Topic: Finance, Banking & Monetary Policy

Venezuela’s Death Spiral, Dollarization Is The Cure

With the arrival of President Hugo Chávez in 1999, Venezuela embraced Chavismo, a form of Andean socialism. In 2013, Chávez met the Grim Reaper and Nicolás Maduro assumed Chávez’s mantle.

Chavismo has not been confined to Venezuela, however. A form of it has been adopted by Rafael Correa – a leftist economist who became president of a dollarized Ecuador in 2007.

Even though the broad outlines of their economic models are the same, the performance of Venezuela and Ecuador are in stark contrast with one another.

The most telling contrast between Venezuela’s Chavismo and Ecuador’s Chavismo Dollarized can be seen in the accompanying chart of real GDP in U.S. dollars. We begin in 1999, the year Chávez came to power in Venezuela.

The comparative exercise requires us to calculate the real GDP (absent inflation) and do so in U.S. dollar terms for both Venezuela and Ecuador. Since Ecuador is dollarized, there is no exchange-rate conversion to worry about. GDP is measured in terms of dollars. Ecuadorians are paid in dollars. Since 1999, Ecuador’s real GDP in dollar terms has almost doubled.

To obtain a comparable real GDP for Venezuela is somewhat more complicated. We begin with Venezuela’s real GDP, which is measured in terms of bolívars. This bolívar metric must be converted into U.S. dollars at the black market (read: free market) exchange rate. This calculation shows that, since the arrival of Chávez in 1999, Venezuela’s real GDP in dollar terms has vanished. The country has been destroyed by Chavismo.

 

Venezuela is clearly in a death spiral. The only way out is to officially dump the bolívar and replace it with the greenback.

Yes, the Federal Reserve Has a Diversity Problem

Federal Reserve Chair Janet Yellen recently appeared before the Senate Banking Committee to deliver the Semiannual Monetary Policy Report to the Congress. A handful of Senators queried Yellen as to the lack of diversity among both the Fed staff and the members of the Federal Open Market Committee (FOMC).

Here, for example, is the exchange between Senator Warren and Yellen (paraphrased, as I heard it):

Warren: Diversity is very important. Studies show gender diversity in leadership makes for stronger institutions. I’m not surprised there’s a stunning lack of diversity at our biggest financial institutions. The Fed’s leadership diversity is somewhat better, but not a whole lot better. … Does lack of diversity among regional Fed presidents concern you?

Yellen: Yes, I believe it’s important to have diverse groups of policy makers who can bring different perspectives to bear. It is the responsibility of regional banks’ Class B and C directors to to conduct a search and identify candidates for regional Fed presidents. The Board reviews those candidates and we insist the search be national and every attempt is made to identify a diverse pool of candidates.

Warren: But what about the outcome? When a new regional Fed president is selected by the regional Fed board that person must be approved by you and others on the Board of Governors before taking office. The Fed Board recently reappointed each and everyone of these presidents without any public debate or any public discussion about it. If you’re concerned about diversity, why didn’t you use these opportunities to say enough is enough? Let’s go back and see if we can find qualified regional presidents who also contribute to the overall diversity of the Fed’s leadership?

Yellen: Well we did undertake a thorough review of the reappointments … [etc., etc.]

Warren: [Interrupting] But you’re telling me diversity’s important and yet you just signed off on all these folks without any public discussion about it. …The selection process is broken. Congress should take a hard look at reforming the regional Fed selection process so that we can all benefit from a Fed leadership that reflects a broader array of backgrounds and interests.

While it is tempting to dismiss such questions as mere identity politics (I’m waiting for Trump to complain about bringing in the Fed Vice Chair from Israel), the Fed has increasingly over time come to look less and less like the rest of America.

Should this matter, at least in terms of monetary policy? I believe it should.

Nigeria’s Floating (Read: Sinking) Naira

On Monday afternoon, the Central Bank of Nigeria (CBN) ended the Nigerian naira’s sixteen-month peg to the U.S. dollar, sending the naira into a freefall. The currency had been pegged at 197 naira per dollar, but as the chart below shows, it had been trading at over 320 naira per dollar for months on the black market (read: free market) and currently sits at 345 naira per dollar. At the time of writing, the naira was officially trading at 282.50 naira per dollar.

The official inflation rate for Nigeria in May was 15.6 percent. However, by using changes in the black market exchange rate data and applying the Purchasing Power Parity Theory, I calculate that the annual inflation rate implied by the free market is actually much higher – currently sitting at over 56 percent (see the accompanying chart).

A managed, floating exchange-rate regime is ill-suited for a country with weak institutions and little discipline, like Nigeria. More troubles lie ahead.

On the Road

If you haven’t heard much from me on these pages of late, it’s because I spent most of the last two weeks traveling back and forth, and so had little time for blogging.

I did, however, participate in some interesting events while I was away.  The first of these was “Futures Unbound,” the second installment so far of Cato’s annual Summit on Financial Regulation, held at the Drake Hotel in Chicago on June 6th.  I gave a talk there on the regulatory role of private clearinghouses.  I also had the pleasure, the night before, of taking part in a speakers’ dinner that was also attended by two distinguished (and very fun!) members of the CMFA’s Council of Academic Advisors, George Kaufman of Loyola University Chicago and Randy Wright of the University of Wisconsin.

After the Chicago event I headed straight to London, where I’d been invited to give the Institute of Economic Affairs’ annual Hayek Lecture.  Before the lecture Philip Booth, the Institute’s Editorial and Programme Director, interviewed me briefly on the necessity of central banks.  The main event took place that evening at Church House, a few blocks away from the IEA’s offices in Westminster; and I was pleased to find that in arranging for that commodious venue the Institute hadn’t overestimated the audience for my topic, which included many good friends from all over Europe.

Alas, much as I would have liked to linger with that crowd, I had to be whisked away, first for some dinner, and thence to a Heathrow hotel, where I could rest a little before catching an early flight to the States, where I took part in the second in what I hope will be a long-lived series of Liberty Fund conferences co-sponsored by them and Cato’s Center for Monetary and Financial Alternatives. This one, on “Liberty and Currency: The U.S. Asset Currency Reform Movement,” took place (appropriately enough) on Jekyll Island, under the direction of CMFA Adjunct Scholar (and occasional Alt-M contributor) Jeff Hummel,  with David Henderson serving as discussion leader.  The other distinguished participants included Rutgers’ Hugh Rockoff and U.C.S.D.’s Lawrence Broz.  Like every other Liberty Fund conference I’ve attended, this one was great fun.  Unfortunately, it’s unbuttoned proceedings were so in part (as is also always the case) because they were both confidential and unrecorded, so I’m unable to share any part of them with you.*

After Jekyll Island it was across the Atlantic again, this time to Zurich, where I took part in the ETH Risk Center’s conference on “Alternative Financial and Monetary Architectures.”  Others who spoke there included William R. White, another member of the CMFA’s Council of Academic Advisors, as well as “Limited Purpose Banking” champion (and write-in U.S. presidential candidate) Laurence Kotlikoff.  Although this event’s proceedings were also not recorded, the ideas I presented were a somewhat modified version of ones I presented at a Cato Monetary Conference a few years ago.

After the Zurich conference, I lingered for a day in Zurich, where I was able, by sheer luck, to dine with Cato Senior Fellow Jerry O’Driscoll, who happened to be on his way to an event in Lichtenstein. That dinner was a splendid and relaxing conclusion to a sometimes taxing itinerary — and the next-best thing to being back home again, with my very best friend.

Penelope compressed


*Those interested in taking part in future Liberty Fund-CMFA events are encouraged to write to me expressing their interest.  Please note, however, that these events are generally open only to academics and other holders of graduate degrees.

[Cross-posted from Alt-M.org]

That Saudi Sinking Feeling

The rate of growth in a country’s money supply, broadly measured, will determine the rate of growth in its nominal GDP. For Saudi Arabia, the following table presents a snapshot of the relationship between the growth in the money supply (M3) and nominal GDP.

 

The chart below shows the course of M3. Following the oil price plunge of September 2014, the growth in M3 has slowed. The rate of nominal GDP growth will follow.

Why is the money supply growth rate declining? Since the plunge in oil prices, the Saudis’ current account has dipped into negative territory. This has to be financed, and the Saudis have used their stash of foreign reserves to do the financing.

Special Favors for IEX Will Not Fix Bad Regulation

It isn’t often that an SEC decision involves the star of a best seller, a “magic shoe box,” and fundamental questions about the meaning of words like “immediate” and “fair.”  The SEC made such a decision on Friday. 

Last fall, the trading system IEX applied for designation as a stock exchange.  IEX, and its CEO Brad Katsuyama, rose to fame several years ago with the publication of Michael Lewis’s popular book Flash Boys.  Lewis, ever the artful storyteller, cast Katsuyama as the likeable underdog, exposing and undermining high-frequency traders (HFTs) through the development of IEX.  IEX, an alternative trading system, or in the more colorful industry jargon, a “dark pool,” has allowed investors to trade away from market scrutiny and the HFTs that populate “lit” exchanges.  But there are advantages to being an exchange, and IEX wants in.

At issue in determining whether to approve the application was the meaning of the word “immediate” in an SEC regulation known as Regulation NMS.  Regulation NMS, approved by the SEC in 2005, was intended to increase competition among trading exchanges, resulting in better execution of trades and better prices for investors.  In furtherance of that goal, a part of the regulation requires that trades be made at the best price listed on any exchange and that exchanges make their quotations “immediately” and automatically available.  In the past “immediate” has been defined as “immediately and automatically executable, without any programmed delay.”  Seems clear enough, right?

Economic Lessons from Muhammad Ali

Since the passing of Muhammad Ali, the establishment has been working in overdrive to convince us that the great boxer was a member of their club. In doing so, the wisdom and wit of Ali has been on display.

Muhammad Ali’s lessons on economics, however, have been absent. Economics? Yes. The lessons were developed in a most edifying book by Donald Sull, The Upside of Turbulence: Seizing Opportunity in an Uncertain World. New York: Harper Collins, 2009 – a book that Mohamed El-Erian recommended to me.

The economic lessons are summarized in “The Boxer Matrix.” A boxer’s fate is determined by a combination of his absorption capacity (read: can he take a punch?) and agility (read: can he avoid a punch?). In the Boxer Matrix, the ideal position to be in is the Northeast quadrant: where Ali and Joe Louis boxed. But, while Ali always had terrific agility, he had to train and think his way to an above average absorption capacity. This capacity was on display in his “Rumble in the Jungle” bout with George Foreman. It was then that Ali’s “rope-a-dope” tactic was executed to perfection.

This brings us to Ali’s message on economics, with particular reference to countries that are heavily dependent on the production of oil. In turbulent times (read: oil price plunges), countries like Saudi Arabia, Venezuela, and Nigeria experience a great deal of pain because their oil-dependent economies aren’t diversified. In short, they lack agility. This is reflected in their position in the lower half of the Boxer Matrix.