On September 4, the hryvnia fell to 8.19 per dollar on the interbank currency exchange. Some banks were selling cash dollars at 8.30 that day. Prior to this, the National Bank had refinanced three state banks to the amount of 3.8 billion hryvnias. After the jump, the regulator “punished” five banks that, in its opinion, had been most actively speculating in currency, driving up the dollar exchange rate.
The event caused a stir in the press. Various interpretations appeared in the media—from the beginning of the hryvnia devaluation to the NBU’s desire to impress the IMF mission, which visited Ukraine during those days (the NBU did not conduct interventions, which can be interpreted as the regulator’s “market” approach to setting the exchange rate).
However, it seems to me that to understand what is actually happening, we must first ask where the “exchange rate” problem comes from and what it means for Ukraine.
Exchange rates are a direct consequence of the state’s monopoly on money. The state exercises control over a certain territory where it has introduced “our” money. Next to it is another territory where the local state produces “their” money. In “our” state, prices are expressed only in “our” money; in “theirs,” only in “their” money. Accordingly, if “our” trader wants to buy “their” goods, he needs to exchange “our” money for “their” money. Here the problem arises of how to express the value of one piece of paper in units of another.
To understand the essence of what is happening, one must remember that this problem exists not for traders, but for the state. Trade balances and budget deficits are the most important part of macroeconomic reporting. This reporting itself is virtually the only way by which governments, as they believe, can objectively evaluate their work. The public also believes in these indicators, and all political life in the modern world develops around them.
The state cannot produce goods, but by owning the monetary unit, it can change its quantity, thereby solving its own problems. This ability creates the most varied pressure groups. In this matter, these are importers and, of course, exporters. The latter are always interested in making “our” money cheaper relative to “their” money, which gives exporters short-term advantages—until the buyer’s government comes to its senses—and the state politically pleasant macroeconomic reporting. This disposition is the same for all states and determines what happens in the world.
There are two ways to solve the exchange rate problem. The first is to fix the rates of state money. This method was used during the Bretton Woods system. The second method is floating exchange rates, when the currency rate is set based on the results of exchange trading. Traders—exporters and importers—sell currency on the exchange under the supervision of the central bank, which can also buy and sell, pursuing goals of achieving a particular exchange rate. Unlike fixed rates, this scheme is considered “market” and assumes that through it one can learn the value of one money in units of another.
In reality, within the framework of fiat money, there is no good solution, and fixed rates may even be better than floating ones. Using the example of Ukraine, we see that a floating rate, like a fixed rate, is simply an arbitrary valuation of currency. On one hand, the regulator can “solve the problem” through political methods—regulating trading participants, and in our case, “punishing” them for wrong behavior. Note that the so-called speculation for which some banks were punished is precisely the content of the exchange trading process. Without speculation, there are no trades, and therefore the currency rate based on their results is arbitrary. The behavior of participants in exchange trading under such conditions is dictated, again, by considerations of political games and intrigue involving the central bank. On the other hand: the regulator is unable to predict how market participants will behave in cases where it cannot directly influence their decisions. We saw how three billion hryvnias given to state banks immediately ended up on the exchange.
And the issue here is not corruption. If you think these are only Ukrainian problems, I hasten to disappoint you. This happens everywhere, just in a less brutal form. The regulator is fundamentally incapable of regulating objectively; it will always have favorites and be dependent on political decisions, not to mention that its very presence in the market affects the incentives of its participants. Recently we saw a similar situation in the EU, when the ECB complained that banks were “in no hurry to lend” the money that the ECB had loaned them almost for free. The behavior of the Federal Reserve leadership at the beginning of the 2008 crisis, which can only be described as chaotic, is also very instructive.
Even if we allow that a system could exist that excludes all subjective intervention and allows the central bank to understand with extreme precision the intentions of currency trading participants, the exchange rate established in this way would still be arbitrary. And here is why.
The “free rate” is set based on the trading results of entrepreneurs engaged in export and import, that is, a group of people selected by the arbitrary criterion of their goods crossing the “state border.” It is clear that these businesses represent only a certain part of the economy, while the exchange process occurs in the economy as a whole and by definition cannot be limited to national frameworks. Exchange ratios between goods arise without any money. Money radically accelerates and expands this process, but the process itself is not fundamentally monetary. One cannot extract from this general process a certain part solely on the basis that it involves goods and services crossing the state border. Simply put, the “free rate” determined by the exchange, by which one supposedly can establish the value of one currency in units of another, is an illusion. One could speak of a “free rate” if legal tender currencies that could be exchanged circulated in the country, that is, if pricing and financial reporting were conducted in them. It is easy to understand that in this case, the exchange procedure for setting the rate, as well as the central bank’s participation in it, would be completely unnecessary; entrepreneurs would simply compare prices in different currencies, choosing the most suitable course of action.
And here we come to Ukrainian specifics. In Ukraine, a variant of parallel currency circulation and semi-legal pricing in a “non-native” currency was actually implemented. The dollar circulated practically on par with kupons and hryvnias, and was and continues to be used for payments between individuals and as an “equivalent” in calculations. In Ukraine, internal dollar prices existed for quite a long time. The fact of a salary of 20 dollars in the ’90s does not indicate so much the poverty of unfortunate Ukrainians as the different purchasing power of the “ukrdollar,” significantly higher than that of the supposedly same dollar in the USA. In fact, it was the relatively free circulation of the “ukrdollar” that allowed Ukrainians to survive the ’90s.
Since then, the “dollar rate” is not simply an element of the foreign trade system. One might say that the dollar rate directly affects the behavior of the overwhelming majority of economic actors, including those not engaged in export-import and who are not “businessmen” at all.
It should be said that Ukrainian monetary authorities realized this circumstance quite quickly. “Holding the rate” has always been a priority of the national bank. Note also that it is precisely for this reason that in Ukraine the position of the Ministry of Finance is always secondary to the NBU.
Recall that after the clever devaluation in ‘98, when the rate jumped from 2 to 5 hryvnias per dollar, the rate of 5 hryvnias was maintained until the 2008 crisis. Let’s set aside the fact that “supporting the rate” is largely a source of inflation; we said that in this matter there are no good solutions (or rather, there are no solutions within the framework of fiat money). Let’s only note that it is unknown what credit the NBU deserves for the rate being stable for a full 10 years. Was the NBU even responsible for this, or was it simply going with the flow? It seems, after all, that all this time Ukrainians lived in a regime where exchange trading and the central bank were simply unnecessary.
However, times are changing, and not always for the better. The current government is perhaps the first Ukrainian government seriously interested in macroeconomic reporting. Accordingly, the desire to tweak indicators using the rate, as well as the pressure of interest groups, has the most direct impact on the National Bank’s desire and ability to “hold the rate.” On the other hand, the same National Bank never tires of producing hryvnias on an industrial scale. Only in August did the NBU “repurchase government bonds” (that is, print money) for 3 billion hryvnias. In general, devaluation seems inevitable. And given that the dollar is here the currency of the real economy, its consequences will hit everyone without exception.
So, as a conclusion, one can say that the central bank is a completely useless institution. In good times, the regulator is unnecessary, as everything works without it. In bad times, it is powerless, and its floundering causes harm.
As a second conclusion, one can suggest that states, if they want to retain the monopoly on money, will have to give up a significant part of it. Under the gold standard, the exchange rate problem was solved automatically. When the banking system of state A expanded credit (that is, produced more unsecured IOUs—banknotes), domestic prices began to rise. Imports to such a country became more profitable, trade expanded, and importers gladly exchanged IOUs-banknotes for gold. Roughly speaking, everything boiled down to the fact that printing unsecured IOUs by a certain state made it profitable to exchange these IOUs for gold. A “gold outflow” began, which forced banks to stop issuing paper notes. The problem was actually solved because in all states, gold was the “real” money, and the growth of fiduciary money supply was corrected by this fact, that is, by the banks’ obligation to exchange their IOUs for gold. For state money, gold is the only independent and objective regulator; that is precisely why it was expelled. And that is why its return is quite probable.