Russia's Black Tuesday


IF THERE is one thing worse than a huge rise in interest rates designed to stabilise your currency, it is a huge rise in rates that fails to stabilise your currency. The Russian rouble fell briefly to 80/$ today. It only hit 60/$ yesterday and the fall came despite a 6.5 percentage point jump in interest rates that was announced in the middle of the night, a move that smacked of panic.

These are huge currency moves. This looks like a Black Tuesday for Russia akin to the Black Wednesday when Britain was forced out of the exchange rate mechanism (when a big rate rise was proposed, then abandoned), the Black Thursday that was perceived to be start of the Wall Street Crash of 1929 or the Black Monday of October 1987 that saw the Dow fall nearly 23% in one session.


My colleagues warned about the looming Russian crisis three weeks ago, and the problems have been a long time in coming. The economy has been overdependent on energy, is controlled by a remote elite, and has treated international investors in a high-handed and cavalier fashion; in a column earlier this year, we showed that it traded at atrillion dollar discount to other emerging markets. The next threat may be capital controls, but the prospect of such controls may cause currency flight; best to get your money out while you still can. By forecasting a fall of 4.5%-5% in GDP next year, the Russian authorities may be adding to the problem; the natural reaction of consumers and businesses to that forecast is to pull in their horns. It is "forward guidance" with a negative twist.

There is nothing wrong with a little mild currency depreciation (or appreciation) now and then. Sometimes exchange rates can get out of line. But a massive and speedy depreciation risks becoming self-perpetuating, as occurred in Latin America in the 1970s and 1980s. A devaluation is a decline in the spending power of citizens; the imports they need to buy cost more. Inflation jumps and workers may respond by demanding higher wages. This erodes the competitive boost to exports resulting from the original depreciation. The currency falls again and the cycle has another turn.

The proximate cause for the rouble sell-off is the fall in the oil price; Brent crude wasbelow $60 a barrel this morning, WTI below $55. That fall may be terrible for Russia, but is good news for most countries. So the slight mystery is why it has led to such a risk-off reaction in markets; the US 10-year yield is close to 2%, and German yields reached at a record low of 0.59%. Wall Street may be higher on the year but London's FTSE and Paris's CAC are now registering losses; so much for the year when there would be a "great rotation" out of bonds into equities. Emerging market equities are now at a five-year low.

The economic data have been mixed (German's ZEW survey was good as was US industrial production, but the Empire State survey was weak) but not bad enough to generate such a sell-off. The most likely explanation is that investors are simply startled by the sheer speed of the fall in oil and the rouble; someone somewhere is losing a shedload of money. When investors lose money in one part of their portfolio they tend to reduce risk elsewhere; the same applies when volatility spikes up and the models tell you to cut positions. Like the rustle in the bushes that may be a tiger, investors figure it's better to run away first and assess the situation from a safe distance.

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