Russia's desperate defence of the ruble

Two pieces (so far) at Forbes on the Russian central bank's desperate defence of the ruble. Well, it appears desperate, anyway. But is it, really?

Firstly, I explain why the Russian central bank can't defend the ruble and shouldn't try to:
When a currency is rising in value due to capital inflows, the central bank can cap its rise by buying assets and foreign currency. This is what the Swiss central bank has been doing for a few years now. Its purchases of Euros amount to possibly the largest QE program in the world relative to the size of its economy. Since it can create infinite amounts of Swiss francs, it is unquestionably the most powerful player in the Swiss franc market, and no market participant will oppose it. Instead, market participants will happily co-operate with it by selling Euros at the price that it sets.
Similarly, when a currency is falling sharply in value, the central bank can support it by selling assets, including foreign currencies. But in this case it does not have infinite quantities of assets. Central banks can create their own currencies at will, but they can’t create foreign currencies or assets. So the ability of a central bank to prevent sharp devaluation of its currency is limited by its asset and foreign exchange holdings. It is not all-powerful – and markets know it.
So what should central banks do? Read the post to find out.

Shortly after I wrote that post, the Russian central bank abandoned any attempt to maintain the ruble within its trading bands:

The Central Bank of Russia (CBR) seems to have decided that it can’t beat the markets. On Wednesday November 5th, it announced an end to unlimited currency support interventions. It said it would spend a maximum $350m per day smoothing out fluctuations as the ruble approached the edge of a trading band. Once that limit was reached, the ruble would be allowed to fall out of the band. The final sentence of the CBR’s press release spells it out:
As a result of the implementation of this decision, the ruble exchange rate will be determined predominantly by the market factors.
Game, set and match to the markets, apparently.
Or is it? Perhaps not. As I explain in this post, it looks more like "game on" to me.

As this game plays out, I shall write more posts about it.

Related reading:

Russia is facing a full-blown currency crisis - Tomas Hirst, Business Insider
Plunging rouble raises spectre of fresh financial crisis for Russia - FT
Rouble rebounds as central bank says it could take action - BBC
Has the Japanese central bank started another round of central bank wargames? - Forbes


  1. When I read the bit about Russian households' demand for foreign currency, it reminded me of the behaviour of German households from 1918 on. Germany printed Marks freely during the Great War, increasing the money stock from M2.6bn in 1914 to M26bn in 1918. A ten times increase in the money supply got them 1000% inflation over four years, and the Mark went from 20 to the Pound to 200.

    During the War, Germans could do little about this, but in 1918 they regained access to markets and visitors to Berlin recounted that whenever Germans got cash, they quickly converted it into real goods. Rich Germans bought gold, silver, foreign currency, real estate and Art, and poorer Germans bought furniture, clothes and other consumer goods.

    The point is that as early as 1918, Germans were shorting their own currency and following pro-cyclical policies. In effect, Germans could see hyperinflation on the horizon - which finally arrived in 1923 - and they were happy to help it along. If ordinary Russians do the same thing, I guess they will get some of the same results.

    The German story is told in more detail in "When Money Dies" by Adam Fergusson and William Kimber.


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