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.