Publication in Russian on the Zen blog
https://dzen.ru/a/ZqpipSxErWWc3k36

Interest rates in Russia indicate a supply-side deficit

Inflation in Russia is not the result of excess demand due to rising incomes of Russians; instead, inflation in Russia is a supply-side problem associated with declining productivity as more capital and people are directed to unproductive geopolitical events in Ukraine. Thus, based on economic theory, we can conclude that there is already a deficit in Russia, which leads to higher prices. The monetary policy of the Central Bank of Russia will not solve this problem, since it is not a monetary cause, but a fundamental problem of the real sector, i.e. insufficient production of consumer goods and capital goods.

In this post we will talk about interest rates, how they relate to Russia, and the fact that the Russian economy is falling and continues to fall, grab some popcorn, let's go.

Nabiullina, the head of the Russian Central Bank, raised rates from 16% to 18%, why hasn't the Moscow leader arrested her yet? First, let's talk about the state of the Russian economy, about the theory of interest rates, to give a conceptual basis to rely on, facts and data. Then we will talk about some of the causes of inflation, the real causes of inflation in Russia, what is actually happening, what is happening with monetary policy. Theory and monetary ideas are the cornerstone, thanks to which we will sum it up.

So, the first thing I want to say is about the state of Russia. Russia is economically similar to an African country. The quality of life in monetary terms for Russia is approximately the level of Kenya or Brazil. The only countries where interest rates are as high as in Russia are Congo, Nigeria and Argentina. I am not saying anything bad about South America or Africa, these are countries that are mismanaging their economies and like Russia, treating people like cattle and not like a free economy. To cut to the chase, the theory is that the bank rate, the interest rate, is a relative rate to the natural rate of interest. The bank rate, which is currently 18%, is the central bank rate, and to get a loan you would have to get about 21%, 28% for credit cards, because it has to match the natural rate, which is the expected return on capital in the economy, or the rate of return. In Western developing countries, the rate of return is 7%, and in Russia, we have a negative rate of return right now. The rate of return could be below zero. What are the implications? The theory behind it is that if you are going to open a pizzeria, you are not going to ask for a loan at 22% and expect to make a 1% return, so it makes no sense for the central bank to raise rates that high. This is an exorbitant percentage, it should correspond to the natural interest rate or correspond to the inflation rate. Currently in Russia they say that the inflation rate is from 7 to 7.5%, and the Bank's target for the end of 2025 is from 4 to 4.5%, and this is the optimal range of inflation that any central bank should support - the range between negative -2 and positive 2. But as soon as you start bringing inflation to 4%, there is a lag, there is an anchor effect on the economy, when it pulls the whole economy down. And the Russian economy now is not 7-7.5%. It can be 50%, otherwise why would the Central Bank take such radical actions as raising interest rates to 18%. In most modern countries, such as Switzerland, it is 1.25%, the United States is 5-6%, but the rates there are quite low, despite the fact that they are historically high. So, what is happening in Russia? Let's look at the causes of inflation in Russia. Let's consider several theories. Inflation is always a monetary phenomenon, which means a monetary cause. According to the theory of money, the monetary base will expand as long as the velocity of money remains constant, and this imperceptibly leads to an increase in prices. In Russia, they say that we have free interest rates, which are simply increased. This is not true.

The economy is growing, the demand is very high, and this is another lie that is common in Russia. Because if the interest rate is 18%, and for credit cards it is more than 20%, and people are getting into debt with a disposable income of 500 dollars a month, while pensioners get hardly more than 200 dollars a month, I can tell you straight, if you believe in a growing economy, then where does this inflation come from, if people are not ready to take out a loan at 18% to open a pizzeria with a profit of 1%? Swedish economist Knut Wicksell in 1898 believed in monetary macro equilibrium, where there should be stable prices in the country. However, after the First World War, he revised his theory, when in conditions and in times of declining productivity, such as terrible events in the world, geopolitical events, natural disasters, everything collapses, you see a decrease in productivity. And this leads to shortages. Scarcity leads to inflation. So productivity is inversely proportional to inflation. If there is 90% inflation in the potato market, or if the price of a house is 18 times the annual income - this is a distortion in the market. It is not because everyone is so rich, it is because no one is building anything, or growing anything. In Russia, there is a deficit in productivity, that is why housing is becoming more expensive, that is why food prices are rising, that is why inflation is rising and there is such a monetary policy, or rather the machinations of the Central Bank, which cannot fix anything. Let's say I put a bag of money in a field where wheat will grow, I change the interest rate, this will create a house, which will create other houses, people from which will grow wheat, people will put in their labor and sweat, people will grow and build. Why can't they do this? Because they are all involved in unproductive activity, geopolitical activity in Ukraine. What is the Central Bank doing? My theory is that they want to drive out all private investment and consumption with exorbitant interest rates. It's a kind of nationalization of the people. On the consumption side, people are not going to borrow money at 22 or 28% on a disposable income of $500. On the investment side, people are not going to open a pizzeria at 0-2% profit if the bank is charging 20%. And this economy, which treats people like cattle, is putting all its energy into unproductive activities. That's the reason for the higher rates, because you can't control the situation and the growth of production by printing more money or raising and lowering interest rates. Let's look at the employment numbers in Russia. Number one in Russia is the military. Number two is the bureaucracy. Number three is the transportation sector, but the transportation sector is actually a branch of the military because it's moving people back and forth. And number four is retail. But that doesn't create anything. It's not like machine parts, and you know what a machine or machine parts is, they are the source of power of any economy, they cut, they grind, they turn metal and parts into machines that they create. So what is happening in the Russian economy? Nothing is happening, just a movement of stocks from the 1960s, 70s, 80s that were accumulated during the Soviet Union. Archaic things. But they are, according to rumors, exhausted. Because in the country there is only bureaucracy, military, police, FSB. Creating machine parts is creating value. So this whole scheme of raising interest rates is absurd, it does nothing, because all this is associated with shortages, which are getting worse as more and more people and materials, productive labor, instead of doing real work, growing wheat and potatoes, building buildings, do unproductive work. Because of this, the Russian economy is on the same level as Congo or Kenya. And Russia itself is like a black box, where people do not want to hear and see that Russia is on the verge of economic collapse. Thank you for reading the publication and good luck to everyone.

The interesting thing is that Nabiullina said that they cannot raise the interest rate any more, otherwise it will kill the economy. Thus, the country is running out of options to fight inflation, which is becoming a force capable of bringing Russia down.

If the Bank of Russia solves the problem of supply shortage with monetary methods, it will only add to the chaos.

The USSR had deeper reserves in many ways, but the economic pressure on a country that produces nothing, with a weak economy, is becoming faster and more profound.

The Russian economy is destroyed. Elvira Nabiullina, the person Putin invited to support the Russian economy and try to present it as successful, announced that the last reserves of the Russian economy have been exhausted. The labor force and production capacity in the economy are "practically exhausted," Elvira Nabiullina, head of the Central Bank of the Russian Federation, said at a press conference. The economy is now in a state of "overheating", the scale of which has become a record for at least the last 16 years. Indeed, Russia's GDP is growing by 5%, but only because of a state-funded increase in arms production, and inflation is accelerating. Meanwhile, businesses have little opportunity to increase production of goods and services. The shortage of labor and production capacity "could lead to the rate of economic growth slowing down, despite all efforts to stimulate demand," the head of the Central Bank warned. "In fact, this is a stagflation scenario, and it can only be stopped at the cost of a deep recession."

Russia is in many ways like Venezuela, a country with vast natural resources but little else. Instead of taking those resources and investing in infrastructure, they simply squander them.

War economies inevitably experience inflation because they have both a reduction in the supply of goods and an increase in cash flows, including higher wages for workers in the military industry. Interest rates help reduce private consumption, but are not the whole answer in a war economy. So price controls, rationing, and labor management are other options, but none of these work well in the long run either.

The current war economy can only continue for a while at the high cost of a deep recession. Foreign investment in Russia has largely dried up, further sucking the oxygen out of an already lopsided commodity economy.

The military complex produces nothing useful and never returns on investment. This contributes to Russia's inevitable decline.

Far-reaching market control, large government expenditures financed by the expropriation of private assets, and the reorientation of the economy toward the military industry with complete disregard for the social and economic well-being of the population. History clearly shows that this is an unsuccessful long-term strategy. Short-term overheating of the economy, caused by large investments in the military industry and very limited access to technology, will likely hinder productivity growth and lead to stagnation of the private sector, even more rampant inflation, and increased pressure on Russian households.

To cover future deficits, Putin will have to use monetary financing, which will further fuel inflation and further deplete Russia's monetary reserves. If Putin continues down this path, the long-term damage to the Russian economy could be significant.

Even Stalin knew that growing weeds and potatoes was necessary. Putin, not so much.

No surgeon, no matter how experienced, can cure a man who has shot himself not only in the leg, but also in the heart and brain. That's what Putin has done to Russia.

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Publication in Russian on the Zen blog
https://dzen.ru/a/ZqpipSxErWWc3k36