Cash Only: The sovereignty of the Czech currency is a myth

Cash Only: The sovereignty of the Czech currency is a myth
Cash Only: The sovereignty of the Czech currency is a myth

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The most widely used world currency is the US dollar. In business transactions, the value of financial assets and foreign exchange reserves. Its position was not weakened by the great financial recession of 2007/08, nor by the pandemic and the consequences of the war in Ukraine, which we are all now feeling firsthand in food prices and energy bills. On the contrary.

Everyone needs to borrow dollars in order to actively trade on world markets. Not only companies borrow dollars for trade and investments, but also states for their operations, and small and large investors keep their share or bond portfolios in dollars, for example for pensions. Almost 90 percent of all currency trades in the world – a daily turnover of $6 trillion before the pandemic – involve the dollar as one of the currencies in the pair.

The dollar is currently ubiquitous and in a superior position to other currencies.

We saw the inexorable consequences of this dominance in the collapse of Sri Lanka this May. Due to the beginning of the US Fed’s monetary policy tightening cycle, the country’s dollar debt, which it was no longer able to service, became more expensive. Sri Lanka did not have enough dollar income from trade and no one wanted to lend it dollars.

This is a problem for the eurozone (including the Czech Republic, which is closely connected to it). Commodities such as oil and natural gas are primarily traded in dollars, so when the European currency (and with it the koruna) weakens due to capital outflows, oil and natural gas in euros and therefore korunas become more expensive. Since mid-2021, the dollar has strengthened by 15 percent against a basket of currencies. Both the euro and the Japanese yen fell to record lows. The Czech crown weakened by 13 percent against the dollar for the year.

Photo: List of News

The dollar dominates foreign exchange reserves.

Europe is also losing competitiveness for this reason. We see it across the Czech economy. High energy prices (including electricity, which is also rising due to the shutdown of Germany’s nuclear and coal-fired power plants) are destroying the entire glass and aluminum industry and significantly increasing the prices of baked goods, as bakeries run on natural gas.

The production of goods for export is becoming more expensive, so despite the cheap currency, there will be fewer interested parties willing to buy expensive ones from Europe, and fewer dollars and euros will flow to the Czech Republic for the goods sold.

After years of balance of payments surpluses, the export-oriented Czech economy began to show deficits, which, according to the Ministry of Finance, will continue in the coming years. In 2022, they will reach 4.6 percent of GDP, then in 2023 they should decrease to 4 percent of GDP. Europe also has balance of payments deficits. Even Germany, which has always been considered an export hegemon, imports more than it exports.

In addition to the loss of competitiveness, the Czechia also feels other ills of the eurozone. Above all, the threat of an increase in the price of the national debt, which is rising sharply in the Czech Republic and will continue to rise in the coming years.

Investors buy bonds of developing countries because of higher yields. If U.S. rates rise, it is logical that capital returns to the U.S. for a return, where the environment is safer. And even though the Czechia is often considered a developed country, a reserve currency or a safe harbor where investors turn in times of crisis, it still has a long way to go.

In order for Europe to strengthen its balance sheet and at the same time tame high inflation, even the European Central Bank (ECB), which has resisted for a long time, is forced to raise interest rates. There are growing voices for another 0.75 percentage point increase at the September 8 meeting. ECB Executive Committee member Isabel Schnabel of Germany said in Jackson Hole that taming inflation would require more “sacrifice” than during previous episodes of monetary tightening.

However, the ECB is gripped by the highly indebted countries of the eurozone, led by Italy. If it starts raising rates too quickly, a situation similar to the one in Sri Lanka could arise in Italy, Spain or France.

However, the developed countries of Europe are at an advantage against Sri Lanka because the Fed has given them very cheap loans in the past in times of crisis. It took place through currency swaps, i.e. the exchange of dollars for euros between central banks. The ECB could then lend dollars to individual central banks in countries that needed dollars, and the liquidity crisis was thus averted.

The Czech National Bank has been massively intervening in recent weeks under the leadership of Governor Aleš Michl, and has so far sold about a sixth of its foreign exchange reserves in order to maintain a stable exchange rate of the koruna. At the same time, we are still in a relatively comfortable situation. While Sri Lanka’s foreign exchange reserves would cover imports for only 1.4 months, the Czechia could purchase existing imports for 7.3 months.

However, in the event of a crisis, the Czechia does not have direct access to the Fed’s swap lines, and would have to turn to the ECB for dollars and euros.

For the Czechia, the current situation means that it has to increase interest rates in order to match the pace of rate increases by the Fed, and thus also by the ECB. Otherwise, there will be another significant outflow of capital and deterioration of the balance of payments. Foreign exchange interventions will help the koruna, but they will not suppress the market in the long term.

In the international world of integrated money and financial markets, the very idea of ​​a purely domestic monetary policy is an illusion, and the interest rate of American money sets the level for the whole world, not just for the United States. “One market means one price, which means one money and one monetary policy,” as today’s rediscovered financial historian Charles Kindleberger argued.

Of course, economists don’t want to hear it, let alone politicians. Nobody wants to admit that monetary sovereignty is a myth.

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The article is in Czech

Tags: Cash sovereignty Czech currency myth

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