Tag Archives: currency

Universal currency is not viable

A universal currency would not be viable and that the biggest issues with using such a currency is not purely political.

Matthew Hillebrand, a fellow classmate of mine, wrote a really interesting blog post today arguing for the use of a universal currency. In his post, he stated that the world would greatly benefit from the implementation of a global currency because the world would be economically united, and that a system similar to the United Nations and Eurozone could work as the governing body of this currency. Furthermore, he stated that the biggest challenge to this system is political. However, I would like to argue that a universal currency would not be viable and that the biggest issues with using such a currency is not just political.

One of the biggest disadvantages from the use a global currency is in fact, the unification of our monetary systems. To implement a universal currency, we would first have to establish a fair entity that oversees the creation and regulation of the currency. The key difficulty with such an entity lies in the word “fair”. It is difficult to determine what country would hold how much power within this organization. Matthew argues that we should have countries with large economies hold permanent decision power while smaller economies will rotate. This would not only be unfair to the small economies but would incite backlash from many of them; then they certainly would not willingly adopt the currency. But if every country in the world held equal power within the organization, that would not be fair the large economies either.

If we somehow overcame these differences and created a fair regulatory body for the currency, to adopt a single global currency means for every country in the world to relinquish the ability to conduct their own monetary policy. A country would no long be able to attract investment through interest rate manipulation. There would be no foreign exchange tools for boosting one’s export potential. There would also be nothing to control the flow of capital in and out of a country. Perhaps the governing entity of the universal currency would intervene to assist certain countries in certain situations, but in doing so would undermine its impartiality. Because most actions to moderate the flow of capital leads to winners and losers, it would always undermine the organization’s “fairness”.

Another big problem that arises with the unification of our monetary systems is that economic crises from one country would have a much greater impact on other countries. This is a story we are all too familiar with in Europe. European countries with bad financial reputations have been scrutinized by their neighbors and have made headlines over and over since the adoption of the Euro; Greece has for years been painted by media as a ticking time bomb for the Eurozone (Washington Post). If we had a global currency, how many ticking time bombs would we have?

All of the above problems would give incentives for countries to either kick financially unstable countries from the currency zone, or voluntarily leave to regain power over a domestic currency. It is not only difficult to implement a universal currency, it is also extremely easy for the system to fall apart. For such a currency to work, our world would have to first be run under a single utopian government.

 

Ukraine needs Money, not Guns

Foreign officials met Saturday at the Munich Security Conference to discuss possible diplomatic solutions to the re-emerging crisis in Ukraine, where fighting has erupted on the eastern Ukrainian border, leading to nine dead in the past 24 hours.  Per the Wall Street Journal, German Chancellor Angela Merkel has been in staunch opposition of U.S. lawmakers, who wish to bolster the Ukrainian armory with weapons with which to defend the country’s borders from Russian-backed separatists.  Merkel was quoted as saying “This cannot be won militarily.  That is the bitter truth.  The international community must think of something else.”  While I disagree with the sentiment that it is unfortunate that the situation necessitates diplomatic responses beyond wielding the biggest club, the international discussions about the situation are completely missing a crucial issue.  The Ukrainian currency has tanked all of the sudden, dropping 50% against the dollar in just the past two days, as reported by the Washington Post.  The drop is the product of the nation’s conflict with Russia, its biggest trade partner, which is facing its own economic issues that ripple down to Ukraine.

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The lack of discussion between international officials about the state of Ukraine’s economy is somewhat troubling – policymakers are too preoccupied with the clashes on Ukraine’s border, which may not have an immediate diplomatic solution, while Ukraine’s economy is desperate for some form of stimulus.  The country’s reserves are dwindling in correlation with the currency’s decline, leading to a dire situation where Ukraine may have to resort to defaulting on its debt if some sort of economic relief does not occur.  The Ukrainian government was in discussions with the IMF two and a half weeks ago about a $15 billion bailout package, per Reuters, which would help the country meet its public funding and debt obligations in the short term, so as to avoid any debt restructuring.  This is a more pressing issue than shoring up the Ukrainian military, where a few extra tanks or UAVs may not have any real impact, and yet the conversations about a stimulus package seem to have died down for the time being.  One of the worst case scenarios here (excluding all out warfare between Ukraine and Russia, which seems very unlikely) is one where Ukraine is thrown into a deep depression yet is dependent on Russia in its recovery.  Ukraine’s economy is overly reliant on Russia, namely for meeting its energy consumption needs, and if a depression is sparked (especially one that includes a debt default) while diplomatic agreements with Russia collapse, it could be years before the nation is able to restore economic stability.  The international community should focus on providing Ukraine with the funds it needs to meet its obligations to avoid crisis in the short run, while establishing foreign exchange programs that help compensate the country for any loss of trade channels with Russia.  There is no reason that work cannot begin on such economic-focused measures while foreign heads of state try to reach an agreement on political-based approaches.

 

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Penny for Your Thoughts

The decision of wether to keep the penny as a unit of American currency is becoming an increasingly hot topic. The debate has even been brought before congress, twice, but neither of the bills, advocating the elimination of the penny, were approved. Even President Obama has stated his willingness to abolish the penny on February 15th, 2013.  Saying,”Anytime we are spending money on something people do not use, its something that we should change.”

The first argument against the penny is that pennies actually cost more to make than they are worth. According to the US mint’s 2013 annual report, every penny cost 1.8 cents to make. Granted, the total cost of minting pennies was only $58 million last year, less than one-tenth of a percent of total federal spending, but groups like Citizens to Retire the U.S. Penny have long been making the economic case for getting rid of the penny. Even the U.S. military has already decided they’re essentially useless with Army and Air Force Exchange Service stores on bases rounding all cash purchases up or down to the nearest nickel.

When looking at the costs and benefits in aggregated terms, there have been studies that have shown that the penny results in an annual loss of $900 million in the US economy each year. How did they come by this number? The economist Robert Whaples stated that every cash transaction that involves pennies takes two extra seconds because people are fishing them out of their purses and pockets.  He and others have stated that aggregated, these two second delays add up to a loss of productivity and opportunity cost of use worth $900 million to $1 billion dollars. He also argues that eliminating the penny could make people keen on using $1 coins, which would save the US an additional $500 million a year because coins are more durable than bills which are torn and lost easily.

The second most compelling argument is that penny’s these days have limited utility, not being accepted at many parking meters or vending machines. Economist Greg Mankiw says that “The purpose of the monetary system is to facilitate exchange, but… the penny no longer serves that purpose.”  There has never been a coin in circulation in the US worth as little as a penny is today.

    Taking into account the arguments of those in support of abolishing the penny, which tend to focus on statistics of aggregated costs, it will not happen.  Popular support for the penny is still high, at 67%. In addition, Keynesian idea of “menu costs” is something that has not been researched fully.  If the abolitionists want the penny to be taken down, they will have to approach it from the stand point that we should limit all of our physical currency monetary transactions and switch to e-currency.

China Latest Country to Devalue Currency

The People’s Bank of China is doing all it can to help quell concerns about the rate of growth in China finally slowing. After achieving miraculous growth for years and as Jake Spring and Xiaoyi Shao write in their article, China’s growth slowest since global crisis, annual target at risk, “China grew at its slowest pace since the global financial crisis in the September quarter and risks missing its official target for the first time in 15 years, adding to concerns the world’s second-largest economy is becoming a drag on global growth.” This article was writing back in October of 2014, but the implications from this slow growth are being addressed today. China has been used to such incredible growth year over year that they have prepared for this type of growth in their industrial capacity. With China finally slowing down, they are going to have vast amounts of factories either not working at all, or working at significantly reduced capabilities. This will also draw down on the potential for companies to expand their businesses in China (an already extremely tough task to do!) As Anjani Trivedi wrote in his Wall Street Journal Article, China Nudges Yuan to 7-Month Low, The People’s Bank of China set the morning reference rate-which typically sets the daily direction- weaker, with traders in Asia then pushing the yuan down to 6.2537 to the dollar, the closest it has ever been to the weak side of its 2% daily trading band.” This devaluing of the currency is an attempt to increase the exports that have been decreasing and increase inflation that has been getting perilously close to deflation. This may seem like a good move on the People’s Bank of China’s part, but they must be concerned into getting into a devaluing race in which all countries lose. This is explained very well in Anjani’s article, “Many central bankers have resorted to letting their currencies fall against those of their trading partners. In the short term, weakening a currency helps exporters by making their goods more competitive in foreign markets. But currency depreciation also raises the risk of a tit-for-tat “race for the bottom” as trading partners seek to outdo one another, only to find gains are limited.” This should be a major concern for countries whose sole reason for devaluing their currency is to try and gain a market advantage and increase net exports. These countries better watch out, as it seems a new countries Central Bank is devaluing a new currency every week!

Has no one told Russia the cold war ended?

If you have been paying attention to the news lately, or even if you haven’t, you have probably heard about plummeting oil prices worldwide. Crude oil, which reached $100 a barrel less than a year ago, has now dropped as low as roughly $45 a barrel (The Wall Street Journal, Market Data Center). Everyday Americans view this as a great thing. I mean who doesn’t like cheap gasoline at the pump. For countries whose economy largely depends on exporting oil, however, this is a very bad thing.

One nation that has been hit extremely hard by falling oil prices is Russia.

“Heavily dependent on oil exports that are priced in U.S. dollars, Russia faces mounting pressure from U.S. and European officials over the unrest in eastern Ukraine. On Saturday, U.S. and European leaders threatened new sanctions against Moscow” (Albanese, Armental, 2015).

Russia is learning that their economy may have one huge fatal flaw, if they already didn’t know. Depending too heavily on one single commodity, crude oil, opens up their economy to extreme volatility. If the value of crude oil falls significantly, which is happening currently primarily due to increased global supply, the value of their entire economy also falls significantly. This openness to extreme volatility is exactly what is crippling the Russian economy currently. This is reflected by the falling price of the Ruble, Russia’s currency. However, this is just one of the issues that Russia is facing.

“The ruble, which has been in a free fall amid slumping oil prices and geopolitical unrest in the region, was trading at about 68 rubles to the dollar Monday, compared with about 35 rubles a year ago” (Albanese, Armental, 2015).

This “geopolitical unrest” that the above quotation is referring to is the conflict in Ukraine that has been going on for some time now.

“A surge in fighting in eastern Ukraine, which killed about 30 civilians in the Kiev-controlled town of Mariupol over the weekend, prompted U.S. and European leaders to threaten new sanctions against Moscow” (Albanese, Ostroukh, Armental, 2015).

“The sanctions, which cut off Russian banks and companies from global capital markets, are widely expected to push the commodity-dependent economy into contraction for the first time since 2009” (Albanese, Ostroukh, Armental, 2015).

If the falling global price of crude oil is not enough to sink the oil dependent Russian economy, facing sanctions and being cut off from global markets should just about do it. Changes need to be made, if Russia wants to remain a global player long term. Now don’t get me wrong, Russia is still one of the world’s most powerful nations that cannot be ignored. However, it seems that all of Russia would benefit, if Putin and Medvedev took a step back and reevaluated their cold-war-esque foreign policy, and drastically restructured their economy to keep up with the changing times. No more, it seems, that a nation can rely on natural resources alone to create a prosperous economy. No more are the days that a nation can invade another nation, and not expect serious backlash from the global community.

Sources

http://online.wsj.com/mdc/public/page/mdc_commodities.html?refresh=on

http://www.wsj.com/articles/s-p-downgrades-russia-foreign-currency-rating-to-junk-1422297409?mod=WSJ_hp_LEFTWhatsNewsCollection

http://www.wsj.com/articles/fears-of-fresh-sanctions-hit-russian-ruble-1422268436

Weakened Euro

The Euro has been depreciating relative to almost all other currencies for a while now. The euro used to be able to buy ~1.40 American Dollars, but now has fallen to just 1.11 US Dollars. This has caused mixed opinions on whether this is a good thing for the Eurozone currently. This depreciating of the currency will bring many benefits to the members of the Eurozone and help get their economy, which has been struggling the most out of all major developed countries following the Great Recession of 2008. This will be done by the influx of demand for now cheap European goods. Consumers from all over the world will flock to the Eurozone as goods produced there have become much cheaper. A simple example of why consumers will flock to European goods is: imagine that France produces widgets. France’s widget costs 100 euros. As late as one year ago, this widget would have cost an American $140. This is because to buy a widget, an American must first exchange his American dollars for European euros. The exchange rate was ~1 euro=1.4 U.S dollars. Today though this same consumer can purchase this widget for only $111. This will cause a lot more consumers to demand these widgets and able to afford them! As Tommy Stubbington wrote in his Wall Street Journal article, Parity Rumblings Emerge Over Euro, “”The euro area stands to be a winner of the currency wars in 2015,” said Jonathan Baltora, inflation linked bonds fund manager at AXA Investment Management, which oversees 607 billion euros of assets, referring to the possibility that a weaker currency would make European goods cheaper than those produced in Japan and elsewhere.” This is precisely what is going to happen, and what Europe NEEDS to happen to finally get out of this period of virtually no economic growth lately. The European Central Bank knows this and that is why (or atleast part of the reason why) the ECB announced a quantitative easing plan of bond buybacks. As Joseph Adinolfi writes in his article, Euro Records Largest Weekly Loss Since Septemeber 2011, “BK Asset Management’s Boris Schlossberg rhetorically asked if eurozone quantitative easing was intended to drive the euro even lower, arguing that ECB Executive Board member Bernard Coeure admitted as much during an appearance from Davos, Switzerland that was broadcast on CNBC Friday. “Taken from that perspective the ECBs actions make perfect sense,” Schlossberg said in a Friday morning research note. “The QE announcement has shaved another 300 points off the EUR/USD exchange rate and the pair is now fully 20% lower than just nine months ago.”” This will hopefully give the entire Eurozone the economic boost it needs to get back on track as an economic heavyweight!

CURRENCY WARS, THE RACE TO THE BOTTOM, AND WHY YOU SHOULD CARE

I have always been interested in international markets, which is one of the reasons I started studying economics at the University of Michigan. It is an extremely complex and dynamic issue, something that I still struggle to fully grasp, with many players involved, primarily central banks. The intent of the post is to shed some light on the role of central banks, why currency rates matter, and what it means for the everyday person like the reader, and myself, basically people without a Ph.D. in economics or finance.

It may seem like what is happening half way around the world in some bank doesn’t affect the day-to-day life of Americans but that is far from the truth. If you haven’t noticed it already start paying attention, but it seems that every clothing label, and nearly every product in the United States today has “Made in China” printed on it somewhere. But, why is that you may ask? To put it simply, it is because Chinese currency is cheap, making Chinese exports cheap, so we buy those goods.

The idea of a cheap currency seems bad intuitively, anything with the word “cheap” in it typically does. Luckily, Jacob Goldstein from NPR can shed some light on this issue of why a cheap currency is not necessarily a bad thing.

“… There’s a big upside to a weak dollar: It makes U.S. exports cheaper, which encourages people and businesses around the world to buy more of our stuff. Increasing exports is key to increasing U.S. economic growth without relying too heavily on domestic consumer spending” (Goldstein, 2011).

Although this quote is from the perspective of the United States Dollar the same logic applies if you were looking at it from the perspective of China, and the Chinese Yuan. When China maintains a weak Yuan, the goods they are producing and selling abroad appear very cheap. This allows companies in China to reach a new consumer base, which is why so many things in the U.S. seem to be made there. They can then rely on this new revenue stream to pay newly hired employees and increase production levels for the foreseeable future.

Now that you have learned that a weak currency can play a positive role in a nation’s economy, you might be thinking that every nation should deflate its currency. Well, that is actually what many places are doing, specifically in Europe, as a way of providing a feeling of economic security domestically, although there are some negative consequences.

“Denmark on Monday became the latest European country to cut its interest rates as it attempted to dampen investor interest in the Danish krone ahead of the European Central Bank’s policy meeting on Thursday” (Duxbury, Cox, 2015).

“Nationalbank’s main policy role is to maintain the stability of Denmark’s currency against the euro to provide stability for the nation’s exporters and keep inflation low and stable” (Duxbury, Cox, 2015).

An issue with Denmark devaluing their currency, or anyone for that matter, is other countries may try to do the same in order to counteract Denmark’s policy and maintain a stable economy at home.

“Neil Mellor, a strategist at BNY Mellon in London noted Sweden’s Riksbank talk about unconventional measures and also said he wouldn’t be surprised if Norway’s central bank, Norges Bank, is pressured into acting too” (Duxbury, Cox, 2015).

With the risk of at home inflation due to currency devaluation, it clearly is not the best action if nations engage in competitive policy to devalue their respective currencies.

“Devaluation can lead to a reduction in citizens’ standard of living as their purchasing power is reduced both when they buy imports and when they travel abroad” (Wikipedia.org, 2015).

Although I have painted a weakening currency in primarily a positive light, that is not always the case. A downward spiral of a nation’s citizens’ standard of living is a never a good thing, especially from the perspective of individual citizens. These negatives can become severe, especially if the battle between nations to weaken their currencies spirals out of control. Hopefully you have come away from this post with a greater interest for and understanding of international monetary policy, and how it affects the lives of every individual, even ones on the opposite side of the globe. Next time you are in the market for a low cost good, and it happens to be from China, you will understand why that is the case.

Sources

Duxbury, Charles, and Josie Cox. “Denmark Central Bank Cuts Rates.” WSJ. The Wall Street Journal, 19 Jan. 2015. Web. 19 Jan. 2015.

http://www.wsj.com/articles/denmark-central-bank-cuts-interest-rates-1421682943?KEYWORDS=interest+rates

Goldstein, Jacob. “The Upside Of A Weak Dollar.” NPR. NPR, 29 Apr. 2011. Web. 19 Jan. 2015.

http://www.npr.org/blogs/money/2011/04/30/135809696/the-upside-of-a-weak-dollar

Wikipedia contributors. “Currency war.” Wikipedia, The Free Encyclopedia. Wikipedia, The Free Encyclopedia, 18 Jan. 2015. Web. 20 Jan. 2015.

http://en.wikipedia.org/wiki/Currency_war#Reasons_for_intentional_devaluation

Hong Kong dollar as a mirror image of the Swiss franc

After the SNB dropped its minimum exchange rate, an interesting comparison between the Swiss franc and Hong Kong dollar is discussed. Paul Krugman introduced this comparison in his recent blog post, mainly to depict how similar Swiss minimum exchange rate policy and Hong Kong’s currency board are, except for institutional setups and history of the system. If this is the case, it might be a good reason to worry about stability of Hong Kong dollar since these two countries used very similar mechanism. Krugman, however, further argues that “no chorus demanding the peg that the peg be abandoned” in Honk Kong because of “hard-money ideologues” which Hong Kong has and Switzerland did not.

On the other hand, the recent article by the WSJ focuses on difference between two countries, as the title of the article “Hong Kong Dollar Peg Doesn’t Fit in Swiss Hole” suggests. While the article also pointed out institutional difference just as Krugman does, it further says that Switzerland and Hong Kong are facing opposite pressure in terms of capital flow, which should lead the opposite implications for the currency management. Specifically, while the SNB probably worried about huge capital inflow comes in the country given widely expected the ECB’s QE and Greek election, Hong Kong would face pressure of capital outflow (thus devaluation pressure on the currency), since the Fed is widely expected to raise its interest rate later this year. And in terms of whether Hong Kong could drop its currency peg, the article insists it’s unlikely since Hong Kong has a long history of defending its currency board system even when other Asian currencies collapsed during the Asian financial crisis in 1998.

On similarity vs. difference discussion, I would rather agree with the WSJ’s argument especially because “the direction of capital flow” matters under their policy mechanism. In theory, while central bank can depreciate its own currency indefinitely by printing money to buy foreign currency, the opposite is not true if central bank used up all foreign reserves. In this sense, we could say Hong Kong dollar is a mirror image of what the Swiss franc was used to be, with severer restriction in maintaining currency peg.

So what about potential instability of the Hong Kong dollar? I’m not confident enough to say it won’t happen. In terms of institutional setup and history of currency peg in Hong Kong, we have to remind how the Gold Standard was abandoned after the Great Depression happened. Although the Gold Standard had been believed as the best policy to maintain currency stability, all major countries eventually gave up their currency peg to restore domestic economy. Thus, we cannot exclude possibility that Hong Kong will follow this case. What’s more, although the WSJ article argues that Hong Kong is unlikely to abandon the policy that has anchored the financial system for decades given the recent political instability, I would say the political instability might be an incentive for policymakers to give up its currency board, since people might not accept sharp economic slump driven by currency defending policy which was implemented during the Asian financial crisis.

Pros and Cons of US Currency’s Rise

4(http://dailyreckoning.com/why-a-strong-u-s-dollar-is-a-commodity-killer/)

Dollar has risen in a steady rate in these days. Many experts hold a positive view that dollar will keep mighty in the near future at least. US citizens are more confident when they found the money in their account becomes more and more valued. However, currency is always a thing with both pros and cons.

Avon Products Inc., which books 88% of its sales outside the U.S., can’t raise prices on its makeup and wrinkle creams fast enough to offset the dollar’s rise against the Brazilian real and other currencies. The suddenly stiffer price of a U.S. holiday means fewer foreign travelers booking hotels through Expedia Inc. ’s travel websites. European rivals to consumer-products makers like Procter & Gamble Co. now have an advantage in price wars for market share in the U.S. And utilities and steelmakers in Europe and Asia may buy less U.S. coal to fire their furnaces.”(http://www.wsj.com/articles/dollars-rise-squeezes-u-s-firms-1421800346This might be a example with sorts of extreme but what cannot be denied is that some US companies do get hurt by dollar’s rise. US has most GDP for dozens of years but it also has trade deficit for a long time, which is always been considered as a negative signal for development. “The US imports commodities and merchandise from over 240 distinct geographic markets. Inbound shipments may be headed for US consumer markets or moving along global supply lines that crisscross national borders. The US is the world’s third-ranked (after the EU and China) exporter/importer of intermediate goods. By value, the US takes the largest share of global imports overall.”(http://www.datamyne.com/us-import-data/?utm_source=google&utm_medium=cpc&utm_term=us+imports&utm_content=US+Imports&utm_campaign=Datamyne-+US+Import/Export+Trade+Data&gclid=CKnys8umpMMCFYRFaQodY08AWQ)If we just put our view on import, then we should be happy for the US importers. Consumers can buy thousands of stuffs with a relatively lower price than before. And firms who depend a lot on importing goods can lower their marginal cost to be more competitive. But things are not so optimistic for us if we perceive this issue in another perspective—export.

Basically, export is the essential fuel to push the economy moving forward, especially for a big country with a huge amount of population. China is an exemplary country who made a surge of economy by exporting manufactures, including apparels, toys, food and so on. Though we have to say that US really did a good job to keep a high GDP (may be attributed by high level of income), with trade deficit, expanding export is still another benefit if it is not indispensable, to say the least. Therefore, US should be eager to find an eclectic point to regulate its currency for further progress of the economy.

Bitcoin Success It’s Own Worst Enemy

The price of a bitcoin has been extremely volatile as of late, with it dropping 44% since the start of the year. That’s right, bitcoin has dropped 44% since January 1st, 2015. That is in fact TWO WEEKS, the value of this currency has dropped from $316.23 to the price of $177.63 on January 13th. This volatility and steep decline of bitcoin’s price has been due largely to bitcoin’s own success. The way bitcoin works, as described by Sweden Boden in his article The Magic of Mining is that bitcoin ‘miners’ have machines that “try to solve fiendishly difficult mathematical puzzles. The solutions are, in themselves, unimportant. Yet by solving the puzzles, the computers earn their owners a reward in bitcoin, a digital “cryptocurrency”. As the price of bitcoin has rose to its peak of $834.03 back on January 15th, 2014, more and more people became bitcoin “miners” using data processers to solve these complex math problems which has raised the overall supply of bitcoins to over $3.8 billion worth in circulation. This rise in supply has driven down the price of bitcoins by oversupplying the market.

 

Michael Casey talks about in his article, Bitcoin’s Plunge Bites ‘Miners, “The people who most believed in the long-term value of bitcoin holdings are the people who got hurt the most… the price decline is causing turmoil for bitcoin ‘miners’.” These miners are the biggest supporters of bitcoin and believe so much in it that they devote cast resources solely to mining for more coins to earn money. This has created more and more miners creating more and more bitcoins in the market. As the demand for bitcoins hasn’t risen to compensate for this increase in supply, the price of bitcoins has to drop. There have been so many new bitcoin miners that, “the financial challenge has been made more acute by increasingly tough competition to earn bitcoin, the result of a 30-fold increase in the computer firepower being deployed by miners.” . This graph demonstrates what happens when you increase the supply. It drives both the price and quantity down. The only way that the price of bitcoins will go back to making it financially viable to mine for them is if enough people stop their mining efforts. The supply has to decrease in order to raise the price of bitcoins again. This is how bitcoins success has lead to its own demise and caused its biggest supporters to lose the most.