By and large, I have felt that RBI has done a pretty good job of the exchange rate
. They doubled currency flexibility twice, in 2004 and 2007. In 2009, they shifted to a floating rate. There were two problems:
- They continue to sometimes do tiny blocks of trading on the currency market. In a market of $70 billion a day, a small scale of trading (e.g. $1 billion a month) is irrelevant, so why bother doing it? This has been pointless, but it has done no damage.
- They have failed to correctly communicate to the market that the exchange rate is now a float. I cannot recall an RBI governor who used the phase “floating exchange rate”. Many economic agents seem to have got the following message: You’re on your own for small fluctuations, but if there are big movements, RBI will block them. This was mis-communication. The people who hedged against small movements but not against large ones, as a consequence of RBI, have now got burned. This is going to further increase the cost of RBI to gain credibility in the years to come, to come to a point where its words are respected.
Barring these two issues, I have felt that RBI has done a pretty good job of the exchange rate. Until now.
- When there is turbulence on the currency market, you want greater activity on the currency derivatives market – which is where people protect themselves from currency risk – not less. Recall how the Greek default really damaged the Italians because on that day, the owner of an Italian government bond was told that maybe his CDS would malfunction if an Italian default came about. It was not good for Italy for economic agents to have a reduced ability to manage this risk.
- This will merely shift business to alternative venues – the offshore market and the onshore currency futures market. To the extent that shifting to these venues is tedious or infeasible (e.g. FIIs are banned from the onshore currency futures market and don’t have that choice), economic agents will be averse to holding India risk. This is bad for asset prices in India at a particularly difficult time.
- In a climate of pessimism about economic policy, it is important to send out a message, through action and non-action every day, that RBI (and more generally the Indian economic policy establishment) possesses top quality knowledge and decision-capabilities in economics and finance. This action of RBI reinforces the gloom about economic policy capabilities in India.
In April, Ila Patnaik and I released a paper titled Did the Indian capital controls work as a tool of macroeconomic policy?
Our answer was largely in the negative. RBI’s actions of today are likely to shape up as yet another episode of this larger theme. It might make things worse for the rupee, for Nifty, etc.; to this extent these decisions would not be irrelevant.
Financial regulation should be focused on the problems of consumer protection, micro-prudential regulation, market integrity and systemic risk. It should not be used as a tool for short-term macroeconomic policy. If this is done, it damages market liquidity and yields a less capable financial market. This further damages the limited monetary policy transmission that RBI possesses.
A reader, LS, asked for my thoughts on the following topics:
2) the gold for oil trade
3) the current price is not a real physical price of gold because of happenings in COMEX/LBMA
4) do you believe the current world affairs will resolve itself towards freegold or something similar?
Firstly, I haven’t had the time to read FOFOA in depth given the amount of material and thus give it justice. My comments here are therefore tentative thoughts.
Freegold is very interesting and I can see the logic of the idea of leaving fiat to perform the medium of exchange role and gold the wealth store role. I have a feeling free banking (see also) and a restriction on maturity transformation would need to be involved for it to work. There is a hell of a lot of discussion condensed in that sentence, more than I have time for at the moment.
I would also argue that Freegold needs to allow gold leasing but not gold lending. By “leasing” I mean as in leasing a car, ie physical asset rented (not borrowed and sold). Manufacturers of gold products like the Perth Mint could not operate without leasing because with Freegold’s ban on lending of gold and other financialisations it would be difficult (impossible?) to hedge against gold price movements.
This leads to my next point, which is that the gold price under Freegold would not be stable and still exhibit some volatility. This is because under Freegold people can save excess wealth either in gold or by investing in productive enterprises (ie true investment). Human nature being what it is we will still have overestimation of the success of productive enterprises, thus failures, thus business cycles, ths varying preferences to store wealth in gold versus investments.
On the Oil/Gold idea, I don’t have an option as this is not an area of FOFOA I’ve looked at much.
The current price is a real physical price as physical buyers and sellers of size (giants) are willing to exchange at that price. When aversion to counterparty risk really hits market players (MF Global you’d think should have been enough), then we will see a divergence between paper and physical.
As to the fourth question, well this is bound to my answer in the paragraph above, which is a necessary condition, but not sufficient, for Freegold to emerge. You would also need consensus that a gold standard is not the answer, and there are strong forces working towards that end. Possibly the biggest problem is getting people to understand the reason why financialisation of gold needs to be banned. How it will end is impossible to predict.
Either way it is going to be exciting to see how it plays out.
Well, in Ohio there is certainly more debate over the economic impact of shale gas development. No, that isn’t right, there is debate here, but I can’t say I’ve seen a headline this blunt in Pennsylvania.
See the Cleveland Plain Dealer over the weekend: Shale gas will not create 200,000 Ohio jobs by 2015, Ohio State University says of industry. Not only that, but here is what it says about the jobs created in Pennsylvania:
“We estimate that Pennsylvania gained about 20,000 direct, indirect and induced jobs in the natural gas industry between 2004-2010, which is a far cry fewer than the over 100,000 jobs reported in industry-funded studies (and the 200,000 expected in Ohio by 2015),”
Hmm… I guess if I had to start to judge which numbers are closer to reality, I would first look at what backgrounds the various authors have in regional economics and employment research.
At 10:00 AM Eastern time, the Housing Market Index for December will be announced. This index is created from a survey of home builders, so it shows the confidence that the sector has in the overall economy and their business.
Thanks to Darwin Barton
Having a house is great. I love having a garage to park in, I love having separate room for my office and my husband’s “man cave.” I really love having a fenced in backyard for our dog and cat. I don’t love worrying about burglary, or fire, or flood. Life was most definitely a lot easier before I had any of these responsibilities. It’s funny that I so completely ignored my parents when they cautioned me to enjoy my “responsibility free” life when I was younger. I’m sure I’ll pass the same advice on to my future children, and I’m sure they will ignore it, just as I did. The one thing that saves my sanity is having a adt. This service allows me to worry at least a little less. I know my house is being monitored even in the event that I’m away when disaster strikes. While it obviously can’t prevent a fire, the service can ensure that the proper authorities are contacted when necessary. This is definitely another piece of advice I’ll pass on to my children—sign up for an alarm monitoring service!
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