Keep your eye on the ruble. Since the default of 1998, when the ruble collapsed and the savings of millions of ordinary Russians became worthless in a matter of days, the Central Bank of Russia has been pursuing a monetary policy known as “exchange rate targeting” – using the levers at its disposal to keep the national currency as stable as possible in relation to a given foreign benchmark currency or a basket of currencies. I’ve got to say that the CBR has done an admirable job pursuing this objective – the ruble has indeed been remarkably stable with respect to the US dollar and the euro for the better part of a decade, right on up until the dollar’s recent downward slide against all currencies, something that can’t be blamed on the Russians. However, this exchange rate targeting has come at the cost of high inflation for Russians, in part due to the continuing fall of the dollar, but also because of the less-than-intelligent fiscal policy the Russian power has been pursuing in recent years. On 17 June, Finance Minister Alexei Kudrin declared that over the next few years, the CBR is going to switch to a different kind of monetary policy – “inflation indexing”, where the objective is to keep domestic prices stable, even at the expense of the exchange rate. It is a maxim of macroeconomics that a central bank can only pursue one objective – you can’t keep both prices and the exchange rate steady simultaneously in the face of economic pressures, so you need to make a policy choice and stick with it.
The switch to inflation targeting makes sense politically. Consumer prices have been rising at an alarming rate in the past year or two, creating dangerous pent-up frustration and dissatisfaction with the power among the masses. But so far, the best solution the power could come up with for this crisis waiting to happen was a ham-fisted Soviet-style “voluntary-compulsory” freeze on prices for certain basic consumer goods from October 2007 until the May 2008 presidential elections, which was earlier analyzed on this blog. Now that the elections are over and the power feels it has been legitimized for the foreseeable future, prices are merrily rising yet again – the Federal State Statistics Service’s official inflation rate for 1 January through 9 June 2008 is 8.1%. The real rate, of course, is much higher. Needless to say, Russia will find it nearly impossible to meet its officially stated 2008 inflation target of 10.5%.One subject that has been quietly bandied about in the recent past is whether or not Russia ought to conduct a “currency reform”, essentially lopping off a few zeroes from the ruble, making a “new ruble” equal to 100 or 1000 or 10,000 or however many “old rubles”. This procedure, which is confusingly known as “denomination” in Russian and is sometimes incorrectly translated that way into English, is largely a psychological exercise that countries undertake after a period of high inflation has finally been brought more or less under control. Russia last conducted such a reform in late 1997, eliminating three zeroes. Unfortunately, it did this several months before the collapse of the ruble in August 2008. As a result, all those bright shiny new kopeck coins became worthless after only a few months in circulation, and the CBR ended up introducing ever-higher-denomination coins and banknotes.That reform, like all previous ones, was preceded by secrecy and vehement denials by the authorities that anything was afoot. During the previous reform, in 1991, when Soviet money was taken out of circulation and replaced by new Russian money, severe constraints were placed on citizens’ ability to exchange large sums of old rubles for new ones, with the result that many people lost their life savings because they were unable to exchange the full amount of the rubles they had stashed in their mattresses over the years.Everybody in Russia has noticed that the power has been sending up trial balloons about another currency reform in recent months, for example, all of a sudden asking readers of a news website in one of those “fun surveys” (you know the kind: “Should Britney Spears have custody of her children?”, “Do you like Barack or Hillary?”…) if they thought Russia should “denominate” the ruble or not. I’m sorry I don’t have the link to that website available any more, but I’m sure you’ll agree that you don’t just ask a question like that out of the blue. Officially, the power vigorously denies it is planning anything, but Russians still remember 1991.In a continuation of this process of slowly preparing the Russian people for a nasty surprise, the Russian website dp.ru, which describes itself as offering “Business news of Moscow”, published an interview on the subject with the economist Mikhail Delyagin early this year. While the article is admittedly somewhat dated, I think it will be of interest nevertheless.Mikhail and I have participated in numerous events together over the years, and his name has appeared numerous times on this blog, most recently when he made the news for having had the top half of his body airbrushed out of a TV talk show because he is regarded as a member of the “opposition”. And because Mikhail is regarded as being Kremlin-unfriendly, his spin on the looming currency reform is anything but positive. Below is our exclusive translation of this insightful interview, the original Russian version of which can be found here.
Mikhail Delyagin: “Currency reform is possible”Elena Vrantseva14.01.2008 15:39In the opinion of the well-known economist Mikhail Delyagin, currency reform, rumors of the impending conducting of which have greatly intensified, may whip up inflation and lead to an increase in prices.There is a flurry of rumors of currency reform in the country. In your view, is it possible?Currency reform is possible. But the point of it doesn’t make sense. It’s not like people are overburdened by excessive zeroes in today’s prices, because the prices for basic products in our country are counted not in thousands and not in millions of rubles. Nobody is getting confused by the zeroes.The wishful dream of returning to the scales of Soviet prices – is very dangerous. People will see just how much higher today’s prices are. Let’s say, a ride on the metro is going to cost 19 kopecks, and not 5 [as it did in Soviet times—Trans.]. And at the same time, the quality of the ride is worse. As a result, the propaganda effect will be not positive, but counterproductive.Currency reform always stimulates inflation. Prices in trade are rounded upwards. Small coins, which are accumulated by the population are not subject to the reform and go out of circulation. Their value will increase by a hundred or a thousand times. The purchasing power of today’s kopeck will become like that of today’s ruble.On the one hand, this is support of the poor. On the other hand, this is an increase in the money supply and inflation. Now, when inflation has gotten out of control and the government is expending titanic efforts to bring it back down, to go for propagandistic steps that risk an increase of inflation is hardly rational.From where could have the talk about currency reform come? What has brought it about?Talk about currency reform – this, in my opinion, is a reflection of the overall nervousness of the population, which knows for sure that everything is going to be bad, but does not know what specifically is going to be bad. This is a collective psychosis.I was pestered before the new year with requests to comment on the imminent currency reform. People were convinced that an ukase had been signed on the start of the reform on 5 January. Now there’s the same kind of wave going relative to 25 January.But is a reform before the March elections realistic? It is more logical to assume that it will be in April.I haven’t heard about April yet. The idea was supposedly to conduct the currency reform before the elections, so as to return the Soviet scale of prices to the people. But this will show the “un-Soviet” level of well-being – it has become lower for the majority of the population.Are the economic prerequisites for a currency reform there now?The economic prerequisite for a currency reform – this is when all prices have an excessive quantity of zeroes. We do not have such a situation now. Why turn 5 thsd. rub. into 50? I don’t understand. Maybe someone pig-headedly wants to earn money on the printing of hundred-thousand [ruble] banknotes, which as a result will become hundred ruble ones. There is no logical explanation for this.What could you advise private investors? How to hold on to money during the time of a currency reform?Money doesn’t vanish during a currency reform. Nothing happens to it. After the currency reform of the year 1997, the old money remained in circulation for a long time still. Restrictions on the circulation of old money were introduced only in the year 1991. But then there was a currency reform that had been conceived of as confiscatory.And could the reform be confiscatory this time?No, because there’s no reason for that.If we assume that there will nevertheless be a currency reform, how many, in your opinion, zeroes might they chop off – two or three?If the objective of the reform will be to bring prices closer to the Soviet scale, then instead of a 50 thsd. banknote there will be a 50 ruble one. Most likely they’re going to be chopping off two zeroes. But there’s no point to this. I don’t believe in this.But still if a currency reform does take place, to what consequences will this lead?Inflation will speed up a tiny bit. By half a percent during the course of two months. So there really isn’t anything to even get worried about with the reform.But if someone wants, they can accumulate five kilograms of small change. Only what will they do with it if the reform doesn’t happen.