Watching the Russian budget for 2022-2024 and surrounding political decisions coalesce in recent weeks amid the current escalation of coercive diplomacy regarding Ukraine has cut an interesting contrast – and underlying discursive similarity – with much of the US political agenda now being debated. One can deduce the fortress mentality that has taken root among Russian policy and decision-makers in a manner largely divorced from the economic lessons the world has gleaned and is still gleaning from the COVID shock and the long shadow of the Global Financial Crisis. If their intention is to hoard money because of some mechanical relationship between currency reserves, budget surpluses, and the ability to finance "rebuilding" in a post-COVID world, their revealed preference is a profoundly stupid one. The leadership are opting for deflation on the basis of what could come tomorrow, and in the process building the same tomorrow they think is coming about as a result of external forces and trends. I've written elsewhere for Riddle about the risk of deflation in 2022, but that only describes the economic illogic of the Central Bank's approach to key rate policy. There's a deeper institutional ill-logic that runs through the course of policy at the moment that is attempting to deploy available existing tools and develop new ones to manage the Kremlin's deflationary regime and future succession risks.
This preference for deflation recalls the "deflationary bloc" outlined by Yakov Feygin in a fantastic essay for Phenomenal World building on the insights of Hyman Minsky and Albert Hirschman as applied to US politics. Few organizational heuristic devices intended to create categories of winners and losers or else catalogue the correlation of political interests and revealed policy preferences with voters and lobbies of various sorts can compete with the insights derived by asking yourself who benefits from inflation and who benefits from deflation. That requires some specification on what the boundaries of that problem are – breaking 2% inflation in the US to achieve more equitable growth differs significantly from breaking 4% inflation in the Russian context – but it's as simultaneously simple and nuanced a means of determining whose side institutions, individual players, and lobbies are on as anything else I've ever come across.
That so few observers and analysts of Russian politics and foreign policy engage with explicitly economic or otherwise materialist frameworks when offering analyses may sometimes be born out of simple unawareness. Few engaged in the tiresome policy work of producing net assessments or templates for US or European policymakers on how to understand and engage the motivations, aims, and strategies behind Russia's foreign policy choices are looking to apply the lessons of dead economists or the COVID shock to their priors for the simple reason that it's not often "digestible" or particularly useful for resolving any given issue. Sometimes it's born out of a rather strange disinterest. Many Russianists seem content to accept that whatever Russia's liberal economists or regime economic establishment suggest is true of their policy choices is, within reason, true or at least couched in an appropriate framework. This deference creates considerably skewed analysis that gets bogged down in the political contexts of decline vs. stagnation and other theses that unhelpfully establish camps who then fight for policy legitimacy. Yet the fact that the regime is clinging so intensely to shoring up and reshaping its own deflationary bloc of support speaks volumes about its perceived power, threats, and capacity to compete globally at a time when economies are entering a period of technical transition, evolution, and adaptation to climate change, decarbonization, and an increasingly politicized international trade system on top of a massive collective shock leading to huge leaps in excess mortality and much suffering.
Oddly enough, though Lenin's (in)famous line that "the best way to destroy the capitalist system is to debauch the currency" was derived from an interview he gave to a New York paper in London in 1919, it was Keynes picking up the significance of the statement in The Economic Consequences of the Peace that gave it life for western audiences. Needless to say that today's economic managers and the current panic over inflation do not engage with Keynes' work or the tradition he gave birth to in policy terms. But that also makes a great deal of sense from their perspective. Price stability is a political imperative for the state's survival in their schema. The original sin of Russian state capitalism wasn't necessarily privatization as such, but that privatization came after price liberalization in a weak state during a period of high inflation. Inflation is perceived to be a political risk going back to Gorbachev's experience – the expansion of the money supply is not enough to trigger rampant price increases alone, but is a necessary condition to trigger political competition over resources between blocs of competing economic interests that then reinforces or even creates inflation across the economy. Minsky and Hirschman's relevant insights here are that inflation is primarily a phenomenon derived from activity in the real economy in a context where political groups, institutions, and interests compete. In other words, the demand for money to do something creates inflation, not the supply of money to do any one thing. After all, expansions of the money supply can't lead to analogous price increases between goods and services. Not all consumption can be substituted neatly. Some goods demand is much more inelastic than services and so on. As this demand shifts, so does the political constellation of interests behind said demand. Cycles of investment into supply also take time to adjust or are hostage to non-monetary forces. Droughts have nothing to do with interest rates and a copper mine or conventional oil field often take more than 5 years to be developed before they come to market. Producers are constantly engaged in a struggle to forecast demand as well.
Russia's painful memory of inflation reflects the collapse of state power and ability of economic agents, particularly the financial-industrial groups that arose post-collapse, to expand credit on their terms for a wide range of activity that was barely profitable or even loss-making without monetary discipline imposed by the state. Maximizing the state's capacity to control the expansion of credit money well as the money supply more generally was core to the reassertion of sovereignty in its various forms that has taken place since Putin's rise to power. Monetary sovereignty was just as important as the formalization of economic activity to raise revenues, military modernization, or the recentralization of political power in Moscow for the viability of the regime. The orthodoxy for an emerging market dictates that getting inflation under control is absolutely vital to prevent capital flight and outflows, both of which occur in Russia for reasons far more driven by the difficulties of doing business and wealthy Russians' desire to ensure the regime can't take their money than inflation alone. If the regime was to maintain its strong position negotiating the distribution of rents between interest groups and power over the expansion of credit, it had to safeguard the ruble within considerable political constraints – the flow of capital had been liberalized during and after the Soviet collapse as a matter of survival. Export earnings were desperately needed to get foreign currency rapidly appreciating in value in ruble-terms into the country to pay for imports of food and other basic goods. Elites rely on this relationship, earning foreign currency where they can or parking their oligopoly and monopolistic earnings in rubles abroad when they aren't buying property or politically useful firms in Russia.
One can trace the rise of Russia's monetary sovereignty in terms of the accumulation of reserves:
We can see that it's 2005-2006 – roughly same time that the regime had successfully de-dollarized most economic activity across the economy – when some semblance of monetary sovereignty emerges. We can also see just how much money was still available to spend coming out of the Financial Crisis that went untouched.
In the current environment, the decisions to cut medical spending, focus on increases in defense and security spending, and more recently rule out the use of any additional infusions of capital from the National Welfare Fund are mind-boggling. Look at Russia's excess mortality alone as a metric of insanity when it comes to priorities:
Between April 2020 and November 2021, nearly a million died above the pre-pandemic trend. Budget spending isn't the reason inflation's gone up in areas like construction. Physically getting labor to work is a problem without as many migrant laborers around and with so many working age Russians dying of COVID-related health complications. There has to be a productivity breakthrough to make up that gap if you want real wages and incomes to rise again, which means increasing investment levels across the economy. That therefore means generating more demand for the goods and services companies short on labor produce – people who are dead aren't earning as much or consuming as much. Commodity markets are their own factor as well. You'd think that there'd at least be some token increase in federal spending to address the health crisis, but instead they've re-strengthened fiscal federalism leaving large swathes of unfunded social mandates at the regional level and a clear preference to proclaim national goals largely divorced from funding realities.
Putin just signed a law granting the Central Bank the power to limit credit issuance to borrowers. For instance, the Central Bank could now decide that a bank can only issue a certain number of credit cards in relation to the volume of loans its extended. Controlling credit was foundational for the COVID stimulus response. Subsidizing mortgages juiced the housing market to keep the construction sector alive, but now faces up to the reality that homeowners that have already paid off their debts won't like higher levels of inflation so that said assets can steadily appreciate in value. These dynamics are only strengthening now that post-Crimea austerity has forced household borrowing to keep rising in order to maintain living standards. So if they aren't spending money on basic needs, aren't signaling any increase in public sector investment or spending to generate consumption, and are increasing the state's power to regulate private access to credit through the banking sector, what are they thinking?
There are three ways to look at the decision not to spend, all of which relate to the question of monetary sovereignty and institutional concerns for the regime:
- Cognizant that potential or else planned military action against Ukraine and/or elsewhere may incur more extreme sanctions, the aim is to hoard as much foreign currency as possible while maintaining budget surpluses so that future expansions of ruble-denominated borrowing from domestic lenders/investors don't incur significant costs
- If they increase spending during a period of sustained inflation largely driven by COVID-related disruptions, they're panicked it'll increase domestic inflation levels. The Ministry of Finance has communicated this view, which is another way of saying "we've run the economy so weak for so long, any increase in domestic demand is a risk"
- The succession problem hasn't been resolved and any change in economic policy undergirding a structural increase in spending levels could lead to a new wave of competition across the regions and in Moscow for various interest groups and priorities. The easiest way to quash that competition is to avoid spending in the first place, leaving everyone who wants more money equally dissatisifed and anyone sitting on large sources of rents happy
My point here is not so much to explore the relative hierarchy of concerns, but to show that deflation and the ensuing pain it inflicts on the public is woven into the fabric of the decision-making process throughout the political system. Yet the deflationary underpinnings of economic policy actually suggest that if security concerns truly trump all when it comes to Ukraine, the worst possible outcome for Moscow would be a commitment of ground forces to secure the Donbas. Setting aside the particulars – analysts like Rob Lee have done a great job Twittersplaining the long-range capabilities Russia possesses that could decimate Ukrainian positions in minutes without a large ground offensive – actually achieving that goal would be incredibly costly for political and economic reasons. I won't dive into considerations in Ukraine so much since I think they deserve their own separate hearing, but for Russia, the real reason sanctions are so damaging is the political response they incur from the regime. By refusing to spend money since 2014 to properly push the economy towards a consumption-led growth model, the result is instead a proliferating system of subsidies, trade controls, and tax policies intended to bolster import substitution and localization without addressing the issue of productive capacity and demand adequately. A SWIFT cutoff seems quite unlikely – payments for European imports of energy would be affected immediately, for instance – and there is only so much left to do effectively without truly multilateral cooperation. Something akin to seizing the foreign assets and property of Russian citizens identified as close to Putin would be more manageable and have a more significant political impact than anything left to sanction economically. There is of course the prospect of cutting off all foreign banks' access to primary markets for Russian OFZs, which would hurt but not be unmanageable. Most of the sovereign debt expansion since the pandemic started was borrowed through domestic state banks so it's reasonable to assume that could be weathered.
Russia's reached a dead end in its foreign policy aspirations because of Putin's political constraints at home. The economy is consigned to persistent underdevelopment and the inadequate provision of public goods like infrastructure, harming investment and raising the stakes for the energy transition now finally underway, if haltingly. Until a process is agreed or else individual successor chosen, the collective Putin can't afford to shower favor on any group on the odd chance they become too successful and dominate economic policymaking. This has always been the problem with the defense industrial complex and oil & gas/extractive sector going back to the late Soviet period, and while today's context differs greatly, that structure persists. Since demand is too weak, that leaves the sectors that have benefited from state largesse in its various guises since 2014 more dependent on the state creating a mutual process of policy capture that paralyzes decision-making. We can see that now playing out with the expanded crackdown on the internet and social media. As economic policy is paralyzed by competing priorities and forces domestically, the political space has come under stricter control and longer-run viability of foreign policy priorities come under threat. Refusing to spend and opting for deflation out of a misguided understanding of what's driven price increases across the Russian economy since 2020 will not, in fact, strengthen institutions to reduce the political risks of inflation. Instead, it'll recreate the problem in reverse. The relative scarcity of capital and access to credit will foster new types of competition that should worry observers given that the power vertical, insofar as there ever was truly one in place, appears to have hollowed out in recent years as Putin has retreated from domestic policy in many respects. Mishustin can't bail him out here.
When we ask what to do about Russia and Ukraine from a broadly western perspective, the implications of the deflationary bias and challenges facing the regime have to be taken into account. Negotiating is useful because Russian policy is stuck, Ukrainian leadership can't politically swallow ceding Donbas, and US policy towards Russia is similarly trapped by the domestic radicalization of policy as a result of the 2016 election. We should take more seriously the idea that the status quo no longer benefits Russia, which has led to a renewed use of coercive diplomacy and, in this case, potential preparation for an expanded conflict. I'm still skeptical that it will result in expanded military operations, but if it does, a tactical victory for Russia would swiftly become a strategic loss the longer the regime is unable to address the internal sclerosis shredding economic policy. Part of me wonders if the intention behind sitting on the National Welfare Fund is to make it a de facto institutional extension of the president's authority, and then allow Putin to manage it in some form if he were ever to formally leave the post of the presidency. But planning for a future – and betting that debt and spending will take down the United States – is a mug's game. Today is as great a problem as tomorrow and on economic grounds, they're getting it wrong. You have to spend money to make money and spend money to spend money well. Neither is happening. That makes the worst case scenario in Donbas a Pyrrhic victory for Moscow, not a devastating blow to US credibility.
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