Russia has seen many battles with inflation since the fall of the Soviet Union. The financial crisis of 1998 saw inflation skyrocket to as high as 84.4%. It’s current financial crisis has roots in the world economic crisis, as well as heavy dependence on sharply falling oil prices and investors’ concerns both over military conflict with Georgia and state interference in the economy.

Immortal Inflation
By Sergei Shelin
October 28, 2009
Gazeta.ru

If you believe the government statistics, then we have had no inflation since August. It ended. Just as it piled up from January through July, it has stopped in the past few months. Even our enemies at The Wall Street Journal admit it: “Recession quells inflation.”

And that’s not all. Prices won’t rise any further as well. At least, that is, through the end of December. This prediction came out easily from the words of Prime Minister Putin at the Russian-Finnish Forestry Summit: “You know that we are striving for a reduction in inflation… This year already it will be, perhaps, a bit more than 8 percent…”

Judging by the fact that we already have “a bit more than eight,” nothing will increase through to the end of 2009. Thus was resolved by the Prime Minister.

A good six months without inflation – that’ll be a historical record for post-Soviet capitalism.

Or to be more accurate, it won’t be; or, perhaps it will. That’s because in reality, the growth of prices has no intention of stopping. It’s also because this “inflation” that the authorities talk about liquidating is not representative of the entire price growth in our economy. It represents but one part: the growth of consumer prices. To be precisely exact, it’s not even that, but just the growth (or lack of growth) of prices of a carefully selected sample of consumer goods. Part of a part.

Calculated in this way, it’s true that the index of consumer prices (CPI) didn’t rise in August, September, or the first three weeks of October. But, like you’ll surely guess, much depends on the technicalities of choosing the sample, and the finesse that goes into the calculations. For example, the so-called core inflation in this same consumer market (but with a slightly different sample) not only didn’t stop, but even grew: having reached its minimum in the summer (with a 0.3% monthly increase in June and July), it then rose again (to a 0.5% monthly increase in August and September).

The “zero growth” CPI is itself the sum of a seasonal recession in food prices and the continuing growth of everything else. In the first three weeks of October, for example, the country was rescued from the general growth of consumer prices by four single vegetables: potatoes (which fell in value by 6%), onions (by 7%), carrots (by 8%) and white cabbage especially, which fell by almost 10% in just three weeks.

Meanwhile, non-food goods rose in price like nothing had hit them (in August by 0.6% and in September by 0.7%; figures for October have yet to be calculated).

But consumer prices, I remind you, only make up a part of all prices. All the remaining prices are growing, and seem to know absolutely no shame. Indeed, they have no public accountability. The index of wholesale manufacturing prices, for example, rose 1.4% in August and 1.7% in September.

In an honest assessment, inflation has in no way stopped. By most measures it is many, even dozens of times higher than in wealthy countries, where the recession has indeed “quelled inflation” and prices have virtually halted.

Here they are rising for sure, although not so rapidly as last year. But that’s understandable. A recession in production as big as ours ought to have induced a powerful wave of deflation. In certain sectors it did, but on the whole, as we see, it has not. You could call it an economic miracle, albeit a special one. And if our domestic inflation, shaky thought it was, withstood the terrible recession of last fall and winter of this year, then why on earth would it stop now, when the worst of it, as they say, is already behind us?

In order to appreciate its full potential for growth, let’s compare our pre-crisis CPI (13.3% in 2008) with the CPI of both wealthy countries, and poorer countries whose economies are stronger than ours. In 2008, the consumer price index in the European Union grew by 3.5%; in the US – by 3.8%; in Brazil – by 5.7%; in China – by 5.9%; in India – by 8.3%. Now the recession in all of these countries is smaller than ours; in some cases their economies have begun to rebound.

In twenty years of high inflation, an entire scientific discipline has formed that wittily demonstrates the benefits of money pumping and the accompanying rise in prices, which our national economy supposedly could not function without.

By this logic, a common man, unhappy with inflated taxes, ones that in reality are worse than any others, just doesn’t understand that this is his advantage. That’s because a stop in price growth, allegedly, is comparable to an absolute halt of the Russian economy. Most amusing is that anti-inflation experiments, conducted from time to time by Russian authorities, have supposedly confirmed these projections, while in actuality they chronologically correspond with successive economic recessions.

Therefore, we have emerged in the current crisis as a world champion of price growth among larger economies. But here, in this difficult hour, it did nothing to help us see straight.

We shall therefore recall the story of our national war with inflation. What went wrong?

We shall remain silent on the first half of the nineties out of tact. After that, however, came three interesting incidents.

The first great battle with inflation took place in 1997-98. The M2 money supply was being more and more strictly held back from growth. At the end of ’97 it stopped increasing altogether, and then until August ’98 even shrunk. Inflation on an annualized basis began to number in the single digits for the first time in post-Soviet years.

But then came the default, generating what later became were clear were the erroneous hopes of the authorities to save the overvalued ruble and excessive fiscal spending both at the same time. The time then came to save the economy at any cost. The inflation at that point was immeasurable. The money supply, as well as the prices, rose rapidly.

The next round of anti-inflation battles occurred several years later, when the dust had settled and the economy was operating normally. In 2002, the money supply grew altogether 32.4% (the minimum growth during all those rich years). Inflation quickly dropped, but the rate of GDP growth fell by two percent. Although the rebound continued and nothing terrible transpired, the slowdown was unbearable for the top authorities. For that reason they gave the economy a fundamental zap the next year in 2003, and greatly built up the money supply. The rate of GDP growth immediately went back to normal, and inflation cased to decline.

But hope did not perish. The next couple of years saw fiscal policy zigzag about – here tightening, there loosening up.

The consumer price index was again measured in the single digits in 2006. Diminish it another two or three times and it might have fit the European standard. But then and there came the time to radically abandon all financial sanity. The nationalized economy demanded new magnitudes of stimulation, and the ambitious authorities demanded new, unprecedented rates of growth.

In 2006, M2 growth was as much as 48.8%, and in 2007 remained at the same level – 47.5%. Consumer prices began to pick up speed – not immediately, but all the more certainly.

Anti-inflation policy was then sacrificed a third time, and in essence for the same reasons as before – poorly chosen developmental indicators, megalomaniacal dreams, and, just like always, the aspirations of the elite to realize their vested interests.

And now our present crisis. What is happening to the monetary supply? At the beginning of October 2009 it was 5% lower than one year prior. As this money maintains the economy – which has shrunk in size by 10-11% this same year – the inflation has remained perceptible. Large new expenditures planned for the near future, however, will drive it up even further.

Additionally, there is something else that is more important than any formal plans – the fact that decision-making logic has remained just as it was before.

All the mechanisms to support the inflation that rose in the nineties before being almost completely eradicated are in the same working condition as they were before.

It is a power that looks strong but is inherently weak, capitulating to the financial extortion of coalitions of lobbyists and acquiring masses of their costly undertakings.

Here we see the perpetual inability to solve the problem of such gigantic petrodollar revenues. On its own, the existence of such massive profits might not drive up domestic inflation. However, this would only be under two conditions: if the country received no income from exports (precisely the Chinese approach; unacceptable here since it provides too great a temptation to grab and split up all the free money) or when the national currency is aggressively consolidated (also an unacceptable choice, as our monopolized economy would then lose its last shreds of competitive advantage).

Therefore, in the years before the crisis, our authorities would coil away every few months from anti-inflation policy (when they allowed the ruble to grow) towards a policy of inflation (when, as a result of the war on ruble growth, they printed fiat money and used it to buy up petrodollars). The crisis itself interrupted both their mental and financial agony; but now, with the new jump in oil prices, it’s amusing to see how they spin right back around.

Now to the most, perhaps, secretive mechanism of inflation: our unique banking system. To be more exact – the lack of one. Our banks are massive points of currency exchange and (or) distributors of government money. Therefore, just as there never was, there is practically no normal credit lending, where money is lent at a reasonable rate of interest; but they do this so that the money is spent rationally.

This banking defect is no accident and is constantly supported from above, attaching irresistible power to lobbyists’ demands to organize widespread distributions of government money – which the lobbyists themselves can’t get through any normal channels. On one hand, such thoughtless infusions of cash are a reliable motor for inflation. On the other hand, without them, and without normal banks, the economy caves in, as if confirming the theory of the seamlessness between low inflation and economic downturn. Not for everyone, to be sure; just for our country and its current methods of economic organization.

Indeed, all of the aforementioned mechanisms have successfully survived the first year of the crisis. Everything in the old system is ready for action, and has even in part already gone back to work.

Mechanisms of inflation are as firmly fixed in the system as mechanisms of corruption.

So from that we have our forecast. A departure from high inflation will occur sometime, of course, but certainly no sooner than a departure from the system.

Translation by theotherrussia.org.

Andrei Illarionov is a former policy advisor to the Russian president, is now an opposition leader. The statement first appeared on his LiveJournal blog.

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A Statement by the Liberal Charter alliance

The Liberal Charter alliance expresses its fundamental disagreement with the measures taken by Russian authorities in the financial crisis, and puts forth the principles of a fiscal policy that a government responsible to the citizens of Russia must take.

1. Today’s financial crisis in Russia has foreign and domestic causes. The most important external cause of this crisis is the world monetary system, which goes through cyclical phases of boom and bust. Such instability is created first of all by modern money, which governments can issue in any amount, combined with a wide range of government privileges and guarantees provided to commercial banks. Interest rates held at artificially low levels and government loan guarantees stimulate the growth of credit that is not backed by real savings, leading to less responsibility on the part of creditors and borrowers, and a collapse of confidence in financial assets.

The main culprits of the global financial crisis are the fiscal authorities in the U.S. and European countries, who have pursued a policy of so-called “cheap” money in recent years. The governments of other countries, including Russia, also carry their share of responsibility for spreading and worsening the crisis. Government encouragement of credit expansion has led to massive investments into overly risky, inefficient, and unsalable projects. The illusion of the accessibility of investment resources, created by governments, has led to a decline in the quality of issued loans and purchased securities. As result, many banks have been unable to meet their obligations before depositors.

2. The Russian authorities have contributed their share to the financial “bubble” in our country. Due to their privileged status, state-owned and partly state-owned banks and companies borrowed heavily on foreign and domestic markets. In doing so, short-term loans were used for long-term investments, and to finance expenditures growing out of control. The disappearance of cheap credit destroyed such financial “pyramids”. With a fall in equity prices, companies whose shares were put as collateral to private and partly state-owned companies to obtain credit were now under threat of handing ownership to those creditors, including foreign ones. The threat that companies would be punished for their irresponsible borrowing policies became an instrument of their pressure on authorities, and the basis for transferring their colossal accumulated debts to the federal budget.

3. Provoked by government intervention, the mistakes made by banks and businesses are at the present largely irreversible; serious problems can no longer be avoided. The economy must undergo a period to correct those mistakes.

4. Presently, the primary danger to the global and Russian economies are the so-called “anti-crisis programs” put on by governments, which are hidden behind demagogic statements that the “free market” is supposedly to blame for the current crisis. Government intervention, which hinders the culling of inefficient investment projects, blocks the review of mistaken decisions and puts off the bankruptcy of irresponsible businesses, only deepens and extends the financial crisis, turning an inevitable short-term economic decline into a long-term depression. In world history, it is precisely the interference with market mechanisms that has had such dire consequences, such as the US Great Depression from 1929-33, or the transformation of Great Britain into the “sick man of Europe” from 1961-79, or the Japanese stagnation from 1991-2004.

5. The Liberal Charter alliance expresses a fundamental disagreement with the actions already undertaken, as well as the stated intentions of the Russian authorities – the president, parliament, government, and the Bank of Russia. Their plans of uncontrolled intervention in the country’s economy are, among other things, a disregard for the rule of law and the existing legislation, the undoing of the separation of powers, and the dismantling of democratic institutions accountable to the people.

We believe that the proposed measures are wrong. [These include] the use of federal resources, administered by the Government and Bank of Russia, to finance irresponsible borrowers, to support banks and stock market speculators who risked their client’s money, as well as acquiring shares of those companies that the market has lost confidence in. These measures will squander the federal gold reserves, which guarantee the value and free convertibility of the Russian ruble. They will inevitably result in higher prices for the public, who will end up paying for benefits essentially doled out to businessmen and managers close with the authorities. The concentration of financial resources in the hands of bureaucrats and their “inner circle” is aimed at further monopolization of property and power in our country.

6. In this time of crisis, a government responsible before the Russian people must follow financial policies based upon the following principles:

-Maintaining the exchange rate of the ruble against the pre-determined dollar and euro currency basket. A guarantee of the sanctity of gold reserves in the Bank of Russia to back 100% of issued Russian rubles. Continuing a responsible monetary policy, dictated by the basic principles of respect for property rights and meeting ones obligations, even if these obligations were not explicitly formalized.

-Preserving a deficit-free budget, where expenditures do not exceed revenues, [and committing to] prohibit the growth of public debt. At a time of unavoidable economic stagnation, public expenditures must be lowered proportionately with the fall in government revenues.

-Establishing transparent mechanisms for distributing assistance from the state budget and special endowments. Excluding the possibility that these funds will head to privileged banks and companies. The main way to use the budget surplus, which has accumulated in special endowments, must either be the return of previously collected taxes, or a reduction in future taxes.

– Directing funds from the budget and special endowments to commercial banks only in exceptional cases, and only through the mechanism of returning money to depositors (the so-called “monetization of bank liabilities”). The banks subjected to this measure must undergo bankruptcy proceedings. This provides an effective countermeasure to owners stripping assets, and allows for an open and transparent sale of all assets, with revenues going to the state budget. The expansion of a government role in the banking system’s equity is impermissible.

-It is unacceptable to use budgetary funds to rescue bankrupt companies. It is unacceptable to increase the government’s direct or indirect control over the real sector of the economy. Irresponsible business owners and managers should be punished by having the encumbered shares of bankrupt Russian companies transferred to their creditors– independent from their citizenship or country of registration. Bankruptcy sales must be carried out in open and transparent auctions.

-Reducing government intervention in the financial sector. The reorganization of the financial regulatory system on the principles of competition and free enterprise.

-Reform of the monetary regulatory system. The Bank of Russia should maintain its aim of supporting the value of the ruble, even as it ceases the additional powers granted it under the “anti-crisis measures.” Regulation of banks should be transferred to a separate government body. [This would] eliminate the privileges given to commercial banks, which arise from the Bank of Russia’s joint function of “printing” rubles and regulating the banking system.

7. The Liberal Charter alliance marks that the result of the so-called “anti-crisis programs” proposed by authorities will be the deepening and widening of the financial crisis, and the transition of a short-term recession into an extended depression. Preserving mistakes made during an economic boom, continuing the policy of promoting risky loans, and the misuse of public resources for false purposes will inevitably lead to grave financial, economic and social consequences. Russia does not need to repeat mistakes made more than once by authorities in the US, the European Union and other countries.

The only guarantee of the Russian economy’s competitive edge and long-term success, and that of the whole Russian society– is the freedom of entrepreneurship by Russian citizens. [Further, the] government must respect property rights and carry out responsible, consistent and ethical economic policies.

translation by theotherrussia.org

“All my contacts with representatives of the real sector of the economy describe how these businesses are starting to experience a certain financial hunger,” Putin said.

Russian companies have increasingly reported difficulties in obtaining credit, which has led to layoffs and shortages. Last week, Russian automakers GAZ and KamAZ announced that they were dealing with financial issued by cutting production and shortening the working week, respectively. Heavy industry, banks and retail outlets were also reportedly cutting staff and tightening operations.

Putin went on to urge lawmakers to act immediately to improve liquidity and access to credit, and to finish work on amending the 2008 federal budget.

“Decisions have been adopted, but in some cases cash fails to reach the real economy,” he said.

Still, the Prime Minister distanced his government from the crisis, saying that practically all world economies are hurting. Putin had earlier blamed the United States for failing to act decisively enough.

The Kremlin has already enacted several measures to improve liquidity in Russia’s financial system, including a 950 billion ruble injection into the banking sector. Despite this, Russian markets have imploded since the start of the year, losing over 60% of their value in 2008. Even with new imminent government intervention, the MICEX dropped nearly 5% today, while the RTS was down over 6% at closing.

Other institutions among the nation’s ten largest banks also saw large outflows of deposits.  Depositors withdrew 6.5 billion rubles from Raiffeisenbank, 4.3 billion from the Moscow Bank, and 2.9 billion from Alfa-Bank, Uralsib and Gazprombank.

The data seems to suggest that ordinary Russians are skeptical about the security of their assets, even as the Kremlin tries to paint a rosy picture about the economic situation facing the country on state-run media.

The banks themselves called the withdrawals insignificant, declining to describe the move as a crisis of confidence in the financial system.  Representatives told Vedomosti that the withdrawals likely had more to do with people returning from summer holidays.

In September, a liquidity crisis hit the Russian banking sector, resulting in sky-rocketing inter-bank lending rates.  A series of financial groups, including KIT Finans and Svyaz-bank, were ultimately purchased by state-run institutions for bottom-barrel prices.