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Tuesday, October 16, 2007

Mugur Isarescu Shows Us How Not To Run A Central Bank

Well according to Bloomberg this morning:

Romania's central bank will hold back from any ``sharp and sudden'' reaction to accelerating inflation and a widening current account deficit.

``Don't expect us to react in an unprofessional way or to overreact or be disorderly or push on the brakes,'' Mugur Isarescu, 58, said in an interview in Bucharest yesterday. ``There's no reason. The situation is manageable.''

Isarescu, who has headed the central bank since 1990, after the fall of communism, said there was ``not a good probability'' that the year-end annual inflation rate will be below 5 percent, though it will probably peak in October.

`We expect some impact of the drought on food prices to remain in October,'' he said. The increase may turn around starting in November and ``we hope inflation at year's end will be close to the target. We aren't only looking at one month's data and then to go and shoot a fly with a cannon. We're looking for sustainability and continuity.''

Obviously this is just not the way to handle a tricky and extremely complex situation. The remarks do not convey the level of concern and getting down to business attitude that the markets are looking for - and are right to expect - at this point. Predictably the leu has again been under siege this morning. If the central bank governor conveys the idea that he isn't particularly bothered, then its do what you like time.

Also, and as is being repeatedly stressed here on this blog, by the IMF and by the world bank, the issues which are up on the table go way, way, beyond food prices. The relate to how you can continue to fund an unsustainable current account deficit, and what to do about a fertility and out-migration driven labour shortage. They need to be addressed, and quickly - at least by offering credible policy responses - or all of this is going to explode, and soon.


Emil Perhinschi said...

What do you mean by "explode", and what do you mean by "soon" ?

thank you.

Edward Hugh said...

Hi Emil,

Well I think what I am saying is that, either we will see one of the "peggers" - the Baltics and Bulgaria - make a run for cover and break the euro peg, *or* we will see a big run on the leu. After that it will be devil take the hindmost.

When? Weeks is my guess. Before xmas. Next months inflation data may well do it if it is bad enough, it depends. At the very latest, my guess is that one of the peggers will leave their peg over xmas, since this is a time when a lot of banks are closed and financial markets are quiet. If I was going to do it I would do it then, if I could hold out that long.

But this is a bit like needing to pee, and hoping to make it home (ageing male prostrate problems) sometimes you just can't wait and need to find the nearest public toilet.

Non of this is calculable in machine terms, but you need to read this post from me, and this one from Claus, if you want to get some idea of where we are up to at this point.

I don't know whether you can believe this or not Emil, but I feel for you all at this point, I really do. I would very much like to be wrong, but I don't think I am. We will all know soon enough. Savings in Euros is a good idea at this point, but please don't quote me on that.

Emil Perhinschi said...

Savings in Euro are good anytime, as long as one still has savings in another currency.

I was afraid you will tell me about 300% inflation and 50% reduction of GDP ... that is what I mean by "explosion" . From my point of view, your post is optimistic :).

Isărescu is cautious ... even if he knew for sure the end of the world as we know it will arrive tomorrow, it would be irresponsible for him to say that in public. Some prophesies just fulfill themselves ...

Robin Bowman said...

Hi Edward

I've been following your posts with interest - especially on Romania.

I wonder if you have a view of what will happen to the Romanian property market when the 'explosion' happens?

Many thanks - and thanks too for the blogs

Edward Hugh said...

Hi Again Emil and Hi Robin,

Firstly Emil I am glad you are taking all this so stoically, this is probably the best approach.

I am intentionally avoiding making any specific predictions since it is really impossible at this stage to see the intensity of what may happen. This will all depend on events which take place outside Romanian frontiers, even if some of these events may themselves be affected by what happens next in Romania.

The more important point is that if I am right, and the underlying problem is a structural one, and the issue is labour supply based on long term low fertility and out migration then there is no easy fix in sight. So this will not be a simple "correction" and then onward and upward we go again. Thinks may well become much more complicated.

"what will happen to the Romanian property market"

Well, in the language of the game, it will have a "correction", how substantial this will be depends. I am sorry for being so vahue, but at this point there is so much that it is very hard to see. We have a sort of fog over the ship, but at some point the mist will clear.

Of course, what happens to prices will depend on whether you are talking in euros, or in leu. In leu the prices may well even go up, depending on the scale of the devaluation and the level of inflation produced, but in euros the direction will almost certainly be down.

How can you sustain rising property prices with a declining population? You tell me.

Anyway, thanks for all the interest, both of you. And please keep the comments coming as we go forward, since this is most definitely going to get very interesting, if you appreciate this kind of meaning of "interesting" that is.

Robin Bowman said...

Hi Edward.

Thanks for your reply re property prices.

I had hoped you would have a more concrete view, seeing as this is probably one of the hottest property markets (for investors) in Europe right now.

But I appreciate why you cannot be concrete....I think.

I say I think because I find it somewhat strange that you are quite adamant about the seriousness of the economic problems (correct me if this is not fair), and use fairly bold language to describe the consequences, so why not something more concrete when looking at a specific within the economy - namely residential property prices (overwhelmingly mortgaged in euros)? A correction, as you say. But how much in % terms?

To turn to your question - how can you have a rising property market with a falling population?

Two factors here - at least to me, and I'd like to know what you think - one, it is not absolute numbers of people that count in terms of property markets, surely - but numbers of households, and this number is growing al over CEE ,as the countries trend towards EU norms.

Second - national population trends are not really relevant from a property market viewpoint - what matters is trend migration into cities. Overall, the population may be falling, but are the main cities growing is the question...isn't it?

Thanks and best regards

Edward Hugh said...

hello again Robin,

"I say I think because I find it somewhat strange that you are quite adamant about the seriousness....so why not something more concrete when looking at a specific within the economy - namely residential property prices"

Well look, I am not simply trying to be coy here, it really is impossible to say.

The thing is, this isn't just a problem in Romania, this is the heart of the current "liquidity crunch" issue.

I don't know how much you have been following this, but the essence of it is that since the middle of August the global market in commercial paper backed by mortgages has effectively seized up. And the reason it has seized up is that no-one knows what the properties which back the paper are worth. This is why noone in their right mind wants to buy such paper at the moment.

But you will forgive me if the largest commercial banks and the most important central bankers across the planet freely admit they have no idea how far all this can go, then I really don't have anything more to add, since I have no private crystal ball here.

Of course the central banks are more circumspect than I am, since they don't want to generate panic, but you could look at but you could look at this piece about the BoE and commercial property in the UK, or this thing on the bold efforts of the US banks with the Master Liquidity Enhancement Conduit. But the important thing to note about the MLEC is that at the moment they can't hold back the flood, water keeps seeping though. If this process is not corrected, then it is, of course, most serious. What more do you want me to say?

It is a bit like we need a CAP for housing and land. Instead of buying up surplus tomatoes or potatoes, the US banks want to buy up and effectively put out of circulation large bundles of commercial paper. Maybe the EU Commission needs a property department to buy up all the surplus building land and new properties, now that the global boom is well and truly over. This is what they were forced to do in Japan in the early 90s, since it is the only effective way to stop prices falling and continuing to fall. The correction starts when people are forced to sell since they cannot maintain payments.

This will all really begin in earnest here in Spain when the people who have been caught with two properties - since they "bought over plan" whilst retaining their old home till the new one was finished - cannot maintain two mortgages. These people will then effectively be forced to sell, for any price they can get, and that is when prices can tumble.

In Romania this will be associated with a drop in the value of the leu. If it falls far enough and fast enough then people simple won't be able to maintain payments. Of course we still don't know at this point what is going to happen to euro-dollar. So there are so many things out there right now, this is all very hard.

Let's take an analogy. You probably listen to the weather forecast for tomorrow and the next day. If someone tells you that it will be sunny on xmas day you are probably a bit more circumspect, while if someone tells you I have no idea what the weather will be like on xmas day, but global warming is taking place, then, if you have any sense, you probably sit up and take notice again.

Be patient. By xmas this will all be much clearer, and we will also get to see whether it was a sunny day or not into the bargain :).

Robin Bowman said...
This comment has been removed by the author.
Robin Bowman said...


Thanks for taking the time to write your lengthy reply. It's much appreciated.

Yes, I have been following proceedings and, yes, I do see your points - disappointed about the lack of a crystal ball, though!

I like the global warming analogy - but I would say, that it's only rational to reply, 'yes, but by how many degrees and by when?'

I certainly take your point that in the case of property markets in many CEE countries - where so much mortgage debt is taken out in Euro or Swiss franc loans - serious currency falls would create forced sales. And forced sales, as you rightly say, are what starts a big correction.

I would be interested to know what you think about the demographic trends I mentioned in relation to property markets, though - when you have time. Do they make any sense?

Best regards