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Friday, January 31, 2014

The Oncoming Storm

As Britain continues to be battered by storms, it and other countries should be aware of the oncoming financial storm approaching from the East.

The crisis in emerging markets has spread to Eastern Europe. The Russian central bank has vowed “unlimited” intervention to defend the rouble after it fell to a record low against a basket of currencies.

Russia’s central bank governor, Elvira Nabiullina, said she would not allow a disorderly rouble slide or risk widespread damage to the financial system. She is quoted by the Telegraph:
We are not planning to quit intervention.” 
A macho defence of one's currency is all very well in the short term, however in the medium to long term it will achieve nothing (as Britain's disastrous flirtation with the ERM in the 1990's showed). At some stage Russia will be forced to allow the rouble to float, or else face a recession caused by an excessively tight monetary policy.

Turkey’s “shock and awe” doubling of interest rates on Tuesday has failed to restore confidence in the lira, it too will have to allow the lira to go where the markets wish.
 
Suffice to say Russia, given its rigid mindset and macho self belief, will not in the near future allow the rouble to float. Instead it will continue to tighten monetary policy, and will impose capital controls to prevent currency flight.
 
This in turn will prompt other countries in East Europe to do the same, resulting in a general stagnation of the world economy as the flow of free moving capital dries up and people's confidence in the banking system is eroded.
 

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