A week ago Janet Yellen, Chair of the Federal Reserve System of the United States, announced that the Federal Reserve had increased its federal funds rate by 25 base points, after seven years at zero.
As soon as the news was out, international stock exchanges saw significantly increased trading, whereas the price of gold reached its six year low at 1,050 USD an ounce.
However, Mongolbank has had its interest rates at 13 percent for a year. The United States has an economy as large as 18 billion USD and accounts for one fifth of global GDP. So, how does a difference of 25 base points in the federal funds rate affect a small, 10 billion USD economy, such as Mongolia?
THE FEDERAL RESERVE SYSTEM AND ITS CHAIR
The Federal Reserve System, also known as the Fed, was set up in 1913 after the enactment of the Federal Reserve Act. The Fed is the central bank of the United States, and is responsible for supervising and regulating commercial banks, and overseeing the monetary policy,
The fifty states of the United States are divided into 12 districts, each of which has its own reserve bank. Commercial banks are supposed to become a member of the district reserve banks and purchase stock.
Every district reserve bank has the right to buy and sell government securities. In order to operate in all states, a commercial bank has to be a member of the Fed.
Every district reserve bank has nine directors, six of which are represented by member banks and businesses, with the rest being appointed by the Board of Governors of the Fed. The Board of Governors implements the monetary policy of the Fed through district reserve banks.
The Board of Governors has seven members serving a 14 year term, appointed by the President of the United States and ratified by the Senate. The President of the United States appoints the chair of the board, with a four year extension. Once a director is appointed the chair, they lose their voting right.
The objective of the United States monetary policy is to eradicate unemployment, keep prices stable, and minimise inflation. Besides supervising the operations of commercial banks, the Fed used to set the maximum savings rate until 1986. Today the Fed has a mechanism of loan control where they set the maximum amount of securities purchase with capital not borrowed from others.
The Fed uses three tools when implementing its monetary policy. They include setting the necessary amount of funds that depository institutions must hold in reserve, setting the discount rate, and the federal funds rate.
The third tool is to take part in the Federal Open Market committee, which is also chaired by the Chair of the Federal Reserve System. The main goal of this committee is to increase employment rate, support economic growth and price stability, and ensure stability of the financial market, loan interest rates, and currency exchange rates.
MONGOLBANK AND ITS CHAIR
The main objective of Mongolia’s monetary policy is to make sure that prices are stable. In other words, it means keeping the inflation rate at a minimum. But the objectives do not include macroeconomic goals such as reducing unemployment rates, as the Fed does. The Law of Mongolia on the Central Bank states that the President of Mongolbank is to be appointed by Parliament to serve a six year term, with a recommendation from the Speaker of Parliament. The President of Mongolbank also has a council to advise them on matters that are in the president’s portfolio. The President of Mongolbank makes the final call on the formation of the council and its operational procedures.
The Council of Monetary Policy, for example, has twelve members. They include the President of Mongolbank and eleven other members, six of which are internals (seven if you count the president of the bank) such as the Deputy President of Mongolbank and department directors, and five externals including the Deputy Finance Minister, representatives from senior management of universities, and scholars.
According to the law, Mongolbank is an organisation dependent on the decision of a single person. Therefore, the person who makes the final decisions has to be held accountable for everything.
The decision coming from the President of Mongolbank directly affects the economy. N.Zoljargal, President of Mongolbank, and N.Altankhuyag, then Prime Minister of Mongolia, signed the Memorandum of Understanding to cooperate on the price stabilisation program in October 2012, and initiated the program to create a stable system for financing in April 2013.
In order to implement these programs, they have printed 3.8 billion MNT so far and injected the money into the market. The fact that the prices of goods and services should be set by the market for its long term benefits, rather than by the government, has been ignored by the governments that have had the ruling power in Mongolia. The reality today is that everything that has been done under the name of setting, or stabilizing, prices ends up leading to an economic decline.
Mongolbank is supposed to be the institution that makes the strongest demands that the government should not set prices, and ensures its independence from them. On the contrary, Mongolbank has initiated those price-restricting policies and worked together with the government. An example of what happens is that the housing prices have increased twofold and disrupted the interconnection between demand and supply.
Today Ulaanbaatar has 40,000 empty apartments and 17,000 households living in the ger district, carrying their water, and using wooden toilets. Soon the commercial banks that funded construction companies will have to take ownership of the apartment blocks they have built. When the constitutional court allowed people to rent out the apartments they were using as collateral, commercial banks stopped providing the eight percent housing loans.
It proves that loans twice as cheap as the market rates cannot keep going for eternity. It means that the government can no longer make up for the deficits by acquiring loans.
The federal funds rate from the Federal Reserve System of the United States will affect every open economy. For instance, it affects the banks that are about to invest 4.4 billion USD into the largest project in Mongolia, on their decisions around when to transfer and what interest rates to use.
LIBOR has already increased by almost a unit. Stronger USD results in weaker currencies around the world, which affect the livelihood of everyone to some extent.
If Mongolbank truly targets inflation, it is time for them to reduce their interest rates immediately. Mongolia currently has an inflation of approximately three percent. Isn’t it time they decreased their interest rate to a single-digit number at least? If it happens, commercial banks will also lower their interest rates, forcing them to urgently resume granting loans.
However, despite what recommendations might come from the Council of Monetary Policy, it is all up to the President of Mongolbank – the King of Money – who will make the final decision.
2015.12.23