Thursday, November 21

The CNB feels misunderstood; whose fault is that?


A few days on from the day the CNB intervened to weaken the crown, there seems no sign that anyone is clearer about the benefits of their action. The majority view remains overwhelmingly negative.

I will not for one moment lay claim to mastery of macroeconomics; so I write as a small businessman, moderately personally affected, and with a foreigner's perspective.

For me the single most worrying thing about the action is how few professionals in the field both here and abroad claim to understand why they have done it. Ludek Niedermayer, a former vice-governor of the CNB himself, said "It seems the CNB have a plan, but it is difficult to discern what it is". In the Financial Times, analysts from Morgan Stanley were reported to have "found the timing of the announcement puzzling, since confidence in the Czech economy had recently been improving."

In my experience, if a manager makes a big and surprising decision which most of his peers do not understand, it means one of two things. Either he is a genius; or he has made a potentially catastrophic mistake.

In this case, the decision is all the more striking, because up to now, as far as the general public is concerned, this CNB board has not really made many decisions of note at all. I cannot recall any such significant general criticism of Miroslav Singer before; as result he and his colleagues have emerged blinking in the gaze of publicity to explain themselves, and they have not shown themselves to be particularly good at that.

However, it is also the burden of the central banker that we tend not to be clear about their role in managing the economy. There is no global rule about what their mandate should be, but the CNB shares with the ECB and the Bank of England the very limited mandate of sticking to an inflation target. The CNB target is given as 2%. Usually the task has been to stop inflation rising above 2%, but now the concern of the CNB is that it may fall below 0%. Generally an economy showing healthy GDP growth also shows a tendency towards higher inflation. An economy in recession shows a tendency for inflation to fall. In this situation central banks lower interest rates to encourage investment and consumer demand, which feeds into positive GDP growth. The problem for the CNB in this recession is that interest rates are already less than 1%. So, if I understand their decision correctly, because the Czech economy is heavily led by exports, the weaker crown will help exporting companies, their prosperity will feed through to the wider economy, we will all feel better off and start spending more, and GDP growth will return.

Hmm. I can see why that might work. But I can see a few reasons why it might not, and think of some other ways to kickstart the economy. However these other ways generally involve government rather than CNB decisions. That is one of my worries. While the CNB and other central banks are usually independent of governments, citizens have a right to expect a certain amount of teamwork on the economy between the Bank and the government. Here the CNB has taken its most aggressive decision in years at a time when we have no effective government. To understand this it is worth reflecting on the personalities involved. Virtually the whole CNB board were appointed by Vaclav Klaus, and according to a friend who knows them, messrs Singer and co. are disciples of the "Chicago school" of economic thinking. This thinking does not believe other forms of economic stimulation (such as targeted infrastructure investment) works. This CNB board thinks it is the only entity which is able to positively influence the economy.

The question I have for the CNB is perhaps not 'why did you act so aggressively now?" but more "haven't you been too passive in the last five years?" Consider this graph of the koruna- euro rate since the inception of the euro.

Interesting, isn't it? It shows us that in historical terms the current devaluation is not so great. The crown 'strengthened' to 23CZK-euro exactly when the crisis hit. This was the time when I first started shopping for groceries in Germany, buying Pilsner Urquell for 20% less than I would pay in Prague. The crown quickly weakened in 2009, and at that time the economy started to pick up. But then it strengthened again and we entered the second, current recession. It is worth noting that just before the CNB took their action the crown was already at its weakest for three years.

Well there are professionals who will do a much better job of analysing currency shifts than I, but as an ordinary Joe I wonder whether the CNB should not have been more actively weakening the currency at various times since 2008, and whether in a few months time the crown would not have weakened to 27/euro anyway, thus avoiding upset for exporters who have hedged currency and now face losses, and avoiding a mini-boom before Christmas which will just make the January hangover worse.

The other graph to consider is the one which measures the CNB's stated KPI: Inflation.

Here we see that the CNB has had trouble in the last five years too. It was far too high before the global crisis of 2008 brought it crashing down, and was too high again by the Bank's own criteria throughout 2012. Why is it low now? Well in the current climate, which businesses can afford to increase prices and wages? Will a weaker crown change everything? The CNB thinks so.

My friend Erik Best floated the idea that the CNB decision is actually part of a move towards adoption of the euro. This entertained many people and prompted the ludicrous idea that the CNB should be tried for treason. But I don't buy it for one minute. Again, look at the personalities. This Board is "eurosceptic' for dogmatic reasons. They would rather chop off their own hands than lead the country into the eurozone. However, it is reasonable to suppose that the CNB was aware that the ECB would take steps to weaken the euro, and seek to stay one step ahead.

The economy and our livelihoods depend far more this time on a government being formed which has a plan for growth which makes the most of our proximity to Germany, and which makes better use of State budgets. If that doesn't happen, the CNB action may fail to help; and that may result in more, perhaps unfair blame for the CNB. So they will learn a lesson about team -play.

The lesson for we citizens is that we have suddenly discovered the importance of the CNB to our lives. From now on we should pay much greater attention to their activities. It is unacceptable that the full minutes of their policy meetings are only released after six years. In the UK they are now released within a couple of weeks. The CNB may in turn want to prepare for this scrutiny by going on a course which teaches humility in front of the public. It may turn out that Miroslav Singer and his team are geniuses. However in my experience true geniuses are humble people who would never dream of criticising others who fail to see the genius behind their actions.

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