at the expense of short sellers, if market conditions dominate prices over the course of a year or more.

For example, some analyses suggest that global oil prices are falling because of an (undocumented) excess supply of one million barrels per day in West Texas Intermediate oil.  Even if the excess supply does exist, it would be trivial in the context of a global market of more than 90 million barrels per day, according to data from the United States Energy Information Administration.  It is not reasonable to think that, given demand, a rise in supply of about 1% would lead to a fall in price of 30% or 40%.  But if investors think that such fallacies are commonly accepted, then they may sell oil short for profit, at least until a sense of reality prevails.  –Leon Taylor tayloralmaty@gmail.com   

Notes

1.  In the game called “prisoner’s dilemma,” each player chooses a strategy that most benefits him given whatever the other player would do – yet the overall outcome is worse for both players than a cooperative solution would be.  In OPEC’s decision, each country might prefer to maintain its own output regardless of whether other countries would maintain or reduce theirs.  But the general outcome might be worse for OPEC than a commitment by all its members to reduce output.

 References

Alex Lawler, David Sheppard and Rania El Gamal.  Saudis block OPEC output cut, sending oil price plunging.  Reuters.  November 27, 2014.

Robert Tuttle.  Brent, WTI slump to 4-year low as OPEC keeps quota steady.  Bloomberg.  November 28, 2014.

United States Energy Information Administration.  Copious oil statistics.  www.eia.gov

     

Cliffhanger

For two weeks, news reports have predicted off-the-cliff falls in the global price of crude oil on the spot market, based on publicized forecasts.  What the newspapers don’t note is that many forecasts are based simply on past data.  They assume that any new data trends will continue, regardless of the reasons (if any) for those trends.  

And rarely do the newspapers report anything more than the point forecast (say, $55); they ignore the range of likely prices (e.g., $30 to $80 – the “confidence interval”) which is especially large for long-run forecasts.  By itself, the point estimate is not of much use because it is rarely exactly correct.  The question then becomes: What values near the point estimate may well occur?  To answer that, we need the confidence interval.     

Finally, most news reports are based on authority, not logic.  In their view, Organization X's forecast is important because X is important, not because its forecast is well-grounded.  

Let’s go back to basics.  The long-run price of any product is an adjustment to market changes.  The price of X will fall if otherwise the market would remain in excess supply.  In particular, the long-run global price of crude oil will fall if either supply has increased or demand has decreased, recently and permanently.  The problem is to determine what might have precipitated either event.  The reason for the last price collapse, in 2009, was clearly global recession.  What reasons stand out today? 

Supply.  World oil output is rising but not dramatically.  It increased by 1.7% from 2013 to 2014 for the period January through August, the latest data available from the United States Energy Information Administration.  It is not realistic to think that a 1.7% increase in supply can lead to a 30% or 40% decrease in price. 

Demand.  The Chinese and European economies have slowed, but those trends are not new.  The Chinese growth rate has been relatively soft for two or three years, according to World Bank data.  The European economy has been sagging for at least five years. 

K-traders

The problem is to explain why short-term oil prices have fallen 30% since June.  The only apparent new event of the past few months has been the tightening sanctions against Russia. It is hard to believe that these could account for a 30% fall in global oil prices.

Another possibility is that oil contracts take time to rewrite, so the recent price decline reflects market conditions of the past year or two.  But since various contracts come up for renewal at various times, this might not explain the suddenness of the price decline.   

Finally, some news reports suggest that prices have fallen because of a confluence of random factors.  In that case, the factors, being random, will disappear.  They should not affect long-run prices.

So, why have crude prices fallen so abruptly?  One reason may be speculation.  Many traders believe that the market price is determined not by supply and demand but by the average beliefs of traders.  I will call them “Keynesian” traders, because John Maynard Keynes analyzed this strategy in 1936, in his General theory of employment, interest and money.   

Keynesian traders regard an initial fall in price, which may occur randomly, as evidence that other traders believe that prices will continue to fall; so they sell the product short.  The short sales themselves reduce prices on the futures market, making the Keynesian strategy a self-fulfilling prophecy.  This may help explain the disproportionate fall in oil prices two weeks ago in response to OPEC's decision not to reduce output.  

Whether you think that the price decline due to shorting is a short-run phenomenon or a long-run one depends on the importance that you attach to supply and demand.  If you believe that long-run prices can fall without fundamental changes in the market, then you may accept the forecasts of $55 oil.  The important point is that a six-month collapse of oil prices is not by itself strong evidence that the decline will continue for years.  –Leon Taylor, tayloralmaty@gmail.com               

Kazakhstani income and oil prices (wonkish)

In Kazakhstan, a 10% change in the annual spot price of Brent oil seems to lead to roughly a 5% change in average real income in the same direction. 

Since oil and natural gas exports comprise more than a third of Kazakhstan’s economy, a simple model of global oil prices well explains changes in gross domestic product per capita, which is measured in international dollars adjusted for inflation. 

The table below reports the results of an Ordinary Least Squares (OLS) regression of real GDP per capita on the spot price of Brent oil (a benchmark for the global market) for 1999 through 2013.  Both variables are annual and in log form. 

In general, the model performs fairly well.  R-squared indicates that the model explains 92.5% of the variation in average income from year to year.  The large F statistic (159.52) suggests that the model almost certainly predicts more accurately than one that assumes that GDP per capita is constant over time.  The root mean squared error suggests that the model’s average annual mistake in predicting GDP (as measured by this statistic) is 8.5%.     

The t statistic for the coefficient on OilPrice is large (12.63).  Setting aside shocks to the world economy that are unexpected and extraordinary, we can be virtually certain that global oil prices will continue to dominate Kazakhstan’s economy in the next few years at least. 

The coefficient on OilPrice is the elasticity of average real income with respect to the oil price.  A 1% increase in that price leads to a rise in income in the same year of .46 of a percent.

The constant in the model (7.845) suggests that 2,553 international dollars of annual real income do not depend on oil prices.  In particular, if oil prices fall to $1 per barrel, then the model predicts an income per capita of 2,553 dollars, about one-seventh of actual income averaged over the period of 1999 through 2013. 

Output for the OLS model

      Source |       SS       df       MS                 Number of obs =      15

-------------+------------------------------          F(1, 13) =  159.52

       Model |  1.147         1        1.147               Prob > F      =  0.000

    Residual |   .093        13         .007               R-squared     =    .925

-------------+------------------------------           

       Total   |  1.240       14         .089                Root MSE      =  .085

------------------------------------------------------------------------------

     GDP      |      Coef.   Std. Err.          t      P>|t|     [95% Conf. Interval]

-------------+----------------------------------------------------------------

  OilPrice    |       .456         .036    12.63   0.000           .378      .534

   Constant  |     7.845         .145    54.28   0.000         7.533    8.158

The estimated model is:

LN (GDP per capita) = 7.845 + .456 * LN (OilPrice)

where LN denotes a natural log.

Caveats.  A plain-vanilla OLS model assumes that the strength of the relationship between the dependent variable and an independent variable is the same whether the latter rises or falls.  Thus our model predicts that if oil prices rise 10%, then income will rise about 5%; and if oil prices fall 10%, income will fall 5%.  In reality, annual oil prices have fallen sharply only once since 1998; and income has fallen only once in that period.  Both declines occurred in 2009, during the Great Recession.  At that time, oil prices fell 36.3%; income, only 1.4%, at least partly because the government stepped up spending to cover the loss of private consumption.  So experience suggests that the model may overstate the loss of income due to a large decline in oil prices.

The overstatement occurs because OLS is a linear model and because it assigns the same weight to each observation.  Of the 15 observations, only one is of a decline in average income.  –Leon Taylor, tayloralmaty@gmail.com 

Technical notes

OLS assumes that the independent variables (which are on the right-hand side) capture all important systematic influences on the dependent variable (on the left-hand side).  Unimportant or random influences show up in the error term, which is the difference between the actual value of the dependent variable and the predicted value.  

The assumption of independent errors might often be wrong.  The error term might correlate with the independent variables since these might influence its variance (heteroskedasticity). Or the error term may correlate with itself; e(t), for example, might correlate with e(t-1) (serial correlation).  Let’s check our model for these possibilities.

Heteroskedasticity.  I ran the Breusch-Pagan/Cook-Weisberg test.  Its null hypothesis is homoskedasticity (that is, the variance of the error is the same for each observation, which is what OLS assumes).  The probability of homoskedasticity, given estimated parameters, is 11.9%, so I did not reject that possibility.

Serial correlation.  I ran the Breusch-Godfrey (LM) test.  Its null hypothesis is no serial correlation.  The probability that the null is correct, given parameter estimates, is .364, so I did not reject it.

Nonstationarity.  A model that changes over time may predict poorly because it is based on obsolete data.  Dickey-Fuller tests found that the GDP variable was stationary but the oil-price variable was not.  (The test statistics were -4.24 and -1.35 respectively.  Both variables were in log form.)

When rewritten, nonstationary variables may have a stable – that is, stationary – relationship to one another.  In that case, the revision may predict well.  To check for this possibility of cointegration, I ran the Dickey-Fuller test on the error term of a model regressing GDP on oil prices.  The test statistic was -2.81.  Given an indefinitely large sample, the critical value under the Engle-Granger procedure at the 10% level of significance is -3.04.  (The level of significance is the largest probability of error that one is willing to tolerate by rejecting the null hypothesis.  In this case, the null is nonstationarity.) 

Although I have a small sample, I concluded that the model may border on cointegration.  I preferred this model to one that first-differences the oil-price variable in order to get stationarity, since differencing would eliminate an observation.  But one should bear in mind that in the model I use, nonstationarity may affect forecasts.   

Omitted variables.  If we fail to control for a systematic influence with an independent variable, then it will show up in the error term.  If it also correlates with an independent variable, then it may bias the coefficient estimate for that variable.  This problem is more serious than are serial correlation and heteroskedasticity since these do not produce bias. 

I applied the Ramsey RESET test, which examines the possibility of omitted variables that are higher-order forms of the independent variables already in the model.  The null hypothesis is that there are no omitted variables.  The probability of the null is .72, so I did not agonize over the problem. 

Warning shot

The communist faction in Kazakhstan’s legislature proposes to require the central bank to give advance notice of a devaluation of the tenge so that people can prepare.

The communists are justly famous for bad ideas, but this has got to be one of their 10 worst.  Suppose that the National Bank announces, on January 1, that it will weaken the tenge to 200 per United States dollar on March 1.  Speculators will immediately cash in their tenge while they are worth something (roughly 180 to the dollar at present), selling tenge for dollars.  This will drain the Bank’s dollar reserves, which are its only means of protecting the value of the tenge in the last resort.  The Bank will have to devalue to 200 on January 2.  So much for advance notice.

The Majilis would be more sensible to require the Bank to issue, in plain language, monthly reports of the state of the economy.  –Leon Taylor tayloralmaty@gmail.com

Reference

Zarina Karymova.  Kommunisti predlagaut preduprezdat’ nacelenie o deval’vatsii zaranee.  [The communists propose warning the population about devaluation in advance.]  Panorama.  November 14, 2014. 

How much money do you want?

The question sounds odd.  Surely the answer is:  “All the money in the world.”  But economists are literal-minded:  To them, “money” refers to the number of tenge available for spending, and “money demand” is the number of tenge that we want to hold, not spend.  Suppose that you had 5,000 tenge in your purse this morning and spent 1,000 on lunch.  Then your money demand fell from 5,000 tenge to 4,000.  Of course, the demand depends mainly on how much you’d like to spend later.

Money demand can determine whether the central bank can navigate the economy to harbor.  Normally, during a recession, creating tenge will spur spending and thus production.  But if people are willing to hold any amount of money, then they won’t spend the new tenge.  Such a “liquidity trap” may have blocked recovery from a long depression in Japan and in other countries where households save an unusually large share of their income.  In any case, we’d like to know how much money people want.

 

That question is hard to answer.  We know what the answer should look like.  Your demand for money should increase with your income, since people who earn more now will want to spend more later; and with prices in general, since you must pay more to buy your usual groceries when prices rise.  Also, money demand should fall as interest rates increase, since you would rather hold bonds, which pay interest, than money, which doesn’t.  (Money in this sense is usually defined as cash and checkable accounts, or M1 money.)  Indeed this model works pretty well in the long run – but not in the short. 

 

The next-door solution

 

Kazakhstan is no exception to this conundrum.  A 2010 study finds that the demand for money (broadly defined) in this country depends in predictable ways on output (which generates income), the interest rate, and on foreign exchange rates (which affect global demand for Kazakhstani exports), in the long run.  But this sensible model breaks down in shorter periods.  The authors speculate that rising interest rates, for example, may have induced people to move their wealth from dollars to tenge.  Thus the relationship between interest rates and tenge demand may be positive, contradicting the usual money-demand model.

 

The difficulty of short-run predictions hinders monetary policy.  Four or five decades ago, macroeconomists led by Milton Friedman argued that the central bank could reduce uncertainty in the economy, and thus spur purchases and production, by targeting the money supply.  The bank should create no more money than is needed to buy new output at the usual prices.  In October 1979, the central bank of the United States, the Federal Reserve, adopted this policy.  But money demand suddenly skyrocketed, outstripping money supply.  Interest rates rose, spending fell, and a wintry recession set in.  By the late 1980s, the Fed had stopped targeting the money supply.  Since then, it has usually targeted interest rates.

 

Sweep stakes

 

New research suggests that we may be able to explain short-run money demand after all.  In 2012 Lawrence Ball of Johns Hopkins University studied American demand for M1 from 1959 to 1993.  He found that it depended less on general short-run interest rates such as the Treasury bill rate than on the rates paid on such close substitutes for M1 as savings accounts and mutual funds in the money market.  In the late 1970s, money holders were sensitive to rises in the interest rate on mutual funds because the Fed’s Regulation Q capped the interest rates paid for conventional bank accounts.    

Should central banks again target money?  Ball notes an intriguing new complication in measuring M1.  Most central banks, including the Fed, require commercial banks to set aside a given share of their demand deposits; otherwise, the amount of money created by new loans, in the form of checking accounts, may get out of hand.  Beginning in the early 1990s, the banks got around the Fed’s reserve requirement by shifting money from demand deposits to money-market accounts.  (This cut in demand deposits reduced the amount of money that the banks were prohibited from lending out.  Suppose that the reserve requirement ratio is 10%.  If a bank reduces its demand deposits from $2 million to $1 million by shifting a million into money-market accounts, then its reserve requirement will drop from $200,000 to $100,000.  Voila!  The bank now has another $100,000 to lend out.)  Since money-market accounts were not part of M1, the banks’ “sweep” campaigns artificially reduced that measure of money supply.  After 1993, M1 data became unreliable. 

In Kazakhstan, could sweeps help account for the stagnation of M1 over the past two years?  -- Leon Taylor, tayloralmaty@gmail.com

 

References

 

Lawrence Ball.  2012.  Short-run money demand.  Journal of Monetary Economics 59:  Pages 622-633.  Informative.   

Mesut Yilmaz, Yessengeli Oskenbayev, and Abdulla Kanat.  (2010). Demand for money in Kazakhstan: 2000-2007.  Romanian Journal of Economic Forecasting 13: Pages 118-129.    

Cold fusion comes back

Are oil prices heading south for good?

In the past two weeks, news has proliferated of a supposed collapse in “the” global price of crude oil.  Since early this summer, the price has fallen from $100 per barrel to $80.  Since Kazakhstan prospers only when the oil industry does, the price decline signals an impending recession.  The solution is for the government to splurge, presumably to cover the anticipated shortfall in private consumption.  Or so go the news accounts.

Like most urban legends, this one has a kernel of truth.  Simple statistical models of data from 1999 through 2013 indicate that a 1% change in the spot price of Brent oil relates to a change in the same direction of Kazakhstani total output per capita of roughly one-half of a percent on average, expressed in annual terms.  (The annual prices are relevant because daily prices, for example, are too volatile to use when we’re planning how much to consume and produce over a year.) The problem with many news reports is that they compare a daily oil price on the futures market to a weekly, monthly, quarterly or annual oil price that is sometimes on the futures market and sometimes on the spot market, sometimes for Brent oil and sometimes for West Texas Intermediate oil, depending on the reporter’s druthers.  The reports compare apples to oranges.  Common sense should tell us that the fact that an oil price has fallen to $80 for a few days does not mean that all of them, or any of them, will stay that low for a year.

So, for the record, here are the latest annual spot prices for Brent oil:  For October 2012 through September 2013, $108.86; for the same period in the following year, $107.23, or a decline of 1.5%, according to data from the US Energy Information Administration (EIA).  I estimated the annual prices by averaging monthly prices. 

Do these data mean that Kazakhstan has nothing to worry about?  No.  It is perfectly possible that the spot Brent price will fall to $80 and remain in the basement for a year.  In fact, the Energy Information Administration this week lowered its 2015 mean forecast for that price to $83.42 (amid great uncertainty, and that is not a weasel phrase.  Unfortunately, in its forecast summaries, EIA does not favor the public with a confidence interval).  

Producers and investors expect price declines.  Saudi Arabia, which dominates the cartel called the Organization of Petroleum-Exporting Countries, recently cut its crude price modestly, and other OPEC members may follow suit.  On the futures market (for delivery in 30 days or so) for West Texas Intermediate oil, the daily price on the New York Mercantile Exchange fell from a 2014 peak of about $108 to below $80.  But those are only expectations, which are historically volatile: That daily price also fell to $80 in 2011 and 2012.  A more reliable indicator is the monthly spot price.  This fell to $87 in October for Brent oil, the lowest since November 2010, reported the EIA.

In general, annual prices will fall by a fifth only if market conditions have changed substantially.  Prices fall because producers want to sell more oil than people want to buy, and the rate of price decline depends on the rate of increase in excess supply.  The annual spot price of crude may suddenly fall sharply if the annual supply suddenly increases more rapidly than annual demand.  Under which conditions would that occur?  

Well, maybe the Europeans aren't buying, note news reports.  But their economy has been weak ever since the financial crisis of 2008.  Why should this weakness suddenly affect oil prices this summer? 

What about supply?  Consider US production of “tight” oil – i.e., crude extracted from shale, sandstone or carbonate rock, as defined by the EIA.  Since 2010, that production has increased about fivefold, from half a million barrels per day to 2.4 million in 2013, said Adam Sieminsky, head of EIA. 

Today, total US production of crude is as high as it has ever been.  But the rate of increase, which is almost entirely due to tight oil, has fallen for about a year.  So why should annual spot oil prices suddenly fall now?

The most obvious new determinants of oil prices are the sanctions against Russia.  Whatever their political merits, they reduce global economic activity and consequently oil demand.  But what are the chances that the sanctions will remain in force long enough to affect annual oil prices?

The vital point – and the one that the media, including the New York Times, rarely mention – is that oil-price forecasts are iffy.  The mean forecast may look precise, until you compare it to the range of other likely values.  For example, for the weekly futures price on NYMEX for West Texas Intermediate oil in January 2015, the mean price was $80 – but the 95% confidence interval ranged from about $60 to $100, reported the EIA.  Futures prices for Brent and West Texas Intermediate oil are more volatile now than they have been for more than a year.

In short, we don’t yet have enough data to conclude that a collapse in oil prices is imminent.  Since 1999, the only time that the annual Brent spot price has fallen sharply (by 40%) was in the Great Recession of 2009.  At that time, annual total output per capita in Kazakhstan fell 1.4%, according to World Bank data.  That was the only decline in real gross domestic product to occur here since 1999.  In light of these trends, it would make sense to prepare now for a price drop -- but to keep one’s options open, in hopes of better information later     

    

By all means, reporters should discuss such improbable but risky events as a depression in Kazakhstan.  But overstatements of its likelihood will eventually turn off intelligent readers.  No one wants to read about cold fusion anymore.  –Leon Taylor tayloralmaty@gmail.com

Notes

The “95% confidence interval” is a range of likely forecasts.  The idea is this:  Any forecast is based on available data, but these vary with circumstances.  I may forecast the 2015 grade of KIMEP students by sampling 50 undergraduates; but if I sample 50 other students, I will get a different dataset and forecast.  If I take 100 samples, then the 95% confidence interval will give the range of forecasts that I am likely to get in at least 95 of the samples.  

Of course, in reality, I probably will take one sample, not 100.  But the dispersion of data in that sample gives us an idea of how scattered the data may be over all samples.  The amount of scatter in the present sample generates the confidence interval.       

Good reading

Clifford Krauss.  U.S. oil prices fall below $80 a barrel.  New York Times.  November 3, 2014.  With specifics about the price declines.

United States Energy Information Administration.  Short-term energy outlook, November 2014.  Online.  www.eia.gov. This Web site also offers copious oil data.    

Adam Sieminski.  Outlook for US shale oil and gas.  United States Energy Information Administration.  2014.  Online at http://www.eia.gov/pressroom/presentations/sieminski_01042014.pdf

World Bank.  World Development Indicators.  www.worldbank.org  Income time series for most countries.     

The trouble with tenge

Does Kazakhstan have enough cash?  The head of Kazakhstan’s central bank thinks so.  Last week, Kairat Kelimbetov told journalists that plenty of tenge were circulating.  If he gave reasons for this view, the newspapers didn’t elaborate on them.

His claim is puzzling.  As a rule of thumb, in normal times, the supply of tenge should rise in proportion to output.  Too many tenge would raise prices, deceiving people about the true value of the products; too few tenge would hinder transactions at the cash register.  Over the past two years, output in Kazakhstan has grown by roughly 9%.  But the amount of cash (measured as the money supply M0) fell by 1.6%, according to data from the National Bank.  Possibly, in purchases, cash is giving way to debit cards, which draw on checking accounts.  But demand deposits aren’t rising rapidly, either.  M1, the measure of tenge supply that includes checking accounts as well as cash, is up by only 1.1%.  What gives?

Cash crash

In theory, one explanation could be falling prices.  The number of bread loaves and phone calls may be rising, but the amount spent on them may increase more slowly if their prices decline sharply.  But in reality, the average rate of increase in Kazakhstani prices – inflation – hasn’t fallen in the last two years and may even be bumping up a bit.  Prices can’t explain Kelimbetov’s claim that the country has sufficient cash.

The only remaining possibility is that people are spending each tenge more rapidly than before.  If a trillion tenge are in circulation, and if each tenge is spent twice per year, then total spending is 2 trillion tenge per year.  If the rate of turnover rises from 2 to 3, then spending will increase to 3 trillion tenge, although the physical supply of tenge remains at one trillion.

To some extent, a higher rate of turnover – economists call it “velocity” – means a more efficient use of cash.  But to make the numbers work, the turnover rate would have to have risen by nearly a fourth since late 2012.  Such a radical change might create difficulties for small businesses, which rely on cash transactions.  The needed tenge spend less time in their cash registers and more time in transit.  The firms' transactions – paying change to customers or a day’s wages to temporary workers – become more convoluted.  So, why, exactly, should we believe that Kazakhstan has enough nalychni den’ge? –Leon Taylor tayloralmaty@gmail.com

Notes

To estimate the required increase in velocity, I use the identity that the number of tenge (M), times the average rate of turnover (V), equals spending on nominal gross domestic product (output Q times the average price level P): MV = PQ.  Solving for V and taking logs gives us this equation: Log V = log P + log Q – log M.  Taking differentials gives us this result:  The relative change in velocity about equals the sum of the two relative changes in prices and output, minus the relative change in money.  For example, the differential d[log V] = (1/V) dV = dV/V, which is a relative change.  Differentiating the right-hand side variables as well, we get dV/V = dP/P + dQ/Q - dM/M.  

Over the past two years, the price level has risen by roughly 14%; output, 9%; and M1, 1%.  Plugging these data into the formula gives us that velocity, which is a rate, has increased by roughly 22%, or nearly a fourth.

References  

Alevtina Donskyx.  Economika viuchennik urokov.  Delovoy Kazakhstan.  October 24, 2014.

National Bank of Kazakhstan.  Various data series.  www.nationalbank.kz

Oksana Kononenko.  Kairat Kelimbetov:  ‘Fevralskaya devalvatsya tenge provedena s bol’shym zapasom.’  Panorama.  October 24, 2014.  

Quote of the week

“Be very, very careful what you put into that head, because you will never, ever get it out.”

—    Cardinal Thomas Wolsey on King Henry VIII

“As long as deflation is a possibility, the [Federal Reserve, the US central bank] would be well advised to explain, again and again, why inflation that is too low is also bad for the economy. The lesson that high inflation is a threat is well known to politicians and voters. There is a need, as Cardinal Wolsey might have said, to get something else into their heads.”  

-- Floyd Norris, “Inflation? Deflation Is New Risk,” New York Times, October 30

An illiquid diet

Does Kazakhstan's central bank view commercial banks with rose-tinted glasses?

The head of Kazakhstan’s central bank points with pleasure to today’s low ratio of foreign debt to the size of the economy, much lower than in the run-up to the financial crisis of 2008.  Kairat Kelimbetov estimates the ratio of Eurobonds to gross domestic product as 2.5%.  He regards this as a symptom of economic stability, reports a business weekly, Delovoy Kazakhstan.

Foreign money is not the only issue confronting monetary policy makers, and possibly not even the main one.  Another is “liquidity” – the ease with which we can spend money.  The ratio of illiquid money to liquid (specifically, the M3 money supply to the M1) is higher now than it has been since 2000 at least – even higher than in 2008, according to data from the National Bank of Kazakhstan.

Illiquidity concerns us because many commercial banks, knee-deep in mortgages and bonds, finance these long-term loans with short-term money.  As long as long-term borrowers faithfully pay interest until their loans come due, the temporal mismatch doesn't pose a problem.  But if they stop paying interest, then the commercial bank’s antsy creditors may withdraw their money in the short term, be they foreigners or natives.  This would leave the bank hard up for cash and may compel it to call in loans, a recipe for recession.

As it happens, the share of all bank loans that are delinquent has hung high in Kazakhstan since 2009.  If this share rises, and if oil prices continue to fall, then creditors to commercial banks may panic.  The rising illiquidity of money suggests that the consequences of the withdrawals may not be trivial.

Biking in reverse

The amount of delinquent loans (that is, non-performing loans, or NPL) has fallen by a seventh throughout 2014, Kelimbetov said. Setting aside BTA and Alliance banks -- as well as Kazkommertsbank, which acquired BTA’s bad loans from the government this year, allegedly for market share -- the NPL ratio should be 15% by January, he noted.  This is a little like saying: “With the possible exception of thieves, no one ever steals in Kazakhstan.”  This summer, the National Bank said the January target for the entire bank sector was 15%, reported Financial Times.  It took the Bank only four months to back-peddle. 

For the sector, the NPL ratio will fall to 10%, which is barely acceptable, by the beginning of 2016, predicted Kelimbetov.  The National Bank has been expressing similar hopes for more than five years. The truth is that the commercial banks are still trouble. 

However, a large M3-to-M1 ratio need not signal trouble.  It may even be a blessing.  Long-term investments in roads, water treatment and education may stimulate the long-term rate of economic growth more than would short-term loans financing household spending on televisions and vacations.   Bank defaults are only one possible consequence of illiquidity – but one worth bearing in mind.  –Leon Taylor tayloralmaty@gmail.com

References

Alevtina Donskyx.  Economika viuchennik urokov.  Delovoy Kazakhstan.  October 24, 2014.

Jack Farchy.  Leading Kazakh bank eyes foreign expansion.  Financial Times.  July 6, 2014.

National Bank of Kazakhstan.  Various data series.  www.nationalbank.kz .

Oksana Kononenko.  Kairat Kelimbetov:  ‘Fevralskaya devalvatsya tenge provedena s bol’shym zapasom.’  Panorama.  October 24, 2014.  

 

     

Heavy money

Why is broad money growing like weeds in Kazakhstan?

Since 2011, a broad measure of money supply, M3, has been rising more rapidly than narrower – that is, more liquid – measures in Kazakhstan.  In the past two years, M3 has been more than triple the size of M1, the narrow measure comprised mainly of cash and checking accounts.  The figure for August 2014 was 3.54.  The last time that August M3 was so large was in 2008 (3.26), just before the real estate bubble burst.  Isn’t that a coincidence?

Of course, a high ratio of M3 to M1 does not mean that catastrophe is inevitable – only that it’s possible.  The ratio indicates that illiquid forms of money – that is, forms that are hard to spend quickly – are becoming prevalent.  This may occur because of major projects, which require large and long-term loans.  If these projects introduce Kazakhstan to new and more efficient modes of production, then they may spur economic growth.

But there is another possibility:  Creditors have loaned generously to construction projects, such as those for residential centers and shopping malls, that are risky because they would pay off only in the long run, if ever.  If these projects fail to pay interest in the interim, then lenders of dollars to the banks – dollars that industries require for buying foreign inputs – may pull out their money in the short run, leaving banks and borrowers up the creek.  Falling oil prices may precipitate this dollar flight.

In response, the government blames economic instability on volatile oil prices.  The ostensible solution is to shift investment away from oil and gas and toward industries that prosper when the former don’t.  This will reduce instability at the price of a modest reduction in economic growth, one hopes.

The argument presumes that the subsidized new industries will make money; there is no point in substituting unprofitable industries for a profitable one.   But if they are haymakers, then why didn’t private investors back them in the first place?  Were they ill-informed?  Then the government should inform them, not displace them.  The sneaking suspicion is that the industries are rewarded more for their political connections than for their efficiency.  Exhibit A is tourism in this remote and landlocked country.   --Leon Taylor tayloralmaty@gmail.com

Notes

Data on M1 and M3 are from the National Bank of Kazakhstan (nationalbank.kz).  To control for seasonal factors, I used the August figures for every year beginning with 2000.

 

Sanction and inflation

Do they go together like a horse and carriage?

Prices bumped up a bit in Kazakhstan last month, reports the government’s statistical agency.  Compared to September 2013, prices rose 7.4%.  This was significantly higher than the 6.4% average for January through September of this year relative to the same period of last year.  Although a one-month change in the inflation rate is too short to tell us much about the economy, it's intriguing to see that since last September, the prices of nonfood goods have risen 8.4%, which is outside the National Bank’s target corridor for inflation of 6% to 8%.

Why the bump?  Ever since the West levied sanctions against Russia because of Ukraine’s civil war, Russian food exports to Kazakhstan have increased, according to Panorama.  Thus Russia may export inflation to Kazakhstan as well.  But the inflation rate in Russia is close to that of Kazakhstan, so the sanctions may not affect Kazakhstani inflation considerably, reports the business weekly.  It is not clear whether this is Panorama’s own analysis or that of the National Bank of Kazakhstan.  In any case, it’s a leaky bucket.       

If anything, the sanctions should lower the price of Russian exports to here.  Since Russia can no longer sell as much as before to Western Europe and the United States, it will try to sell more to Kazakhstan.  That will require price cuts.  And food prices, for once, do not comprise the fastest-rising category of Kazakhstan’s inflation. 

A more logical cause of this price blip is that Western countries want to buy more than before from Kazakhstan, since they no longer can buy from Russia.  This will raise Kazakhstan’s export prices -- and consequently its domestic prices, since producers will shift output from the home market to the foreign one.  Kazakhstani consumers will compete for now-scarce goods by bidding up prices.  That, at least, is the theory.  In reality, Kazakhstan’s leading export, crude oil, is restrained by the recent fall in global prices to below $100 per barrel.  Consequently, this back-channel seems unlikely to fuel much inflation here.       

Money is no object?

Let’s round up the usual suspects.  The February devaluation must lead eventually to higher prices expressed in tenge, because the currency has lost a fifth of its purchasing power over foreign products.  A delay of several months in the inflationary consequences of a devaluation is not unusual, since the trade contracts must be rewritten to take into account the weakened tenge. 

And there’s the variable that Panorama, the statistical agency, and (above all) the National Bank rarely want to discuss – money supply.  Here the picture is mixed.  Over the last two years, the narrowest types of money – pure currency (M0), and currency plus transferable tenge accounts in banks (M1) – have been stable.  The total rates of change since August 2012 are -1.6% and 1.1% respectively. 

Broad money is something else.  M2, which encompasses M1 as well as transferable foreign-currency accounts, has risen 13.8%.  M3, an even broader measure of money, is up 29.3%.  In contrast, gross domestic product over the past two years has risen only about 9% in terms of output.  To the extent that people and firms spend broad money on goods and services, the potential stimulus to inflation is clear. 

But recognizing this possibility would require the National Bank, which is supposed to manage the money supply, to admit that it may be the villain in the inflationary story.  --Leon Taylor tayloralmaty@gmail.com

References

Panorama.  Uroven’ centyabriskoy ynflatsii mozhet stat’ kluchevim dlya peresmotra prognozov (September inflation may be key to forecasts).  October 3, 2014.

National Bank of Kazakhstan.  www.nationalbank.kz. The source of monetary data used here.

 

Statistical Agency of Kazakhstan.  www.stat.gov.kz.  The source of GDP data used here.                     

Is the population boom a bust?

Checking in with Malthus

Now exceeding 7 billion, the world population has been rising by nearly a billion souls per decade.  True, the growth rate has nearly halved since 1960, to 1.2% per year.  But the poorest populations have been growing at almost double the world rate.  They account for almost a fourth of the addition to world population although they comprise only an eighth of the total population.  Five African countries are growing by 3% or more per year, including Zimbabwe (3.1%).  The Palestinian West Bank and Gaza Strip also grow by 3%.  No wonder demographers suspect that population growth creates poverty, although the most rapidly-growing nation, the small Gulf state Oman (9.2%), is rich, according to World Bank data.

In Soviet days, Soviet scholars fearfully anticipated rampant growth throughout the Central Asian satellites.  That hasn’t transpired.  Three countries grow at the world rate or slightly lower: Kazakhstan, Kyrgyzstan and Turkmenistan.  The largest populace in the area, Uzbekistan, is growing faster (1.5%).  But the pacesetter for the region is its poorest nation, Tajikistan (2.2%), in line with demographers’ expectations.

A simple model, assuming a constant rate of growth, predicts more than 90% of the fluctuation in population for most nations over a period of 10 or 15 years; after that, the growth rate tends to change.  This suggests that a simple theory may explain the size of population – and Thomas Malthus provided one, in 1798.  One of the first professional economists, Malthus argued that population growth doomed humanity since the populace would expand more rapidly than food supply.  The amount of food per person would fall until we starved.  Famine, pestilence and war would thin the population, raising the amount of food available to each survivor until people had recovered enough to beget children again.  Then food supply per capita would fall back to the subsistence level. 

Charitable cruelty

We cannot escape this cycle of catastrophe because – according to Parson Malthus -- we cannot control our passions.  Consequently, the rate of population growth will be determined largely by the fertility rate (the number of children born to an average woman), which changes slowly.  (From 1965 to 2008, the fertility rate in Kazakhstan fell just 27%, from 3.49 to 2.56 – but fell as low as 1.8, in 1998 and 2000.)  So it’s no surprise to find that most populations grew at a constant rate over the medium run.  Food supply, on the other hand, depends on a finite amount of land, so it grows linearly – that is, at a diminishing rate.  The populace grows faster than the harvest.

Malthus’ dark vision extended to altruism.  He opposed welfare for the poor since it would merely encourage them to have more hungry children.  “Such charity was only cruelty in disguise,” explained Robert Heilbroner, the late historian of economic thought.

China adopted a Malthusian policy in 1979, when it forecast a spike in fertility in the 1990s.  Parents with just one child received priority in health, housing and education.  Those with more than two children were taxed 5% of their income per child; the rate increased with each additional child.  The policy may seem a success:  Since 2000, China’s population has grown by less than .6 of a percent per year, half of the world average, and the fertility rate fell by two thirds in less than 30 years.  But China’s sizzling economic growth may have played a role, too.  Richer households have fewer children, perhaps partly because they would have to give up high wages in order to devote time to the bambinos.  In any event, the policy incurred social costs.  In 1986, one child was aborted for every two births. 

Calling Dr. Pangloss

Though compelling, Malthus’ theory does not fit the facts.  Since 1798, both the world population and world income per capita have grown sharply.  Latter-day Malthusians, such as the Club of Rome, warn that catastrophe is just around the corner; witness global warming.  Nevertheless, the past two centuries have given us a pretty good dataset.

Anti-Malthusian economists explain that an increase in population density stimulates innovation, since more people can exchange more ideas.  Whatever the reason, some nations would welcome a population boom.  Russia lost five million souls from 2000 through 2009, when its population dipped below 142 million, though it has grown slowly since then, to 143 million in 2012.  An indicator of the future labor force, the share of the population younger than 15, fell from 1990 through 2004 in China, Japan, Kazakhstan -- and sharply in Russia, from about 22% to 15%.  Maybe two heads are better than one, especially if one head is young. --Leon Taylor tayloralmaty@gmail.com

Notes

1.  The growth rates of national populations reported here are annual averages for the period from 2000 through 2012, using World Bank data.  I estimated them with this OLS model:  Ln Pop(t) = a + r*Year, where ln denotes a natural log and r is the exponential rate of growth.  R-squared for most estimations exceeded .92 and usually exceeded .99.
2.  Concerning the fertility rate in Kazakhstan: A measure of volatility, the ratio of the standard deviation to the mean, was .21 – lower than one might have expected, given the dramatic changes due to migration over the 1990s, and given that there were only 25 observations for the 44-year period.  

Good reading

Karen Hardee, Zhenming Xie, and Baochang Gu.  Family planning and women’s lives in rural China.  International Family Planning Perspectives 30(2): 68-86.  2004.  A source of the material used here about China.

Karen Hardee-Cleaveland and Judith Banister.  Fertility policy and implementation in China, 1986-88.  Population and Development Review 14(2): 245-286.  June 1988.  Another source of the Chinese material.

Robert Heilbroner. The worldly philosophers.  Touchstone.  Seventh revised edition.  1999.  Depicts Malthus vividly.

Thomas Malthus.  An essay on population.  1798.  Online.  Brilliant and provocative.

Joseph Schumpeter, Capitalism, socialism and democracy.  Harper.  Third edition.  1950.  Argues that returns to producing ideas do not diminish as ideas increase, because they don’t require finite resources – just imagination.

References

United States Bureau of the Census.  International data base.  2013.  The source of estimates of world population used here.

World Bank.  World Development Indicators.  2014.  Online.  The source of estimates used here for population levels, fertility rates, and the share of youths in national populations.