Markets flooded with koruna as the Czech central bank pursues ambitious inflationary target.
When faced with the issue of no-growth, sometimes even deflation, what do you do as a responsible central bank? The most played game in town among central bankers is quantitative easing, stimulus policies and aggressive inflation targets, aiming to reignite stalling economies. The Fed has entertained the market with three rounds of monetary stimulus. The ECB followed suit and has bought up significant amounts of covered bonds, a type of corporate debt. The Japanese central bank is on the frontier of experimental execution of QE, dubbed Abenomics, with an expansion of their existing asset purchase program, worth 1.4 trillion USD over the next two years. Now the Czech central bank is stepping up their attempts at averting deflation. It has “signalled a willingness to play hardball in its foreign-exchange policy,” according to Luis Costa, emerging market strategist at Citigroup Inc. The Czech Republic is joining a prominent circle of nations in Club Currency Intervention.
In early November, the Czech central bank broke an 11-year interventional hiatus to stave off an 18-month recession, which has taken its toll on the economy. The country has not experienced recessions this long since records started, and the pain of an inert economy is starting to show. The interest rate has been kept at 0.05% for the past year, but now Governor Miroslav Singer has pledged to pursue a target of 27 koruna per euro, last seen in 2009. In a record drop that must have pleased monetary policy makers in Czech Republic, the koruna sank 4.4% to 26.975 per euro on November 7th, following a sell-off in the market. According to Governor Singer the currency intervention will be on “for as long as needed” to induce inflation in the struggling Czech economy. The short-term effect has certainly been spectacular, as shown in the diagram below.
The intervention aims at driving down the value of the koruna, as depicted, by printing more of it. It is the hope that such expansion of the supply of koruna will result in inflation is the medium run, and spur growth. As aforementioned, this treatment is becoming popular, yet we will have to wait and see how it all pans out. After all, it seems implausible to assume that all nations can simultaneously engage in inflationary monetary policy, forcing through depreciation of their domestic currency, because an exchange rate expresses the relative worth of currencies measured against each other. Not everyone can weaken their currencies at the same time; but for now it seems the only available solution for central banks worldwide. Guillaume Tresca, a Paris-based strategist at Credit Agricole SA, noted, “The power is unlimited. They can theoretically print as much koruna as they want.”
Naturally, the proposed ‘ideal’ level of 27 koruna to the euro is rather arbitrary, especially seeing as the ECB is simultaneously trying to intervene its way out of recession by the same means as the Czechs (and everyone else). One cannot help but see this as some sort of race to the bottom, or wherever it may end. Furthermore, the medicine may be bitter. Depreciation of domestic currency does not necessarily make consumers better off, especially in the short term. When the value of the koruna goes down, imports become costlier, reducing the purchasing power of Czechs. According to a BBC article citing a report by McKinsey, “the big winners, to the tune of 1.6 trillion USD by the end of 2012, were the governments of the US, the UK and Eurozone, from the reduced costs of servicing their debts and from the increased profits made by the their respective central banks”.
Furthermore, McKinsey believes that “households have been significant losers from cheap money. That may be surprising because one motive for quantitative easing was to ease the pain and financial stress for those millions of people who had borrowed far more than was prudent in the boom years. However, McKinsey looks at the whole picture of household financial assets, including pension fund savings, life policies, and other forms of long-term savings. On this basis, households in the US and Europe are net savers, rather then net borrowers. So when interest rates fall to exceptionally low levels, in the round they are losers.
It seems appropriate to ask whose economy central bankers are saving by blowing up the money supply. It may well be that inflation, and the growth hopefully associated with it, is beneficial for overall GDP in the long run, but the relevant questions regarding the interventionist, stimulus-oriented conduct of monetary policy remain unanswered.