Where Is Russia’s Disastrous Inflation Coming From?

In November the officially-calculated inflation in Russia hit 8.1% annualized — a record since 2016. Altogether the inflation in Russia from the start to the end of 2021 will be around 7.5%. (It was already 6.25% in the first 10 months, with November and December coming in at 8% annualized that will be another 1.3%.)

Inflation hit 8.1% last month, the Rosstat national statistics service said Wednesday — the fastest rate of price increases since February 2016, and more than double the Central Bank’s 4% target. That was up from a reading of 7.4% a month earlier and ahead of market expectations.

This is all the more curious since the Central Bank has been in a self-proclaimed war on inflation since 2015 and has kept interest rates high to make the point. Yet instead of reigning in inflation and hitting the 4% target, Russia is recording official currency depreciation on par with that in the US, except that Russia hasn’t given away trillions in new currency since 2020. So where is all this inflation coming from?

When new money is printed it’s usually to cover deficit spending but that isn’t the case here. Russia has been running surpluses or tiny deficits. Nothing that would cause 7.5% inflation in just one year.

Another source of new money is fractional-reserves lending. Since banks are required to actually possess only a fraction of the money they lend out the difference is made up for by money creation. This can happen on a scale big enough to show up in purchasing power drops but realistically that only happens when interest rates are unjustifiably low and there is a self-reinforcing snowball of loan-taking as one cheap money project makes other potential credit-funded projects upstream and downstream incorrectly seem attractive and prudent against the availability of cheap money, and these have the same effect on yet more. However, since 2015 the Russian Central Bank has famously made loan-taking very expensive. It only eased to the still moderately high 4.25% last year, and only for several months as it has already been jacking back up since spring. Thus there is very little possibility that Russia is in a large credit bubble or that one is popping right now.

The high interest rate and the lack of deficits have in the past led me to describe Russia as a “financial fortress”. Fiscal fortresses however do not rack up 7.5% inflation rates so I am forced to reconsider. If ruble is losing purchasing power that means that somewhere more ruble is being added, the question is only where.

This is conjecture but I think the likeliest candidate is Russia’s foreign currency stash and how it gets funded through the export duty on natural resources.

In the aftermath of the US-Western-Saudi financial war on Russia launched by Obama in 2014 Russia was hit hard enough that its reserves dropped from $500 billion to “just” $360 billion. However Russia has since completely rebuilt its reserves and even drove them up to an all-time high of $620 billion, exceeding the stash it held before the 2008 financial crisis. It has done so despite the fact that Obama’s offensive also caused the ruble to go from being valued at 35:1 to the dollar to just 70:1.

How was Russia able to accomplish this feat of quickly re-accumulating massive reserves of (mainly) euros, all the while under a machine-tool, credit, and investments embargo by the West?

Was Russia running big budget surpluses, converting the surplus rubles for euros on the foreign exchange, then adding the euros it had purchased to the reserves? No.

The Russian government does not need to buy foreign currency because it already collects a portion of taxes in dollar and euro. Russian exporters of oil and other mineral resources sell them to foreign buyers for American and EU currency and Russia taxes them before they convert the proceeds back to rubles. For example in December 2021 oil exporters must surrender $77 dollars for every metric ton of oil sold abroad.

From there the obvious course of action for the Russian government is to sell the dollars collected for rubles, and use the latter to fund its expenses. From the fact that foreign reserves have been growing quickly, it is obvious however that that isn’t what Russia has been doing. Instead, it has been funneling much of the foreign currency earned into its reserve funds. That wouldn’t be a big deal if Russia was able to balance its budget without these earnings but the fact that there is inflation is a sign that it is not.

Instead, it seems that when Russia earns dollars through the sale of oil and metals it prints new rubles against those dollars, uses the rubles to finance the budget, and debits the dollars to its strategic and investment reserve funds. In this way, the government is able to earn “double”. It profits both from the dollars it earns, and the new rubles it prints against them. This doesn’t weaken the ruble on the foreign exchange since the equivalent in foreign reserves is taken out (but does make it very unlikely it can ever appreciate). What it does do however is to add a small but constant stream of new rubles that ordinary Russians have to deal with.

When the US prints more money those extra claims for goods are soaked up by its domestic physical economy, but also by the entire international trade and the entire world of global finance. Inflation is spread out between goods and services in the US, but also between any goods and services moving between two foreign states. It is also soaked up by all manner of speculative markets and financial instruments where it blows up bubbles and delays the onset of inflation as expressed in basic goods prices until the bursting of such bubbles (which can take decades).

In Russia however, every billion printed goes straight into prices of basic goods almost immediately. There is no trade between third states in rubles, or massive ruble-denominated stock markets to help soak those notes up. In this way, much less expansive money printing can still take a heavy toll on the populace. 7.5% does not sound like much, but if you are a pensioner surviving on 12 checks per year it means that you are de facto left with only just over 11. And that goes on year after year. Russia admits that pensions won’t keep up with inflation in 2021, but whether there is an official admission or not that is true virtually every year. Russians do not enjoy a high standard of living, and most of the retirees lead extremely modest lives, materially not much above bare survival.


“This is an absolutely catastrophic picture,” notes Evgeny Suvorov, an economist at Tsentrokredit Bank. – We are not dealing with a rise in prices for individual product groups. The acceleration is on a broad front.”

According to Rosstat, prices for chicken increased by 4.8% since the beginning of October and 30.18% year-on-year. Beef is 14.07% more expensive than a year ago, pork is 14.68% more expensive. Buckwheat is becoming more expensive at a rate of about 1% per week and has reached an annual growth of 18.46%.

Flour has added 1.9% to price tags since the beginning of October and 10.56% in annual terms. Eggs have skyrocketed 11.13% in four weeks and are 26.78% more expensive than a year ago.

The annual growth in prices for vermicelli reached 11.31%, for sugar – 13.57%, for cucumbers – 60.50%, for tomatoes – 58.82%. Potatoes and cabbage continue to share the “pedestal of honor” with growth of 74.11% and 87.87%, respectively. [Link.]

The Russian government earning “double” in the export-duty-to-reserves scheme comes at the cost of the ruble never appreciating and foreign goods and travel never becoming more affordable for Russians (except to currency disaster zones like Turkey). And more importantly, at the cost of steadily increasing prices for domestic goods, even basic ones. In fact, the government double-dipping means the reserves are boosted through the steady theft of purchasing power of the populace.

61% of citizens cite the rise in prices as the main cause of anxiety – this answer is by a large margin ahead of others, including poverty (36%), corruption (33%), rising unemployment (33%), the Levada Center poll showed.

Even the pandemic (32%) worries people less than the inflationary fire that has engulfed the economy, which has barely managed to catch its breath after the historic collapse of oil prices. [Link.]

The Central Bank can jack up interest rates into the stratosphere and scream that it is waging war on inflation until final victory until it is blue in the face, but as long as new rubles are being added into the mix that simply isn’t true.

Having a massive foreign currency stash allows Moscow some flexibility and peace of mind in case of a crisis (sanctions, war), but given the hardships building it up without accompanying spending cuts imposes on the Russian people (which historically never ceases to be asked to sacrifice yet more for the state) it is fair to ask if it is worth it? Especially since hoarding the currency of your enemies actually helps soak up their inflation and alleviates the downsides of their money-printing for them.

Compare this to a hypothetical situation where Russia restored its 1897-1914 gold standard. That would immediately stop all money creation ushering in a situation for the Russian people where theft of their purchasing power was impossible and they enjoyed stable prices which actually slowly fell over time as technology and productivity leaped forward. It would be a great deal for the Russian people and gold would represent a challenge to world dollar hegemony in the way a paper ruble never can. The potential upside would be nothing short of gargantuan —— if the dollar’s primacy was shaken up and the US was again forced to live within its means all of Russia’s security problems would be solved at a stroke, without ever having to fire a shot or forcing a dangerous confrontation. The only Russian entity that would have to bear the “costs” would be the Russian government itself on whom harsh fiscal discipline would be imposed.

Between these two options of building up a mildly useful stash of depreciating and potentially worthless foreign paper at the expense of Russian grandparents and the working class on the one hand. And pointing a spear at the very beating heart of Washington’s global dominance but at the expense of real fiscal discipline for the Russian government, the Russian government naturally picks the latter.

The technocratic “system liberals” who manage the investment portion of the reserves, as well as the financial policy itself, wouldn’t want it any other way. Nor would the classical statists who put them there.

The silver lining is that Moscow is phasing out export duties and plans to end them by mid 2020s (it is moving toward taxing resources at the point of extraction). With that, the window for this particular inflationary scheme will be closed. In fact, I wonder if Moscow has in the last few years been “earning double” in a particularly aggressive way knowing that the window is closing, and if the record 2021 inflation isn’t a consequence of that.

Another question is, is there another reason Russia was particularly aggressive in adding to its reserves in 2021? (It added nearly $50 billion in just the short 8 months since March. That doesn’t sound like much to American ears, but that is one-half of the annual Russian military budget.) Is there an expectation of more sanctions in 2022 and why?