Russia's economic crisis

Hello,

I have released this video about the economic crisis that is emerging in Russia. Putin's order of priorities is pretty clear: the war is more important than the economy. He just wants the technocrats to make the economy work so he can do what he wants. If that means ordinary Russians have to suffer a bit, then that's acceptable for him because it serves a greater purpose. However, after three years of war, we are reaching a point where things might become unsustainable, and the economic wizards in Russia's Central Bank are running out of tools.

Watch the video here or read the transcript below.

Best,
Anders

Transcript:

In this video I want to talk about how the Russian economy is doing. Not just the war economy but the economy as a whole. In a war of attrition there is a clear connection between the ability to sustain the fight and the economy because it's a war of production, and since the economy and the war are so interconnected, I think it's important to keep an eye on what's going on and to also talk about what it might mean for the war. So, let's talk about it.

Recently I've been spending more and more time following the Russian economy because it's a really interesting situation and it's something that might have significant consequences for the war in Ukraine. In the West there is often a strong focus on the visible, tangible indicators such as the ruble exchange rate or the interest rate from the central bank. There was just a meeting at the Russian central bank where they decided not to increase the interest rate for the coming months. This meeting was covered quite a lot in the Western media so it shows how things like this are on the agenda.

But I thought what I want to do is to step back and explain, some of the dynamics of why the Russians are experiencing the problems they are right now and why it's so difficult for them to do anything about it. And keep in mind, I'm not an economist so this is a layman's explanation but I think the basic dynamics aren't that complicated so they're pretty easy to understand.

If we look away from the military sector and we focus on the rest of the Russian economy, they are experiencing two things that would normally be mutually exclusive. On the one hand, there is stagnation. Businesses are struggling to make money, people are not buying things or making investments, the stock market is down, there is concern about the potential bankruptcies among big Russian companies. Especially if we look at something like the real estate construction sector, things are looking really bad. If there is a bubble in the Russian economy that's going to burst, then there is a high likelihood that it will start in real estate construction.

So the Russian economy is suffering from signs of stagnation. But the other phenomenon that we see is that inflation is rising. Things are getting more and more expensive. If you go to the grocery store in Russia, you'll have to pay significantly more for food now than you did a year ago. And that's the case for almost all goods in society. Prices are increasing. Officially, the inflation in Russia is about 9% now, but in reality, it's probably closer to 25 to 30%. So it's quite dramatic and it's still accelerating. So it's a problem that's getting worse.

The dilemma that the Russians face is that the solutions to these two problems are the exact opposite of each other. So if you have a stagnating economy, what you want to do is to stimulate it by creating more investments. You can either do that through government spending or you can lower the interest rate, which will make it more attractive for the private sector to invest. And this is what all the business people in Russia are yelling about right now. They need lower interest rates so they can save these businesses that are struggling.

But if you have inflation in society, then what you want to do is the exact opposite. Because what's causing the inflation is that there is too much economic activity. So you need the economy to cool down. There are too many investments just being made. So different companies are competing with each other over labor, over resources, and that's pushing up the prices. And to stop that inflation, you need to have fewer investments. You can do that either by reducing the public spending or by reducing the private investments that are being made, which you can do through increasing the interest rates.

This is the essential problem that the Russian Central Bank is having. To save the economy, they need to both increase and to decrease the interest rate at the same time. And that's of course impossible. So the quick, very quick conclusion is that things are looking really bad for the Russian economy. We are in the early phases of this, but a crisis is coming and it's pretty much inevitable.

What Russia is getting into is a condition that is called stagflation. That's when you have this very strange situation where on the one hand there is stagnation in the economy, but on the other hand there is also very high inflation. And as I said, in a healthy economy, those things would be mutually exclusive. So it's not something you're supposed to experience at the same time. But it does happen from time to time. For example, Western economies also experienced something like this in the 1970s.

But when there is stagflation, it means that there is something structurally wrong with the economy. There is a deep underlying problem that needs to be solved before anything can improve.

To illustrate what I mean by a structural problem, let's say I have a company that produces disposable cameras. And now everyone watching who is under the age of 30 are going to be asking, "What's a disposable camera?" A disposable camera was something that was actually a thing 20 years ago. People used to have disposable cameras for vacations or special occasions. Then you could take them to a shop, you could have the pictures developed, and about a week later you could go and pick up your photos. At one time, producing disposable cameras was a viable business, but not anymore. Because nobody buys disposable cameras because everyone has a smartphone and it's just objectively better in every possible way. So if I have this company that produces disposable cameras, there is really nothing I can do to grow the sales. No matter how much money I put into refining the models or making more attractive packaging or advertising, it's not going to lead to more people buying disposable cameras.

So, that's what I mean by a structural problem. And that's what Russia is experiencing as a whole in their national economy. There is something structurally wrong with the way that the economy is running, which means that the normal tools a central bank would use to control the economy, they don't work anymore. Over the last year and a half, the Russian central bank has increased the interest rate from 7.5% to 21%. And the inflation just keeps rising.

So, the tools the bank has don't work anymore. It was expected that the central bank would increase the interest rates to 23% in December, but that did not happen. The way we should understand this is not that there are improvements in the Russian economy because there are not. The inflation has been accelerating over the months of November and December. So, they really should be doing more to get this under control. But I think what we are seeing is just that the Russian central bank has given up. They realize that it doesn't actually make a difference because inflation is going to keep increasing anyway, so why bother, right?

Over the last couple of months, there has been severe criticism of the head of the central bank, Elvira Nabiullina, from both politicians and businessmen in Russia. They say that she's destroying the economy with these high interest rates. And recently, Putin himself also came out and said that in his mind, the interest rate was perhaps not the best tool to deal with inflation. So, he suggested that the central bank should do something else. He did not specify what "something else" was supposed to be, but the message was quite clear: it's not popular to increase interest rates. So, I think what happened was just that Nebulina just decided that it's not worth it to take this fight if nobody appreciates what she's doing.

The structural problem that is driving the country into stagflation is, of course, Putin's war in Ukraine. The government is pouring so much money into the war effort that it's driving up inflation and it's pulling resources away from the rest of society. So, that's both military production in itself, but it's also the way that Russia is manning its forces. They don't have mobilization, but they get people to sign contracts in return for huge bonuses, and that is driving up the wages. The sanctions are also working. Russia has been very good at trying to circumvent them, but all these hoops and loops that they have to go through, they just mean that everything is more complicated, it takes more time, and it just costs more money to get the things that they used to buy in the West.

So, that's also creating inflation. And to stop that inflation, Russia needs to end the war. That's the only thing they can do to solve the economic crisis that is starting to materialize. And if the war does not end fairly soon, it will be harder for Russia to sustain the war simply because the economy will be running out of steam.

I'm going to mention just two areas where we might see these economic problems start materializing into military problems for Russia. I won't analyze these problems in depth here. I might do that in separate videos.

The first one I want to mention is about manning. Because of the way that Russia has been recruiting soldiers for the war, they have essentially built an army of men who are there for personal enrichment. They are fighting to make money for themselves or their family. What will happen when Russia can't afford to do that anymore and the money that the soldiers are earning begins to be eaten away by inflation? What at one point looked like a very good bonus suddenly doesn't seem like a good bonus anymore. That might affect the morale of the troops. Because, well, basically people who fight for money will have an expectation to get paid.

The other problem that I will mention is that Russia's stocks of military equipment are beginning to run out. When the Russian defense industry produces equipment today, most of it is not actually new. Most of it is old stuff that gets refurbished and then is sent on to Ukraine. There are different estimates, but it's something like 70% to 80% of armored vehicles that are made this way. Over the next year, the stocks of many of these types of equipment are going to run out. This means that the Russian defense industry will have to double or triple the production of actually new equipment within the next year just to maintain the current pace. This will require significantly more investment in the military industry. But how will Russia handle that when the only thing that can save the economy as a whole is to reduce the investments?

These are just two examples of how the war and the economy are connected and how Russia will be facing hard dilemmas related to both in the near future.

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