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The rate can not change the fall in currency demand

Do we have today a drop in the demand for currency, a change in the investment portfolio or both?

July 18, 2018 3:11 pm A+ / A-

When one explains currency, when addressing the issue of the purchasing power of the currency teaches that it depends on three factors: 1) the demand for currency, 2) the supply of currency (the inverse of demand) and 3) the productivity of the economy. The secret is in understanding well what is demand for currency.

Just as ordinary people believe that the interest rate is the cost of money, a gross conceptual error, many confuse demand for money with demand for financial assets. Even some economists even say that if the interest rate increases, the demand for currency increases. This phenomenal confusion leads to create problems such as the stock of LEBACs that today pay interest rates close to 50% per year in the secondary market.

To be clear: the currency, which is a merchandise like any other, serves as a means of exchange. People, in addition to wanting to own assets, want to have money (demand for currency) to buy goods at a given time. Obviously, that demand for money can be constant, increase or even tend to decrease to almost zero when entering into acute inflationary processes.

What has to be clear is that when someone demands money is demanding unpaid money balances. If with your money someone buys a bond or makes a fixed-term deposit, you are not demanding money, you are demanding financial assets offering money in return. I give pesos in exchange for LEBAC. Therefore, when the interest rate is increased to keep the demand for currency stable, conceptual nonsense is being committed. The demand for monetary balances does not increase, the demand for LEBACs increases and, in any case, the supply of currency. I offer pesos (the demand for currency falls) for LEBACs, which is a financial instrument.

Does the problem of demand for dollars is solved by the interest rate rise? Absolutely no. It is postponed and strengthened by the interest rate that it accrues. The point is that for there to be a demand for financial instruments issued by the state, in the case of Argentina, the rate offered by these financial instruments must be greater than the increase in the expected exchange rate. Why the exchange rate? Because Argentina does not have currency in the sense that it serves as a reserve of value and unit of account. People have already chosen the dollar as currency, even if a false nationalism wants to deny such a reality. Those who compare the interest rate against past or expected inflation make a serious mistake. Nobody who invests in LEBACs or other instruments does that calculation, they do it by comparing with the exchange rate. If they expect the exchange rate to remain stable or rise slightly, they sell dollars and buy LEBACs. That the LEBACs are denominated in pesos does not mean that the demand for pesos or currency increased. That is a conceptual bluff. Increase the demand for a financial asset. Therefore, how much higher interest rates the higher government pays is the demand for that financial asset, but greater the amount of accrued interest that at some point the investor will make. There is no investor who indefinitely earns a profit. And less in the financial market. At some point realizes the profit and when it performs an unsustainable pressure on the exchange market, not only because of the social effect of running for the same objective but because of those who go from LEBACs to the dollar demand dollars for the capital invested plus interest earned. That is why it is said that those who leave first are the winners and the last to leave the losers of arbitration.

The question that an economist asks when he sees that the state arms these arbitrations is the following: is the interest rate paid by the BCRA consistent with the average rate of return of the economy? Can any company pay those real interest rates without merging? Or, if preferred, one can ask this other question: if the BCRA pays a real interest rate in dollars to the investor of 25% per annum, say some number, to whom it lends at that rate and then be able to return the capital plus accrued interest? If you find that no one can pay that real interest rate, then you can bet that the state will not be able to make its financial commitments and at some point there will be a problem.

Since the United States in 1971, under the presidency of Nixon, abandoned the gold standard, the entire world monetary system is based on trust that people have in the currency issued by the Central Bank of each country.

Since the BCRA was created in 1935, the cumulative inflation rate was 1,239% trillion. If someone has a notion what that number means, it is even smarter than Einstein. It is no coincidence that 5 monetary signs have been destroyed and we have gone through periods of inflation, high inflation, mega inflation and hyperinflation. In other words, Argentinians doesn’t have confidence in the currency issued by the BCRA. Not the demand. Believe that you can increase the demand for currency, in this case the peso, raising the interest rate is adding fuel to the fire because it can postpone the flight to the dollar for a while, but at some point, there will be no interest rate compensate for the risk of staying in LEBACs. I insist, a true nonsense to confuse demand of financial instruments with a demand of currency. If there is confidence, people demand a certain amount of currency to exchange it for goods at a given time and do not need sidereal interest rates to demand currency. They are two totally different things.

Is it better to continue raising the interest rate in this context? I do not see it as logical. With this interest rate, not only it generates a greater future complication, but they are killing economic activity because the state enters like an elephant in a bazaar to demand the scarce credit that there is in the market, offer that has as a counterpart the savings, not the demand for currency. As the savings on the domestic capital market is negligible (the bulk of Argentine savings is abroad financing the growth of developed countries given the legal insecurity of vernacular populism), the state demanding the scarce supply of domestic savings displaces the private sector deepens the recession and possibly, complicates more the fiscal goals due to the drop in revenue given the looming recession.

In short, today we have a drop in the demand for currency and a change in the investment portfolio, going from financial assets in pesos to assets in dollars. Both things are given. Trying to stop this with more rate is crazy, and believe that the demand for currency is a function of the interest rate is a complete madness.

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The rate can not change the fall in currency demand Reviewed by on . When one explains currency, when addressing the issue of the purchasing power of the currency teaches that it depends on three factors: 1) the demand for curren When one explains currency, when addressing the issue of the purchasing power of the currency teaches that it depends on three factors: 1) the demand for curren Rating: 0

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