Smooth devaluation rake
Not for the first time, Russia is facing a powerful attack on the ruble. The first time was in 2008. The ruble experienced even more pressure in the 2014 year. The thing is that the Central Bank of Russia is attacking the same rake for the second time under the name of “smooth” devaluation.
In order to understand the problem, you must refer to ... some of the rules that apply when pricing. The experience of KAMAZ will help us in this. In particular, thanks to this experience, we understand why George Soros’s famous attack on the British pound in 1992 was successful, why the pressure on the ruble in 2014 turned out to be so powerful, and how Nobel laureate Robert Schiller has to do with it.
Two times on the same rake
In 2008 and in 2014, the exchange rate of the ruble was subjected to very strong pressure. In 2008, the exchange rate did not change so extensively (from 23 to 36 rubles per dollar, by 56%), but the Central Bank of Russia spent currency interventions for more than 200 billion dollars for foreign exchange interventions, having bought back more than 5,5 trillion rubles for bring down the weakening of the ruble.
In 2014, the scale of operations of the Central Bank was somewhat lower, and currency worth more than 70 billion was spent to buy out almost 3,5 trillion rubles. But at the same time, the change in the exchange rate of the ruble at times reached 100% even at the “conservative” official rate. From 33,6 rubles to dollars at the end of June 2014, the ruble exchange rate fell to 67,8 rubles to dollars in December 2014.
The fact that the ruble fell along with other currencies of developing countries is little comforting, because in terms of the scale of the fall, at a certain moment (albeit temporarily) it became the world record holder, even ahead of the Ukrainian hryvnia. What is the reason for these repetitive situations? From further presentation it will be clear that the reason for everything is a “smooth” devaluation (sometimes it is also called “velvet”). And Russia is already the second time attacking the same rake, not taking into account past lessons.
Marketing lesson for the Central Bank
Marketing will help us to understand the reasons for what is happening, or rather the marketing section dedicated to pricing. Economic theory suggests that with increasing prices for goods, demand decreases (the so-called law of demand). But in marketing, situations are described where a rise in the price of a product increases sales. And this is explained by the fact that in some cases, the buyer perceives a rise in prices as confirmation of the high quality of the goods or as a signal that the goods are in demand. And he buys the goods “until prices have risen,” even if he had not previously planned to do this. So where is the truth? Rights economic theory or marketing?
The KAMAZ company (of which I am an employee) faced situations when wrong decisions in setting prices resulted in significant losses. Here is one of many examples. At the end of 2011 - the beginning of 2012, KAMAZ sharply raised prices for one of its models, the KAMAZ-6520 dump truck. Increased costs were pushing prices up, but there seemed to be no problem with demand. This decision was a mistake. Sales dropped sharply, and following the results of 2012 of the year (compared to 2011), KAMAZ reduced its share of the heavy truck market from 44% to 27%.
Learn from mistakes. An important conclusion was made: the key, often decisive, nature of price increases is whether it is smooth or abrupt.
Four variants of price dynamics and market reaction
Let us consider four combinations of two parameters of price dynamics: price increase — price reduction, smooth change — sharp change.
1. Smooth price increase
A gradual increase in prices, as a rule, increases the desire to purchase a product (and in general, any asset).
A case of gradual price increases is schematically depicted on the 1 graph.
1 chart. Smooth price increases stimulate an increasing number of customers to purchase goods faster.
The thoughts of a potential buyer in this case are approximately as follows: “The goods are in demand and it is worth purchasing them faster before they become too expensive”
If this situation occurs in the asset market (for example, stocks), then it is important to understand the thoughts of potential sellers, that is, those who have this asset. In the present case, they are approximately the following: “My asset becomes more expensive. Good thing I bought it before. It’s not worth selling now, I’ll wait for further price increases. ” There are more and more buyers, less sellers, which pushes prices further upwards.
“The price will rise!” - this is the general mood of the market.
2. Sharp price increase
If the price increase has occurred sharply, then this can very significantly reduce demand (graph 2).
2 chart. Sharp price increases reduce the volume of purchases, especially if prices then freeze.
After takeoff prices, the volume of purchases is sharply reduced. The thoughts of the buyer are approximately as follows: “I did not have time to buy on time. Prices will now fall (option: will not grow), you can not rush with the purchase. " Such a situation arose in the case described above with a sharp rise in prices by KAMAZ by their dump trucks.
Sellers, on the contrary, believe that their finest hour has come and it's time to sell the asset until prices fell. The decrease in the number of buyers and the increase in the number of sellers are pushing prices down.
“The price will fall (or not grow)” - this is the general mood of the market.
3. Smooth price reduction
With a gradual decline in prices, customers are getting smaller (3 chart)
3 chart. A gradual increase in 1 prices leads to a reduction in the number of purchases.
Thoughts of potential buyers are clear: why rush, because prices are falling. And those who have such an asset, they think that it is necessary to get rid of the asset, while prices have not fallen even lower.
As a result, there are many sellers in the market and few buyers, and this pushes prices down.
"Prices will fall" - this is the expectation of the market.
4. Sharp drop in prices
A sharp drop in prices attracts buyers (graph 4)
4 chart. After a sharp fall in prices there is an increase in the number of purchases.
Potential buyers believe that it is necessary to use the moment until prices have risen. And those who have an asset think something like this: “I was late with the sale. It is probably better to wait until prices rise, than to sell at a loss. ” Both those and others expect a rise in prices.
There are more buyers than sellers and this is pushing prices up.
"Prices will rise" - this is the expectation of market players.
Key findings
Of the four options considered, we can draw several conclusions:
The behavior of buyers and sellers due to the expected dynamics of prices.
This expected dynamic becomes a “self-fulfilling” forecast.
If possible, a manufacturer (seller) interested in sales growth should adhere to the following rule: "Increase prices slowly, lower quickly."
As a marketer, I can add that there are exceptions to these rules. For example, if you want to change the positioning of the product in the eyes of customers (so that it is considered prestigious, for example), then the manufacturer may behave differently.
As a person who has experience in operations in the stock and currency markets, I will cite one more exception. Exchange players (speculators) know that trying to buy a sharply depreciating asset may be like “trying to catch a falling knife.” This means that asset prices may continue to fall further. Peter Lynch in his book “Peter Lynch Method” (M. Alpina Publisher, 2011) writes that “trying to catch the bottom of a falling stock is akin to trying to catch a falling knife - you invariably grab it at the wrong moment”.
Despite these individual exceptions, the general “laws” of price dynamics described above act exceptionally well, as can be seen from specific examples. This is what we will do.
Soros's attack on the British pound in 1992
In 1992, George Soros, then a little-known American public financier, led a speculative game to weaken the British pound sterling. As a result of his actions, the pound rate plummeted, and Soros, according to various estimates, earned from one to two billion US dollars on this operation.
The simplified scheme of [1] of Soros’s actions was as follows:
The British pounds sterling worth about 5 bn.
These pounds were sold (they bought German marks), which caused a drop in the pound exchange rate relative to the mark (and, as a result, to other currencies too).
The Bank of England tried to resist the fall of the pound, buying 15 billion pounds during interventions (spending gold and foreign exchange reserves on these interventions). This did not help, and 16 September 1992, the Bank of England announced the termination of the intervention. Pound crashed.
When the pound exchange rate collapsed, returning the loan in pounds cost Soros 1 billion (according to other versions, 2 billion) cheaper in dollar terms. This was his profit from this speculative attack.
Note the bold amounts. The key question for us is: how could Soros, with a capital of about 5 billion pounds, be able to withstand the Bank of England's interventions in the amount of 15 billion pounds and win?
The answer is contained in the above-established “laws” of price dynamics, they are also the laws of the attractiveness of assets:
The German brand grew smoothly in price and customers (besides Soros) became more and more. And the owners of the German brand, who wanted to sell it (it would be the "allies" of the Bank of England), became less and less.
The British pound was gradually losing its price and it became more and more willing to sell it. Conversely, the number of people willing to buy a pound was becoming less and less (why buy if tomorrow you can buy cheaper).
George Soros turned out to be only those who gave an initial impetus to the “smooth” dynamics of the course, infected the pound sales with a virus. “Soros was not alone: many investors followed his example and sold pounds, putting tremendous pressure on the exchange rate of this currency” (Ketti Lin, “Day Trading in the Forex Market”, Alpina Publisher, 2013).
Clearly, the entire operation of Soros can be seen on the 5 graph.
5 chart. The “smooth” devaluation of the pound by the Bank of England allowed Soros to draw a huge number of followers into operations against the pound
Chart Source: Ketty Lin, “Day Trading in the Forex Market” (M., Alpina Publisher, 2013); comments by the author. Note: A downward movement of the chart means a weakening of the pound sterling relative to the German mark.
The above “laws” of price dynamics very well explain what happened.
The German mark was perceived as a smoothly rising asset (see 1 chart). The number of brand buyers quickly increased, and those who wanted to sell it became less and less, which further strengthened the brand's course.
The British pound was perceived as a smoothly depreciating asset (see the 3 chart). The number of sellers of a pound increased rapidly, and those who wanted to buy it became less and less, which further affected the depreciation of the pound.
An attentive reader can now find analogies in the situation with the Russian ruble in 2014. We will look at this question further.
Robert Schiller on price bubbles
The behavior that we described in our "laws of price dynamics" is very well known. For this, even the Nobel Prizes receive.
So the Nobel Prize in Economics in 2013 was awarded to three economists, one of which was Robert Schiller, a professor at Yale University (the other two are Eugene Fama and Lars Peter Hansen). The prize was awarded for an "empirical analysis of asset prices."
The Vedomosti newspaper writes about this: “Schiller can be considered the most famous among the wider economic circles of today's laureates. He is actively studying the dependence of asset prices on the psychology of people, in collaboration with the Nobel laureate George Akerloff, he wrote, in particular, the book Spiritus Animalis, or How Human Psychology Manages the Economy, where he spoke about the features of human behavior that affect macroeconomic processes. Schiller can be considered the author of the definition of a “market bubble” - this is “a temporary rise in asset prices, due more to investor enthusiasm than a true, fundamental assessment of their real value”
“The appearance of bubbles is impossible to predict. I tend to think of them as social epidemics: they are transmitted from person to person in much the same way as ordinary infections. A bubble begins to form when the level of contagion of ideas that forms it grows. But the level of infectiousness depends on the thinking patterns and psychological attitudes - the subject of which it is extremely difficult to judge, ”he writes. And we add that it also depends on the smooth growth of prices for the "infectious asset".
In his article in another issue of the Vedomosti newspaper, Schiller writes: “In the second edition of my book, Irrational Euphoria, I tried to give a better definition of a bubble. “The price bubble,” I wrote then, “is a situation where news The growth of prices is stimulated by investor activity 1 and this enthusiasm is spread through a kind of epidemic, psychosis, transmitted from one person to another, while multiplying in parallel the explanations for this price increase ... envy of the success of others, and partly the excitement of the player. "
It is easy to imagine not the abstract “price increase” mentioned in this quotation, but concrete examples of such growth. Just imagine that we are talking about, for example, the price of a German mark during the attack of Soros on the British pound. Or about the US dollar during an attack on the Russian ruble in 2014.
Schiller talks more about the rise in asset prices, and not about falling prices. But we described above about the impact of falling prices on the behavior of buyers and sellers.
For those who want to read more on this topic in a fun and accessible way, I recommend the book by the wonderful author Elena Chirkova “The Anatomy of the Financial Bubble”, which is replete with numerous interesting examples from the literature.
It was precisely the type of behavior described by Schiller that helped George Soros bring down the British pound.
Bank of Russia in the 2014 year repeats the mistakes of the Bank of England 1992 of the year
In 2014, the situation on the currency market for the ruble evolved just as it happened with the pound in the distant 1992 year. First, the ruble gradually devalued over several months (from June to November). Then, in December of 2014, there was a precipitous depreciation of the ruble exchange rate (6 chart).
6 chart. The smooth devaluation of the ruble has attracted more and more players to play against it in 2014.
Source: Central Bank of the Russian Federation, official rate (rubles per dollar). Note: the upward movement of the chart means a weakening of the ruble against the US dollar.
Now many are trying to understand the reason for such a collapse. But for those readers who read the basics of the “dynamic pricing theory” outlined above and know the reasons for the successful attack of George Soros on the British pound, one of the reasons is clear. This is the involvement of more and more players in the game against the ruble due to the “smoothness” of the devaluation.
Involving an increasing number of people can be seen with the naked eye. Even Elvira Nabiullina said in an interview with Russia 24 10 on November 2014 of the year: “On expectations of a weakening (ruble), this game, unfortunately, includes everything, including the population,” the head of the Bank of Russia explained. - Both banks and companies are involved in this. Exporters can delay the sale of foreign exchange earnings, and importers can buy currency for the future because they have to pay for contracts. This behavior, which stems from the constant expectation of a weakening course. "
Elvira Nabiullina does not know about one thing alone: these expectations of the fall in the ruble exchange rate were created by the Central Bank itself under her leadership. The main reason is the “smoothness” of the weakening of the course, which involves more and more players in the sale of the ruble. And in this case it becomes less and less willing to sell their dollars. All as in "primer".
A weak consolation for Elvira Nabiullina, but an additional alarming circumstance for all of Russia is that this is already the second time. Exactly the same situation was in 2008 year (7 graph).
7 chart. In 2008, the situation followed exactly the same scenario as in 2014.
Source: Central Bank of the Russian Federation, official rate (rubles per dollar). Note: the upward movement of the chart means a weakening of the ruble against the US dollar.
If for Elvira Nabiullina a repetition of the situation of 2008 of the year can serve as a kind of excuse (“I did not do this alone”), then for the Central Bank, as an institution, and the economic authorities in general, this is a very disturbing sign. After all, the repetition of errors means one of two things: either the so-called “engineering memory” does not work in the system, when bad practices are rejected and not repeated. Either (which is also likely) the correct conclusions were not drawn from the errors of 2008 of the year. And the conclusion, confirmed by two unsuccessful practitioners (2008 and 2014), is the same: smooth devaluation is a very unfortunate solution for the stability of the exchange rate (and the Central Bank is legally responsible for this stability).
Analysis of the reasons for failures in the exchange rate policy of the Central Bank is an interesting and useful matter. But the question always arises: how is it right? What was the correct tactics of the Central Bank? And here, to our happiness, it is not necessary to go far behind the experience. Our closest neighbor, Kazakhstan, can serve as a wonderful example.
Kazakhstan as a good example
The Central Bank of Kazakhstan, in contrast to the Central Bank of Russia, more competently built its exchange rate policy. Back in March, the 2014 of the year, when the pressure on the gold and foreign exchange reserves of Kazakhstan increased, the Central Bank stopped protecting the tenge rate at the level of 156 tenge per dollar. He switched to “prepared defensive lines” at the level of 186 tenge per dollar.
As a result, the devaluation was not smooth, but sharp. It is for this reason that the “broad popular masses” did not join the game, as in Russia. This eased the task of the Central Bank of Kazakhstan to stabilize the exchange rate, retained the country's gold and currency reserves.
The tenge exchange rate to the dollar has since strengthened even slightly (graph 8). And the tenge to the euro strengthened very significantly (graph 9). This absolutely confirms our “theory of price dynamics”. Forms of graphs generally repeat the case of sharp price increases (see 2 graph and commentaries to it), and the dollar and the euro act as a sharply appreciated asset. Now "bite your elbows" those who did not have time to sell the currency at a higher rate.
8 chart. The exchange rate of the tenge to the dollar after a one-time devaluation in March 2014 remained stable, slightly strengthening.
Source: www.finam.ru
9 chart. The exchange rate of the tenge to the euro after the devaluation in March 2014 year strengthened and is close to its values before the devaluation.
Source: www.finam.ru
As a result, Kazakhstan now has a completely different set of problems. He is concerned not with weakening the tenge, but with his too strong strengthening, including with respect to the fallen ruble.
Conclusion
It is possible that the basis of the described behavior is some very deep, general principles. If a group of predators (for example, wolves, hyenas) feels the weakening of resistance on the part of the victim, then it intensifies the attack. This, perhaps, is repeated in social life. Gradual and continuous concessions, for example, to terrorists, only whet their appetites, as if confirming the weakness of the other side.
It would be very useful for the Central Bank of Russia to write down all the drawbacks of a “smooth” devaluation to itself in “engineering memory” and not step on the same rake in the future.
The “smooth or sharp” devaluation dilemma is not the only issue of a verified exchange rate policy. But this is the topic of other articles.
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