MinFin

We all have that one friend who knows exactly how much the dollar will cost in a week, a month or in a year. And there is always another friend who also knows, but has a completely different story. Which of them do you trust? As some of you might know, I come from Ukraine. A country in Eastern Europe. A country that is going through a period of transition and change. But I am not going to touch the topic of political and economic instability in my home country. I want to talk about predictions. Predictions that people, who live in a country that is experiencing a period of uncertainty, are making. Prediction about prices, inflation and exchange rates. In the past years, people’s lives in Ukraine, in particular, became very much dependent on the cost of the dollar. When Ukraine experienced the first wave of gryvna (Ukrainian currency) depreciation, everyone in a country suddenly became experts and knew exactly how much currency to buy, how much to sell and when will be the best time to exchange it back.

«In reality, no one knows anything»

Let’s face it. In reality, no one knows anything. Professionals who work in the largest private companies and in governmental institutions, have a large amount of information and have tools for forecasting the exchange rate. They have financial models – in simpler terms, Excel sheets, in which they enter different figures such as interest rates, the volume of imports and exports, etc. Specific formulas consider all given numbers and the forecast is being based on that. Easy and simple. Although, how reliable are these predictions?

In quiet periods, the fundamental forecasts do not differ much from the current situation and therefore, are of a little interest. In the times of instability, however, no formula can take into account the whole diversity of life – every fundamental model has its own set of unpredictable factors. As a result, the forecasts turn out to be ad hoc and inaccurate. In such periods of uncertainty, one of the main questions that people face is whether to keep their saving in home currency or any other currency, for instance, dollars or euros. We, as future economists and financiers, know how it works – when we save money, we are interested in their safety and the ability to use money when necessary. Savings are usually stored in cash, in bank accounts or in deposits. If you store savings in the deposit, the bank will charge interest on it, the savings will grow. Because of inflation, today’s gryvna or dollar is almost never equal to tomorrow’s. Money is gradually depreciating, prices are rising. For a 1000 gryvnas 10 years ago, you could have bought groceries for the whole week, today – you will barely able to buy at least half of those products.

«What matters is the purchasing power, not the amount of money on your bank account»

As a result, the amount of money on your bank account is not important, what matter is what you can buy for this money in the future. The future purchasing power of gryvna is affected by two interrelated factors: the exchange rate and inflation. The exchange rate is important because Ukraine does not produce enough goods on its own. And what is being produced within a country, is still done on imported equipment and technologies. Thus, prices for almost any good, from an iPhone to sugar, depends on the cost dollar and euro. From this point of view, keeping your money in foreign currency is better: it keeps the purchasing power more stable. An iPhone is worth $ 700, and it will worth it in the future. Another issue, though, is that the majority of the population in Ukraine receives their salary in gryvnas, and $700 dollars today in gryvnas, will, most likely, cost less in the future.

Moreover, in addition to the exchange rate, there is one more factor influencing the relation between gryvna and dollar – the difference in interest rates. In the case of savings, this is the interest for which money can be placed in the deposit. Rates on gryvna deposits are traditionally higher than for foreign currency. This is not because the gryvna is so cool, but because of high inflation and general uncertainty in Ukraine. The contribution in gryvnas brings more profitability than in dollars. This is some sort of reward for supporting the home currency. Deposits in gryvnas are good when the dollar rate does not change. And when the gryvna rises in price (that is, the dollar costs less in gryvnas), then you find yourself in an even better position: not only  you have a higher percentage, but the currency becomes more valuable. The question that arises here is whether the interest received at a high gryvna rate compensates for the losses from the devaluation of the currency? There is no clear answer to this question, and after all, it depends which time interval is compared. For instance, when gryvna depreciated from 8 gryvnas to almost 30 gryvnas per $1 in 2015, it was more profitable to keep your savings in dollars because of the amount in gryvnas. Originally equivalent to $ 1000, turned into $ 869, and $ 1000 turned into $ 1150. Two things can be concluded. First of all, in short term, the dollar does not always provide a winning situation. And secondly, dollar gives greater stability in the long term.  Over the last 5 years, a thousand dollars turned into a thousand and a little and the equivalent in gryvnas turned into less than a thousand. The reason for that is a drastic devaluation in 2013-2015.

Lesson learned?

What are the lessons that Ukrainian people should have learned over the past couple of years? Firstly, and most importantly, there is no simple and accurate answer to how much the dollar will cost in the future. Even the most logical and stable model of predictions cannot take into account sudden shocks and unexpected changes. Secondly, a gryvna today involves risk but possible profit. A dollar today – is stability. Savings imply stability, investments require some risk, speculation is a concentrated risk. If you want to risk in the hope of getting a quick profit, choose for the gryvna. If you want to invest for a long time – rather, the dollar. Have Ukrainians learned their lessons? Well, this is a whole different topic for debate.