By Philip Kozloff, Kozloff Consulting, firstname.lastname@example.org
Foreign currency is a pain in the butt. Producing, handling and re-circulating bills and coins is one of the dirtiest, least-appreciated jobs of a banking system. But unless you operate a foreign exchange kiosk or are planning a trip to another country, you are more likely to think about foreign exchange in terms of bank debits and credits.
However, it might be appropriate to consider what role currency, especially some foreign currencies, will play as the Year 2000 issues emerge.
A smooth-operating economy manifests itself in a robust domestic circulating currency and depends on it at the same time. By the same token, should there be a currency disruption, the effects can be widespread and destructive. National currencies in circulation – not broader economic definitions of money supply – might take on unusual importance as 1999 comes to a close and the Year 2000 opens.
If a country mismanages the run-up to Y2K and seriously under-provides for real or imagined consumer currency needs, a crisis is likely to be the natural by-product. This can lead to panic and bank runs with serious consequences for the national economy. This, in turn, leads to an unexpected crisis as investors retreat from this chaos and choose safer havens. The time scale for these occurrences can telescope into a surprisingly short period of time as we have seen in Mexico in 1994 and Asia in 1997 and 1998.
The mini bank-runs in Hong Kong in the early 1990’s showed how fragile consumer confidence in the banking system can be. Even though there was no substantive basis for the rumours that drove the panic, cash was king for a few fraught days.
There is an inordinate amount of media focus on the potential for Automated Teller Machines (ATMs) and their potential vulnerability to the “Millennium Bug”. This plays on the shakiness of the consumer’s trust in these ubiquitous contraptions. Banks are doing their best to offset this concern with reassurances of Y2K readiness. But will consumers opt for prudence and withdraw large sums in advance of January 1st?
In some countries, there has been public speculation about how much currency in circulation is required. Y2K analysts have looked at changes in consumer year-end currency-holding patterns and have estimated how much currency should be in circulation to meet these demands. The challenge is dealing with the consequences of us all converting bank account credits to hard cash in our pockets or under our mattresses. The production task is immense. For instance, are there enough printing presses; is there enough paper stock; where are the bills stored until needed?
Certainly, central banks must take whatever measures are appropriate to defend their currencies against emotionally driven crises such as this. Any increase of currency stocks to deal with Y2K concerns must be balanced against the inflationary impact, however.
The Bank of England seems to be preparing an exceptional £30 billion for possible circulation. The US dollar is appropriately attracting the most attention. There is talk of an additional $200 billion over the usual $500 billion in circulation. With an estimated half of its currency in circulation outside of its home country, what pressures will the greenback be subject to? And is $200 billion enough?
But it doesn’t have to be a major international currency to be worthy of Y2K consideration. Many other countries are less obvious, but still possible, candidates for disruption. It is impossible to know if a country is stockpiling enough currency for Y2K. There may be no discussion in the country’s news media. The central bankers may be reluctant to share this information.
Local senior bankers, on the other hand, may have a reasonable idea of what is being done. The operations side of banks may be able to provide some useful information to the front office. Responsible senior management will foster internal and trading partner discussions.
When it comes to Y2K, key information is typically so sparse that it is appropriate to fill in the gaps with guesses. One reasonable assumption might be that if a country’s government appears to be insufficiently attuned to dealing with the Year 2000 issues in general, it is unlikely to be taking steps to assure that adequate currency stocks are in circulation.
Even countries that are addicted to strong foreign currencies in domestic circulation are vulnerable. Take Russia, for example. The computer may not have replaced the abacus there yet, but it still plays a role in government and banking. And the reports out of Russia on Y2K are far from encouraging. Does any population understand commodity scarcity better than that of Russia? Should those consumers pick up a whiff of approaching currency shortages as a result of Y2K, there will be a spike in demand for both dollars and rubles.
It is doubtful that the Fed’s increased currency production was intended to anticipate Russian demand, as well. The logistics of getting significant volumes of incremental dollars into timely Russian circulation would be horrendous, so we can count that out.
Dollar shortages would exacerbate pressure on the ruble. Whilst it might be difficult to see economic conditions actually getting worse, a currency crunch in Russia could easily push things over the edge.
The Year 2000 may place some unusual demands on financial markets. Those who are the best prepared and have the best information should have an advantage.