Howard Barrell
Over a Barrel
Since this story is about the currency markets, let’s engage in a bit of speculation: you are the leader of a middle-income country of little importance to any but the people who live in it. South Africa would be a good example
You are trying to transform your country. Your government wants to narrow the big differences in wealth between a rich minority in your country, most of whom are white, and a mainly poor majority, who tend to be black.
But the circumstances are difficult. Among other things, whites dominate not just your own economy but much of international business as well. And many whites, sotto voce, believe dusky folk cannot manage money.
The result is that, when you appointed a black-ish fellow minister of finance a few years back, the value of your currency dipped on the international markets. Perhaps you should have anticipated it would. But you preferred to be optimistic about white people and their attitudes.
Last month, the time came to decide another delicate financial appointment: the next governor of your central bank. He is the man who has formal constitutional autonomy when it comes to deciding the cost of borrowing money and what people should earn when they save it.
The incumbent was a well-established reactionary from the old regime. To give central bank autonomy a good name among your own supporters, you needed to succeed him with a different kind of political animal. A black chap with political street cred would be best. And one candidate looked promising. Mr Watchamacallit was from your party, he had a degree in economics and he had a certain independence of mind.
His candidacy had other attractions. Among other things, the appointment might shut him up. In Cabinet he was more sceptical than most about your policy for growth, employment and redistribution. His criticisms came from the political left. Moreover, he had produced a new labour law which had prompted howls of anguish from the managerial classes.
So, you reasoned thus: “Why not make this chap central bank governor. Let him be exposed to the same chill winds of the international economy in which I must sail the ship of state. Let him take the difficult decisions demanded of a central banker and, intelligent fellow that he is, he will soon forget all his wouldn’t-it-be-nice-if left- wing bullshit and come round to my way of thinking.”
But, you recognised that his appointment might cause a fall in your currency. First, because he was a dusky fellow. Second, because the financial markets fear for the independence and probity of monetary policy whenever politicians take charge of nominally independent central banks.
So you asked yourself if there was any way you could prevent such a fall. You came up with an idea. You decided to consult a handful of businesspeople with whom, over the past 10 years, you’d shared much good food, wine and whisky in various capitals. You used them as a sounding board. They understood the international markets; you didn’t; and your in-house advisers didn’t either.
You told them: “Chaps, this is confidential, strictly confidential. I plan to appoint Watchamacallit to the central bank.”
“What! You mad?” asked one. “Holy excrement!” exclaimed a second. “Effing disaster!” gasped another. “You must be joking,” suggested a fourth more charitably. “Your currency will be massacred,” exclaimed a fifth.
Once you’d let their anguish spend itself against the rock of your resolution, you asked those of them from your own country: “But will you promise me this: will you publicly support the announcement when it is finally made?” Yes, they would.
On this, they would prove true to their word. But, in the interim, one or more of the trusty people you had let into the secret – or an associate of theirs who just happened to come by the same confidential information – reasoned thus: “The currency will fall sharply when the market finds out about this. Ergo, if I bet against the currency now, I could make a lot of money.”
So this individual – or a nominee or a friend – did just that. Other big players in the markets took note and followed suit. The value of the currency fell sharply. Thus your plan induced exactly the result it was intended to avoid.
Meanwhile, you had kept your sitting central bank governor out of the loop. He didn’t know about Whatchamacallit’s appointment. So he saw the fall as ill- reasoned speculation against the currency. He reckoned he could beat the speculators off. So he marshalled the country’s foreign reserves and committed $1-billion or so to buying the national currency to force its price back up.
But the price kept falling. Eventually, a friend of his in the market asked him: “Why the hell are you intervening?” Out tumbled the vital titbit.
The governor realised he was one of the few people in the market who didn’t already know about Watchamacallit’s appointment as his successor. He looked foolish and felt angry. And he then did only sensible thing he could. He suspended the intervention. He recognised that, in an instance like this, the markets would do what the markets would do, and there was no dissuading them.
Word about Watchamacallit’s appointment spread, and there was, by now, a massacre of the currency. In just 45 days, the currency lost a third of its international value. And by then just about everyone in the markets and the press knew about it.
You had no choice at this point but to announce the appointment publicly. You did so over a weekend. As your trusty business friends had promised, they now publicly declared their support for Watchamacallit’s appointment and the Sunday press presented it as the best thing since Joel Stransky’s drop kick in 1995.
Let us now return to the here-and-now.
This story is, of course, just a speculative exercise, a scenario dreamt up as a problem-solving technique.
What was the problem?
It was an inability to appreciate properly the markets’ concern about the independence and probity of monetary policy. You just did not have the trusted in-house economic advisors who actually understood the markets, how they work and what moves them.
Instead, to obtain advice, you had to farm out market-sensitive information to those whose first duty was to their shareholders, their partners, or just themselves – not to you or your country.
Clearly, as national leader, you need advisers who really do know about the markets. You must pay whatever inflated salaries are necessary to get the best. You need to be clear that you are employing them to improve your acquaintance with reality, not with your image in the mirror. And you need to take their advice.