Russia’s economy has been a
sore spot for more than two years now. Since the ruble crisis of late 2014 the
role of the Bank of Russia has been to apply IMF-style counter-cyclical
tightening to stabilize the situation in the wake of the decision to allow the
ruble to float freely on the open market.
That
was the right decision then. It was the move the US did not expect President
Vladimir Putin to make. It was expected Putin would hold to his natural
conservatism and keep the ruble trading in the 30’s versus the US dollar as
opposed to risking a collapse in exchange rate in the face of an historic drop
in oil prices over the eighteen months between July 2014 and the low made in
late January 2016.
Oil
dropped from $120+ per barrels to around $28 during that period. And if Putin
hadn’t proactively allowed the ruble to fall from RUB32 to a high of RUB85 in
early 2016 Russia would have been bankrupted completely.
During
that time Bank of Russia President Elvira Nabullina raised the benchmark
lending rate to 17.00% and Russia began the slow, painful process of
de-dollarizing its economy.
It’s
been five years since those dramatic times. But a lot of damage was done, not
just to the Russian people and their savings but also to the mindset of those
in charge at the Bank of Russia.
Nabullina
has always been a controversial figure because she is western trained and
because the banking system in Russia is still staffed by those who operate
along IMF prescriptions on how to deal with crises.
But
those IMF rules are there to protect the IMF making the loans to the troubled
nation, not to assist the troubled nation actually recover. To explain this, I
have to get a bit technical, so bear with me.
The
fundamental problem is a miseducation about what interest rates are, and how
they interact with inflation and capital flow. Because of this, the medicine
for saving an economy in trouble is, more often than not, worse than the
disease itself.
If
Argentina’s fourth default in twenty years doesn’t prove that to you, nothing
will.
Nabullina
still believes that her job is to get inflation down to 4%. Inflation
targeting, as central bank policy, is a disease that needs to be placed next to
smallpox at the CDC in Atlanta.
It seems I have to write this
article once every few months just to remind people what the
problem is.
When
inflation is above the target an austerity mindset dominates at the central
bank who keeps interest rates above the market rate in the vain hope they can
wring the last bits of inflation out of the economy, because sufficient
confidence hasn’t returned to the banking system after the crisis.
This
is Russia’s problem today. Nabullina still believes there’s work to be done
before allowing the economy to grow.
When
inflation is below the target, like in the ECB and the US, then to the
miseducated central banker growth is sluggish and demands stimulus in the form
of cheap money to create a virtuous credit cycle. It hasn’t worked and it won’t
work.
Because
both of these theories about the effects of inflation targeting are dead wrong.
They
haven’t worked in the US and Europe because there is no more capacity within
their economies to take on more debt to stimulate demand and increase spending.
All they are doing is, as described by Mises and others, “pushing on a string”
offering money no one wants at interest rates the market cannot sustain.
That
cheap money inflates asset prices like stocks and bonds while diverting capital
to long time-horizon projects like fracking in Texas, and housing and car
loans, but it thieves working capital from the future by mispricing the risk of
those projects in the form of the interest rate.
The
net effect is enriching the already obscenely rich and powerful, through wealth
transfer which feeds leftist and Marxist criticisms of the ‘free market’ while
they proclaim the end of capitalism.
But
central bank inflation targeting and control is the height of a
centrally-planned economy. Control the value and cost of money and you control
the means of production. So, capitalism this ain’t folks.
Miseducation
on matters economic are commonplace today from the commanding heights to the
lowest barrios.
Eventually,
you reach the point we’ve arrived at in the west where no amount of forcing the
market, through punitive negative rates, can stimulate growth. This is simply
arrogant men praying at the altar of math torturing equations which have no
resemblance to reality and turning it into policy.
On
the other hand, we have Nabullina trained in this world of econometrics and its
econo-babble, holding back the Russian economy with interest rates set above
the market. She is either overly-cautious, if I’m being generous, or a full on
fifth-columnist stifling growth to support Russia’s enemies, if I’m being
cynical.
I
think the truth lies somewhere in the middle, if I’m being fair. Today I’ll be
fair.
The
Russian economy, structurally, is in excellent shape. John Hellevig at the Awara group
recently published an excellent report explaining the guts of
what’s going on there. And John notes, like I have been for more than a year (here and here), that the Bank of
Russia has interest rates too high given what the market is telling it.
It’s
not that tough really, just look at the Russian yield curve and you can see
what I’m talking about.
The
current benchmark rate in Russia is 7.25%, down from 7.75% just two months ago
(and that I’ll get to in a minute). The entire interbank market and short-term
deposit market is trading below that benchmark rate.
This
means the central bank is holding back a market that wants to trade at lower
rates. This is keeping liquidity low and access to loans in the domestic and
commercial market low as well.
Meanwhile,
the demand for Russian debt, because as a country Russia’s balance sheet is so
clean, in part due to Nabullina’s stewardship of the 2014-16 crisis period, is
pushing rates lower. And for the first time in close to 5 years Russia has a
normal positively-sloping yield curve from 1 year to 20 years, with no humps or
flat spots.
Demand
for Russian debt is finally market driven in a way that is predictable and can
allow banks to make money paying short and lending long. This is how banks are
supposed to make their money, not speculating on stocks and currencies!
Moreover,
domestic savings rates at all maturities in the CD and money markets are below
the benchmark rate, so Russian banks are under zero stress. High savings offer
rates indicate a need to shore up reserves by attracting savings. It’s a bad
sign.
Non-performing
mortgage loans stand at less than 1%…. 1% !!
The
only worry is the outstanding dollar-denominated debt, but that makes up around
1% of the total Russian mortgage market. It’s literally chump change.
I
mean, for pity’s sake, what on god’s green earth is Nabullina waiting for? An
engraved invitation from the Fed to the next convocation at Jackson Hole? She’s
done her job, now let the Russian people do theirs.
Nabullina
has kept rates high out of fear of inflation returning due to a rising US
dollar and falling oil prices which is putting upward pressure on the ruble.
She made an egregious policy error hiking rates in response to Trump’s crazy
aluminum tariffs last year. And then held that level until June.
She’s
only now just beginning to lower rates after the policy became ludicrous and
Russian GDP growth has stalled. Again, incompetence and treason look very
similar from a distance.
She
keeps jumping at the shadows of a dollar-induced crisis. But the Russian
economy of 2019 is not the Russian economy of 2015. Dollar lending has all but
evaporated and the major source of demand for dollars domestically are legacy
corporate loans not converted to rubles or euros.
So,
the Russian economy is so much more insulated from a rise in the dollar than it
was before.
The
fundamental flaw in the thinking behind most central bankers, especially those
trained by the IMF, is that lowering the cost of money stimulates growth and
raising it reins it in. It’s an overly simplistic model to explain why we need
philosopher kings like Nabullina, Mario Draghi and Jerome Powell to tinker with
the economy and engineer growth and stability.
The
reality is it’s more complicated than that, because access to capital means
different things at different parts of the business cycle to different
economies. And Russia’s role in the global economy is changing.
Russia
is becoming an independent node in the global economy. Shut out of the US
dollar markets, Russia now has to lead the part of the world it dominates – the
EAEU, Turkey, Iran, the CSTO states – and show confidence by making the ruble
more accessible to foreign investment.
Projecting
confidence comes in the form of lowering rates to reflect a healthy domestic
market, not keeping rates high because you’re afraid of the US
That
yield curve I posted above is a picture of a central bank scared of the future,
like Jerome Powell at the Fed, and not one sanguine about Russia’s future
prospects. Powell has problems Nabullina doesn’t have, like hundreds of
trillions in unfunded future liabilities that require much higher rates to
stabilize.
Lowering
interest rates in Russia from 7.25% to 6.5% or even 6% is likely all she needs
to do and then let the markets take care of things from there. That’s what the
market’s actually telling her.
And
I believe Vladimir Putin has had enough of Nabullina’s fears. He’s getting more
and more impatient with his central bank president. He sees the lack of growth
of the Russian economy and wonders why capital formation is locked up behind a
wall of overly-high interest rates.
Recently
Putin sat down with Nabullina and right after that interest rates dropped
0.25%. The same thing happened in 2015 when she had rates stuck at 10% and
Putin had to finally forced her to justify herself.
It’s
clear that there is something wrong at the Bank of Russia; whether it’s
Nabullina herself, her staff or the legacy of insipid and dangerous Western
economic theories refusing to die, is beyond my knowledge.
The
cynic in me says the foot-dragging by the Bank of Russia is the final vestige
of US infiltration in Russia’s institutions rearing its ugly head. That fight
is ongoing, but the recent drops in the benchmark rate are a good start.