Russian Economy The global economy has been brought about through innovation, technology and de-regulation. To the extent the government prints more Rubles than the equivalent of the hard currencies earned on exports, it will lower the real exchange rate value of the Ruble. In effect the government makes itself a forced partner of anyone with Rubles, whenever it prints Rubles for which there was no corresponding production of goods. By laws and policies it transfer this money from the poor to the rich. Printing Rubles is the same thing as collecting a tax.
But it is a tax on possession of money not production of money and is therefore parasitical. If a country runs a current account deficit it needs to finance it with a capital account surplus (i.e. inflow). If it has a current account surplus, it must have a corresponding capital account deficit (i.e. outflow). Comparing 1979-81 with 1985-88 West Germanys capital balance moved from an inflow of $8 billion to an outflow of $40 billion.
Japan’s from an inflow of $5 billion to an outflow of $75 billion, and Americas from an outflow of $2 billion to an inflow of $129 billion. But this yardstick is hardly of any use: it is inaccurate and misleading. A balance of payments yardstick for capital flows gives a misleading impression because they show net rather then gross flows of capital. In 1980 total world bank cross border and foreign currency lending was $324 billion. By 1991 it was $7.5 trillion.
The combined GDP (Gross Domestic Product) of the 24 industrial countries in 1980 was $7.6 trillion; in 1991 it was $17.1 trillion. 1996 GDP of Russia as half a trillion. So during the past ten years bank lending has risen from 4% of GDP (Gross Domestic Product) of these 24 nations to 44%. From 1970 to 1988 the ownership of American bonds by foreigners increased from 7% to 17% and for Germany from 5% to 34%. Turnover in foreign exchange is now $900 billion each day. There are now 35,000 trans-national companies with 147,000 foreign affiliates.
Finance has become totally global. History shows that the countries whose governments do not involve themselves in business and have the fewest regulations about business, get the most investment. Russian budget investments are not investments at all but subsidies. They is no substitute for real capital. Neither are Western government budget allocations investment. Elimination of regulations about business (Freedom) is what develops economies. Currency risk is the greatest deterrent to investment.
In an international economic system of global integration, differences between interest rates precisely match the expected changes in the relevant exchange rates. If a one year dollar assets yields 5% and a one year Ruble asset yields 600%, investors must expect the dollar to appreciate 595% against the Ruble over the next 12 months. It is more difficult to steer economies with Monetary policy and fiscal policy when capital flows freely in a global economy. Financial interdependence has neutered government economic policy makers. Monetarists believe that all you have to do to control inflation is control the supply of money. The quantity equation of monetarists says that the supply of money in circulation multiplied by the number of times it turns over in the economy each year must equal the price level, multiplied by the amount of output produced.
Under these conditions slowing the growth of money will slow the growth of demand. The events of the 1980s have obliged us to disregard this theory. It has however been accepted that output is driven by supply-side factors and not by demand. For monetarism to succeed it must be possible for the government to control the supply of money and there must be a stable relationship between the amount of money and the amount of demand in the economy. Due to financial innovation and the expansion of global finance neither of these conditions was met in the big industrial economies in the 1980’s. Raising interest rates no longer controls the money supply.
Domestic interest rate policy is undermined in a global economy. Higher interest rates increase exchange rates. If governments chose to limit exchange rate fluctuation they cannot increase interest rates. The truth is that there is no longer any such thing as money in the historic sense. Charles Goodhart proclaimed the following law.
Any statistical regularity breaks down once pressure is placed upon it for control purposes. Governments change the way an economy works when they try to act upon it (control it). In a time of rapid innovation, expanding cross-border flows of capital, diminishing control through regulation, and the creation of new borders, the opportunities for statistical regularities to break down in unforeseen ways are multiplied many times over. Loosening fiscal policy (budget deficits) together with tightening monetary policies (currency exchange controls, higher taxes, business regulation) create high interest rates. Russian policy has driven $260 billion in flight capital out of Russia in the past five years negating the effect of all foreign investment. International capital has played a big role in supplying the needs of the American government.
America’s account balance worsened from a surplus of $1 billion in 1980 to a deficit of $160 billion in 1987.- the mirror image of the country’s inflows of capital. If capital controls had been in place, America would have had to finance its fiscal deficit domestically. That would have required interests rates to rise significantly. If the deficit had been financed by printing money, as Russia has done in 1991-1996, rising inflation would have resulted. Without open borders to capital and a free market economy absent of government regulation of business, interests rates, or exchange rates, the choice facing Russia is the same.
Since Russia has limited borrowing credit abroad it cannot be irresponsible in spending or it will inflate the Ruble. That is a useful reminder. The ability to borrow money can be harmful to an economy. Russia can follow the example of Baltic currencies or those of The Ukraine. The greatest opportunity for Russian economic recovery is to eliminate all rules and regulations and allow business the opportunity to expand GDP (Gross Domestic Product) and thereby pay more to the government at lower rates of taxation.
This will permit the government to spend more of this revenue on social services and invest in expansion of future production by providing credit to industry at affordable interest rates. To survive through the transition period it will be necessary to substitute compensatory finance for printing of currency. It is also necessary to repay debt by transferring ownership of industry. The market is self disciplining with punishment (bankruptcy) for failure. This is much preferred over government regulation by fiscal policy.
Open capital markets lets business men pass a vote of no confidence in the government by moving money abroad. Such exercise of discipline by the market over government is the best self correcting economic policy. The threat of capital flight is a powerful sanction on the government and assures efficiency. It vetoes unaffordable programs and establishes priorities. It delays purchases until the purchase price can be earned by producing it. Is the market vicious, frightening and unfair? So far those Governments who live by it have survived and reached the highest standard of social services for their citizens.
America, which has increased its capital inflow to compensate for its trade imbalance, is surviving on trust that it will not start the printing presses and inflate its currency, thereby settling its debts by inflating them away. America continues to attract capital because its creditors trust it not to inflate. Will Russia …