Top of the Pops
As much as I'd like to have a hot take on Putin and Belarus now that he's told Lukashenka to start a dialogue with the opposition, there isn't much there to unpack I think. First, clearly Moscow is fed up with the escalation cause it's a diplomatic headache, nets them nothing politically, and Merkel has already folded and ensured it will be an issue in German politics. Second, Moscow's experience managing its relationship with successive governments in Armenia has likely taught it valuable lessons in maintaining continuity despite a formal change in government. His speech laying out Russia's desire to security guarantees and establishing red lines seems straightforward insofar as the military buildup around Ukraine clearly has a diplomatic intent even if it's also creating potential for an operation and nothing he said was really new, aside from clearly articulating a willingness to keep upping the pressure. The much bigger but less concrete development right now is taking place in Washington as we watch the US House of Representatives stumble into passing their version of the Build Back Better act and await the fresh hell Senator Joe Manchin and his more conservative colleagues will spring on the bill once it reaches the senate. At stake is about $550 billion in spending on climate initiatives and investments and, in one salient case, additional tax credits for union-made electric vehicles. Biden's set a target of 50% of vehicle sales share for electric vehicles of all stripes by 2030. A hard US commitment to spend on electric vehicles is of massive significance for oil markets, even if it takes at least 3-4 years to feel even marginal effects:
Building EVs doesn't magically kill oil demand. Petroleum products are used at every stage of production. What do you think your dashboard is made of? Even asphalt is made from an oil product. It does, however, allow for reductions in end demand worth millions of barrels per day while other stuff gets sorted out, including one hopes improved investments in public transport infrastructure and more support for housing density in major cities.
Manchin is expressly against the pro-union tax credit, as are the Canadian and Mexican governments who rightly see that it will discriminate against their own producers. But if that additional tax credit is applied regardless of unionization among manufacturers in the US, the constituency demanding more public investment in charging infrastructure and deployment of better battery tech expands a lot more rapidly. Many were worried about the what the Congressional Budget Office about the deficit implications of the bill such that it'd scare off moderate Democrats from supporting it on the relatively spurious grounds that the deficit is a problem today. Supporters like myself got lucky. The CBO offered up a relatively generous assessment about how much the bill would add to the deficit:
Just $159 billion, nothing compared to the defense budgets that regularly fly without any concern about inflation or deficits. We don't yet know if the final bill will pass and there's a decent chance it gets stuck once again. But if we're going to talk about a broader toolkit when planning for competition with Russia in the longer-term, this is the kind of bill that's desperately needed to shift terms of trade, weight on commodities markets, and the ability of the United States to proactively set economic agendas through its example. Declining oil demand would be terrible news for Russia's oil sector because of the lack of large new finds and rising costs of production whereas it'd be great news for Saudi Arabia. It would also pressure Russia's fiscal system, but the greatest harm would come from a decline in export earnings affecting the ruble, reserve accumulation, and the capacity of the oil sector to prop up domestic demand and transfer wealth to other sectors. If only Democrats were smarter about messaging the security implications of good climate policy and other proposals in desperate need of passage like an industrial finance corporation.
What's going on?
As expected, there are huge problems for small and medium-sized businesses trying to make use of federal support schemes in service industries worst affected by COVID and COVID-related safety measures. Restaurants, tour operators, beauty salons, events organizers, and more are complaining that banks keep denying them subsidized bridge loans capped at 3% interest rates intended to help them get through sporadic downturns in demand while banks are adamant that anyone eligible is accepted. This has been a near constant issue this year since federal support programs are only applicable to periods when federal decrees/laws are invoked for public health and safety. No wonder it's hard for banks to make sense of who to actually help. Implicitly businesses have to plan around their real and expected losses from interruptions, decide how to handle the debt load which even with higher inflation at a 3% interest rate is an cash additional outflow, and then also forecast the market for their services next year somehow despite the growing signs that the economy has returned to stagnation and incomes aren't rising with growth. MinEkonomiki is expected to sort out this problem in the next 3 days since Mishustin and the cabinet will undoubtedly want this behind them as quickly as possible. And there are clear signs of discrimination in support schema – the state-controlled "cultural" sector has gotten money, the non-state share of it hasn't for instance. Worst of all, there isn't any sound basis for not providing more direct support in place of loans:
Revenues are up nearly 9% above the Ministry of Finance's plan for the budget, which means a year-end surplus in the range of 2 trillion rubles is in sight. One can take the increased tax take outside the oil & gas sector as a positive indicator of economic recovery, but that's not quite true. Price inflation borne by consumers and businesses would show up in tax receipts – businesses might be able to report higher profits to be taxed as a result and VAT, for instance, should be overperforming by more than 0.9% if that's truly the case. Pair this with the record high level of currency reserves currently available (more than $620 billion) and the National Welfare Fund sitting above 12% of GDP and it's not like there isn't enough money going around to utilize the Tax Service's considerable success formalizing more business activity and tracking receipts. The IRS would be jealous of that digitalization drive. It would have made it considerably cheaper and more cost efficient for the US congress to target support measures last year and earlier this year. Any notional growth targets for SMEs and services through 2030 is going to take a considerable hit next year when the government finds out that maybe putting businesses heavily reliant on discretionary consumer spending out of their disposable incomes in more debt isn't a great approach if you don't offer real income support and let real incomes fall after a brief period of growth in 2Q 2021.
As one might expect given its proto-libertarian leanings on economic policy, the Gaidar Institute's industrial optimism index does suggest that sky-high demand is a looming factor for the macroeconomic environment. November showed industrial players broadly starting to revert to stagnation levels of optimism on throughput, stocks, and expected changes in output. The graph tells an interesting story from the survey respondents:
The key takeaway here is perception. The actual change in demand levels per the surveys is actually relatively small in the scheme of things per responses, but the perceived increase in orders is massive. What does that tell us? First off, there's little reason expectations of demand or higher prices would influence the actual pricing schema of various firms. Anyone who overcharges relative to a competitor would lose market share quickly, so it's more useful to imagine that purchasing and pricing decisions reflect real-time assessments of the actual state of the market or very short-term considerations rather than a longer-term abstract idea of "inflation." Second and more importantly, this graph captures just how slack the Russian economy has been run by design for most of the last decade. This is a consistent theme in my newsletter because it's a lesson COVID has made much clearer for me – sustained under-consumption leads to sustained under-investment which then creates physical and psychological bottlenecks for firm behavior. If companies have adapted to operating on a stagnant market, what would be a relatively manageable increase in output in an economy that's running hot or at least hotter becomes insurmountable because firms have no reason to believe that future demand will justify investments into capacity expansions today. The result is surges in short-term inflation because of a bottleneck brought into existence through weak past economic performance, a key reason why western recoveries from the Global Financial Crisis were so problematic and shaped so much of the political discourse seen in the US and Europe since 2010.
What's all the more maddening is that the current wave of inflation striking the economy has nothing to do with "expectations" or a rapid increase in the money supply. It's basically down to supply constraints. The Stolypin Club, affiliated with business ombudsman Boris Titov and the "systemic" business leaders who don't blindly call for privatizations or other liberal shibboleths, has openly criticized the Bank of Russia's approach hiking interest rates to quash inflation arguing that the Central Bank's remit should be expanded to support growth and business. If supply constraints are the primary causes of inflation, then hiking interest rates will slowly kill the business case for making the investments needed to address them and hope they go away by making the economy weaker and weaker until prices stop rising so much. Stagnation teaches businesses – and policymakers – the wrong lessons the longer it sets in. Just look at how difficult it is to pass even marginal changes in federal outlays in the US on an annualized basis.
New research from the Eurasian Development Bank shows that Central Bank statistics tracking the level of Russian investment into former Soviet states (excluding the Baltics) woefully underestimate the depth of Russia's economic links across the region. Per a new report, they estimate that as of 2020 Russia had an accumualted $37 billion in direct investments across the CIS + Georgia, roughly three times higher than Bank of Russia data suggests. Instead of taking a balance of payments view, the EDB focused on the end investor and stripping out flows to assess which investments from Cyprus or other offshore jurisdictions originated in Russia:
No surprise that Kazakhstan and Uzbekistan take top billing. The size of their resource export sectors, capacity for industrial investments, and elite ties make them prime territory. The structure of mutual direct investments between members of the Eurasian Economic Union is also no surprise:
Russian firms and investors retain a large role across Eurasia despite the gaps in official data that's easier to cite. That makes perfect sense, and also helps explain the relationship between Russian economic performance and investment decisions/levels and decisions taken elsewhere both at the national and sector levels. My money's on Uzbekistan being the primary growth driver going forward thanks to its favorable demographics, reform efforts (though they aren't touching the political sphere), and political understanding between Moscow and Tashkent. I'm particularly curious to see where the current proposal for Uzbek firms to effectivcely rent out 1 million hectares of Russian farmland goes given that Uzbekistan faces problems with desertification on top of a growing population and climate change is also going to shift more Russian agricultural production into its interior where it's less competitive for export.
The Federal Anti-Monopoly Service (FAS) is now finally setting its sights on regulating prices for fuel oil as fuel prices in general keep rising on the Russian market. Fuel oil is particularly sensitive for the Far East where it's used as feedstock for heating systems. Precedent's already there for national price regulation given the management of benzine prices, but many doubt that the Far East's troubles alone would be enough to justify a new national approach. Kommersant's writeup cites rising fuel prices in Europe as the proximate cause, which makes sense. There are also broader market shifts afoot since IMO 2020 took effect last year and maritime shipping is steadily cutting its consumption of heavier fuel oils, putting pressure on refiners trying to assess what products demadn will look like and adjust their own operations accordingly. Plus the downturn last year was brutal for European refining and, naturally, Russian refineries undergoing modernizations post-2015 are losing some of the price arbitrage benefits of supplying dirtier, heavier products to European markets no longer interested in the heaviest parts of the barrel. Of all that's being discussed, my best guess is that FAS will go with a compensation mechanism based on relative price levels akin to the "damping" mechanism used to subsidize fuel prices by paying refiners so they hold wholesale costs lower than they would otherwise on the basis of crude oil prices.
There's another logistics story here at play since fuel prices are a source of panic for any government, but one made much worse when general increases in prices are being observed across the economy. UNCTAD estimates that if current shipping rates stay in place over the next 2 years – admittedly a huge if – the cost of imported goods would rise by 11% and global consumer prices would rise by 1.5% on average. Russia gets off easier – just a 1% consumer price increase – but that would disproportionately affect regions like the Far East that face shorter import distances and more efficient transport by bulk shipping from abroad than domestically via rail and truck. Fuel prices for heating don't neatly correspond to markets for road fuels, though they may share a feedstock in the form of crude oil. But the relative costs of heating are easier to subsidize or manage if other inflationary bottlenecks facing households are eased. Greater investment into rail and port capacity in the Far East, Siberia, and European Russia is a no-brainer in this regard.
COVID Status Report
37,156 new cases and 1,254 deaths were reported today. Cases are finally falling in the regions, not just Moscow, but deaths are likely to continue at record highs for the next week if we assume a roughly 2-3 week lag. Good news is that vaccinations are back up to over 400,000 first doses a day – about 0.3% of the population as Jake Cordell notes:
Aside from the KPRF's blasts against the potential federal approach to QR codes, the more important development I'm following is regionally specific to the Far East. China's further tightening import controls on goods and food from Russia at a time when regional producers and exporters really need the money. Internal debates about the level of antibodies required per any national QR code scheme are far more bureaucratic than political in nature. Since it appears the peak of the current wave has passed, that buys the authorities a bit more breathing room to work out how to sell what's necessary and push it through. 16 regions have now adopted mandatory vaccination for students older than 18, which seems like a good way to manage some inter-generational transmission risks. We're still waiting for that Duma debate on the policies Tatiana Golikova and others announced to take place in full.
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