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Trade Deficits and the Health of the Economy-3: Dialog with Nikola Gruevski, former Minister of Finance of Macedonia

Sam Vaknin, Ph.D. - 3/13/2006

SV: Macedonians (politicians as well as "the people") adopted a magical mode of thinking. They believe that Macedonia is geo-strategically so important, that it will never be abandoned by the West. True, unilateral grants, aid and other non-returnable transfers have dwindled lately (to the point of disappearing altogether). But Macedonia is getting increasing amounts of credits, loans, military aid, structural aid (EU through PHARE) and other forms of lending. Some of this money is directly injected to the arthritic veins of the banking system in the vein hope that it will trickle down into the real economy. But most Macedonians find the idea that these monies have to be returned one day – hilarious. They believe that, when push comes to shove, these debts will be rescheduled, rolled over, renamed, converted, diverted, reverted, anything – just NOT PAID. The West will take care of it.

A parasitic economic culture has developed, dependent to an unhealthy degree upon handouts, charity, donor conferences and tacit blackmail (Kosovo, Albanians, anything goes). Instead of developing their businesses – managers dedicate all their energy to lobbying, wining, dining and bribing the politicians that hold the right purse's strings. Instead of production and exports – the country sprouted a breed of financial mediators, financial consultants, contact men and go-betweens who know (or purport to know) how to extract money from international financial institutions. Instead of worrying about structural changes – the elite concerns itself with the perpetuation of tense geopolitical situations. The nation becomes submissive, obedient and oppressive. Central Planning by faceless bureaucrats has been replaced by the Central Planning of Eurocrats, dictates from Moscow – now come from Washington, Communism is now called IMF-ism. How convenient it all is!!! How cozy!!! If the economic policies fail – the minister can blame the IMF. If they succeed – surely it is the undeniable fruit of his towering intellect.

NG: In 1949, Stalin asked a specially formed group of professionals to calculate the exchange rate of the ruble against the US dollar. Their final calculation was 14:1 to the dollar. Stalin became angry and from "14" he deleted "1". That way the USSR nationalized their first post war "exchange rate": ruble – dollar 4:1. Unfortunately, that didn't help them much in their economic development.

The dilemma: Has RM lately paid too high a price for the stability of its currency, the denar, is getting more pressing recently. The balance of payments deficit as a percentage of the GDP according to the data of the National Bank is as follows: 1994 - 5.5%, 1995 – 5.8%, 1996 – 6.4%, and according to official sources in 1997 it is pretty high, 8.13%. It seems that the macro-economic policies of RM in this respect were created only to maintain currency stability, until the balance of payments was in its function. RM should lead a more balanced policy of these two very important parameters: exchange rate of the domestic currency and balance of payments deficits. That means that in no case should the unlimited (or considerable) fluctuation of the exchange rate of the denar be allowed. Such a phenomenon will become entrenched and will foster a bigger volatility of the domestic currency. This will facilitate the conditions for an extremely unstable economy. Rather, we should create an atmosphere for a more realistic exchange rate of the domestic currency with the possibility to control the average fluctuation instead of the present de-facto fixed exchange rate. This will create a better export climate in the short-term. Even the variant of programmed monthly fluctuation of the domestic currency is already exercised in some countries, and can be subject to discussion. Anyhow, a higher instability of the domestic currency will have, besides the positive consequences, some negative ones, as well. It is like poisoned medicine which, while curing one organ harms the other. But if the patient is in a very difficult condition, the first thing, which should be done is resuscitation, the better of two evils. A More flexible domestic currency is a measure of the same caliber as short-term debts, but it seems that, at this moment, it should be a less harmful short-term interventionist measure.

By the way, maintaining an unnaturally stable domestic currency has its own time limits, following which it becomes extremely exposed, because the consequences increase geometrically and are borne by future generations.

SV: "The Economist" referred to the Macedonian denar as "eerily stable". There can be no question that it is artificially stable. The Central Bank is evidently at play and is doing a commendable job in as far as its goals are defined. Prices are stable and the domestic currency is stable – what more can a Central Banker ask for in life?

But this is an illusion, which will cost the country dearly – and very shortly. It is useful to be reminded that Russia had low inflation, a trade balance surplus and a stable Ruble rate for two years. Now it has none of these "achievements". It lost its illusory stability because it was illusory. No country in the world can maintain an average of 6% of its GDP in balance of payments deficits year in and year out and maintain a stable exchange rate. This can be done only through strangling the economy. The money supply is draconically curtailed, liquidity is snuffed, cheap imports are encouraged, inflation remains subdued and even turns into deflation. With price stability – exchange rate stability is obtained. But at what a horrible economic price!!! In a graveyard there is no inflation and the exchange rate remains eternally stable.

Granted, Macedonia should not succumb to the latest fashions. It should not allow its currency to be fully convertible internationally or traded in foreign stock exchanges. These steps are advisable only after a certain level of foreign exchange reserves is reached together with a high credibility of the Central Bank, the result of a long and successful track record of reliability. Only an exporting country with its balances in equilibrium can afford itself these luxuries of the absence of exchange controls. Even the foremost free marketers (Hong Kong, the USA) manage their currencies and intervene in their capital markets. This is not only legitimate – it is essential.

But the unnaturally overvalued denar damages Macedonia greatly. It encourages the export of scarce foreign exchange (also known as the importation of goods and services). It distorts the domestic interest rates structure. It destroys whole industries. It leads to deflation. It threatens a run on the currency, a panic similar to the one that engulfed Russia. What will the government do if Wall Street will collapse, the IMF and the World Bank will cease all disbursements, foreign investments will completely dry and thousands of citizens will want to buy dollars at any price? Will the government impose exchange controls? Freeze denar savings? Lose what remains of the credibility of the banking system?

NG: All this makes for social instability in the country, because, even ignoring the stable currency, investment rapidly decreases. Under such conditions, interest rates not only do not decrease (for which there are other reasons), but they remain at incomprehensibly high levels, where especially big margins between active and passive interest rates (about 18%) exist, a situation which sends many messages. According to some experts even this interest rate level is not very high taking into consideration the whole social instability and uncertainty as much in the economy as in the political and geopolitical situations.

SV: High interest rates in Macedonia do not intend to insure lenders against inflationary risks, because today there are deflationary risks rather than inflationary ones. Taking deflation into account, real interest rates are outlandishly high. We are forced to believe, therefore that the high interest rates are intended to compensate lenders for the risk of lending money in Macedonia (country risk) to Macedonians (half of whom never pay back) in denars (which might be severely devalued within the life of the loan).

NG: The monetary policy is an important auxiliary measure for improving the balance of payments deficit, but not the main one, especially in countries where the problem nests are of a structural (realistic) character. Its basic aim should be: matching the money supply with the money demand (transactions) while realizing the planned rate of inflation in a given year. At the same time, the monetary policy should find an optimal relation between maintaining a more realistic exchange rate together with reasonable deficits/surpluses as a function of a dynamically stable economy and in support of exports.

The balance of payments is a mirror of the national economy, and the exchange rate is the reflection in that mirror. RM has a twisted picture of that mirror.

To balance the balance of payments (realistically, not only for accounting purposes), the main aim of every macro-economic policy should be to reach a medium sized surplus in the trade balance. Of course, that is impossible to achieve in the short-term. But by implementing additional measures, which we will discuss later, the realization of the new trend in this direction should start.

The first and the most important step intended to change the situation in the long-term and to find the exit from the never-ending labyrinth of the heterogeneous structure of the problems of RM, is to present a developmental-monetary-political strategy and STATE STRATEGY FOR STIMULATING A TRANSFORMATION OF THE CURRENT ECONOMIC STRUCTURE. The sooner the basics of this policy will be revealed, the sooner the realistic solution of the problems we are discussing will start.

In the beginning I would like to emphasize that privatization doesn't mean re-structuring (transformation of the economic structure). The state can fully privatize its property and again to have an extremely bad economic structure. To start to develop the Macedonian economy, first an act is needed in the direction of changing its current structure... because a man cannot go ahead with a view to the stars if he has needles in his shoes.

The long-term aim of the Macedonian macro-economic policies should be to reduce the imports and at the same time to increase the exports.

Promoting exports (and import substitution) is a strategy around which the development of RM should revolve, through which the biggest economic problems should be solved, such as the deficit in the balance of payments, unemployment, and the indebtedness of the country.

Basically, as I have already mentioned, to secure more serious results in the field of the trade deficit and exports, a change of the economic structure is needed. Something like this, basically, should be a spontaneous process. But if that is not the case anymore, or it is being realized very slowly, the state should more actively, using the democratic and usual instruments available in the world economy, chart a way to the harder basics for the Macedonian economy.

(continued)