Uldis Rutkaste, Bank of Latvia asks, RTFL answers

Discussion topic: Martin Wolf's Financial Times article: http://blogs.ft.com/martin-wolf-exchange/

Questions by Uldis Rutkaste, Bank of Latvia.

Answers by RTFL financial experts.

Uldis Rutkaste:

Key questions that must be answered before prescribing Latvia a recipe for printing money (rather than the U.S. does -> Latvia does so as well):

Q: Is LVL an international reserve currency?

A: No, but every currency is required by those who would wish to buy things from it. Obviously not being an international reserve currency means one cannot do what the US is trying to do – make its problems someone else’s. But even that is beside the point as creditors such as Chinese demand real assets.

Latvia can easily arrange a currency swap with China, just as Malaysia and other countries are doing. That will make it a reserve currency - of China. Similar arrangements can be made with the Fed, as other countries do. Unfortunately, if Mr. Rutkaste is in charge, this will run the danger of providing an opportunity for American hedge funds to raid the money in Latvia’s central bank, if done in the neoliberal way.

Q: If and who will be ready to hold assets of LVL knowing that a printing machine was deployed? In particular, given the euroisation level already in place.

A: Latvians as there is no other legal tender. We were surprised that euros were not generally accepted in Latvia. As for creating credit, if inflation is too much money chasing too few goods a lot depends on whether the credit created is being used to create goods. It also matters whether the central bank is bedding down government debt. A major function of the Bank of England was managing government debt by selling consols to make sure that monetary accommodation did not turn into “printing press” or assignat inflation.

Mr. Rutkaste is a few decades behind the times. Printing machines aren’t used for treasury debt any more; computers are. It’s electronic. But what Mr. Rutkaste is trying to say is that “Government money is bad, because it’s printed. Only private banks - and only my own personal financial backers - can create credit on THEIR computers, as we’ve privatized money creation.”

Q: How monetary financing will impact on velocity, the demand for money and real money supply?

A: See above. Depends on how the debt is bedded down in the long run as economic activity picks up.

Q: How monetary financing will impact the exchange rate?

A: If by monetary financing you mean printing money willy nilly, then obviously the lat would fall. But that is not what central bank financing need be if the central bank beds down government debt over the longer term. Also, of course, the lat is over-valued and internal devaluation is merely a harsher and more costly way of doing what an external devaluation would have done – recognize that Latvia was living beyond its means and equilibrium had to be restored.

Q: What impact will it have on the economy, knowing that, Latvian exch rate pass-through to domestic prices is a complete and very fast, the fastest in CEE countries, see: http://ej.uz/cb1

A: It will stimulate employment, thereby raising tax receipts and ease the pressure on the government to borrow. The major reason the Latvian government needs to borrow is that its tax revenues are collapsing along with employment. The flow through of external costs to domestic prices is fine, as it will encourage import substitution and exports and help restore external balance.

Q: What are the balance sheet effects at 20 billion FX denominated foreign debt?

A: What are the FX assets of Latvians? How much of the FX denominated debt is legally enforceable? How much would be liquidated by insolvencies? The losses could fall on foreigners to a great degree – which would be a good thing for Latvia.

Q: If and how the CB money expansion will transfer into domestic credit?

A: CB-financed Government spending will end up in the pockets of teachers, police etc and as deposits in the commercial and savings banks – and increase the base for lending.

Q: What impact can be expected on financial intermediaries; FT Martin Wolf expressed explicit concerns of that in his blog.

A: Devaluation will mean losses for foreign lenders. Domestic credit expansion will see better conditions for domestic lenders whose loans will be more solid as employment rises and debtors become more solvent, after the FX overhang is got rid of.

October 15, 2010