In light of the collapse of the Ruble I think it’s worth revisiting what controls exchange rates.
Supply and Demand.
Yeah, if you know something about the subject you’re probably shaking your head.
Supply and Demand doesn’t set prices in many cases in the way that an Economics 101 course tells you.
Such texts will say that the exchange rate is based on exports and imports.
For many countries, that isn’t true; or not all the time. The US dollar can move up even when the trade balance is south (as it has been for decades now.) The same is true of many other economies.
Britain hardly exports anything any more. But people want to live in London. Or they want the city to invest their money, or they want to buy art at Sothebys, or they just want a relatively safe place they can run to if the politics in their country go south.
People likewise want Manhattan real-estate; a US passport, and so on. A vacation or home in Paris or the South of France.
They want to buy stocks in important companies which are defining the future, like Apple, or Tesla, or Google, even if those companies manufacture overseas.
They want money in China to take advantage of China’s high growth rate and returns, while Chinese want money out for diversification and to have a safe place to go if the politics turn against them.
People don’t want vacation homes in Russia, by and large. They may want to take advantage of growth opportunities (which exist in certain sectors), but before the sanctions they were scared of corruption (with good reason) and post sanctions they are worried about getting returns out. Since most of Russia’s exports are of hydrocarbons, and since people don’t want to move money into Rubles otherwise, the value of the Ruble in terms of other currencies moves up and down with the price of hydrocarbons.
There are other factors, for example if you offer high returns, that can matter (raising returns didn’t matter to Russia, because the potential value was swamped by fears of further ruble and oil devaluation.) Speculation of future gain or loss in the futures and options markets can raise or lower the value of your currency as well. You can fix your currency and you can make it stick if your economy is strong enough in specific ways (mostly having to do with producing what you need). China did this for years, and so have many other countries. This can lead to black market currency markets and problems, but that can be better than the alternatives (as Russia may now be finding out.)
But if you float your currency, the bottom line is that excahnge rates (with a few exceptions) to rise and fall based on how much people want from your country which they have to buy with your currency.
jsn
Excellent summary.
With regard to the future of reserve currency status for the dollar, making your country someplace rich people want to move to is the biggest challenge contenders to topple the dollar must address. Of course what with torture, rendition, drones, surveillance etc, we are trying to help….
Les Jones
Yep: “Switzerland’s central bank said it would introduce negative interest rates to cool the strength of the Swiss franc, as central banks across Europe scramble to protect their economies from the threat of falling consumer prices.” – WSJ
Tony Wikrent
Jon Larson reminds people that the Russians have faced much worse – including Putin’s mother, who survived the Siege of Leningrad. Larson posted an incredible picture of Russian women digging tank traps outside Moscow in December 1941. But what he adds in commentary is, I believe, one of the few times where a picture may be worth a 1,000 words, but is worth even more accompanied by some trenchant words.
Gloating over the ruble’s fall
http://real-economics.blogspot.com/2014/12/gloating-over-rubles-fall.html
Lisa FOS
As has been said by many commentators, the fall in the Ruble is actually acting like as ‘shock absorber’ for the internal economy overall from the (manufactured) fall in oil prices.
If it continues the impact will be to increase investment in internal manufacturing in Russia. Foreign companies, like car companies will move more production there and so on.
Provided the Govt and central bank don’t go all stupid this is actually an opportunity for Russia. You could argue that the Ruble has been overvalued (like the Australian and Canadian dollars) for far too long.
A low ruble will help protect the Russian economy (at the price of some more inflation though, but so what) from the Saudi oil war. Sit it out, let SA take out US (etc) oil and gas production, build up the internal economy and other trading partners.
Then later, when prices inevitably rise again, screw the EU into the ground while watching the US having to bailout its banks and financial systems yet again from the inevitable ponzi shale/etc oil/gas collapse…while screwing it’s ordinary people ever more (I fully expect compulsory confiscation of gold fillings to happen sometime soon) .