More on Russia, The Rouble, Sanctions & Gas.

By | October 10, 2014

The western media likes to howl about how sanctions are affecting Russia. But who do they really effect?

The effect of US trade sanctions on Russia and vice versa is minute as their total annual trade value was about $5-6 billion. If this halved to $3 billion neither the US or Russia would notice. That is pocket change…

The effect of trade sanctions on Europe is much more severe. Putin has always said that trade sanctions cuts both ways. It appears that these trade sanctions are now tipping continental Europe into a “triple dip” recession.

Europe has “shot it’s bolt” on trade sanctions, but Russia has held back from further escalation. Russia is waiting for mid-winter when the “gas weapon” has maximum effect.

Come December, Ukraine will have no choice but to steal the gas flowing through its pipelines to Europe. Russia will use this as a pretext for shutting off ALL gas supply running through Ukraine. The effect on Europe will be devastating.

Expect a whole heap of back tracking by European leaders. Cancellation of nearly all the current trade sanctions imposed by Europe will be part of Putin’s price for switching on the gas supply.

Gazprom and the Russian government have made it clear that they have no intention of breaking sales and supply contracts, not from their side. There’s all sorts of reasons to not do so.

But if customers insist on breaking their contracts then the supplier might choose to agree that the contract has been broken by the buyer and cease supply prior to re-negotiating a new contract.

As for the economy as a whole, while the accelerated fall in value of the rouble was a concern, and addressed by the Central Bank, there’s good evidence that the ruble was over valued. The currency has been on a consistent trajectory for many months, a year or so before the current silliness, interrupted only by a short blip in February of this year.

In 2015 the ruble will become fully convertible currency moving away from its currently managed ‘dirty float’ to a full floating currency, that is why the ruble has been allowed, encouraged even, to fall to its true value now rather than after the full float takes over.

The suggestion is that the currency against the dollar may now be slightly undervalued, having overshot slightly. Which might explain the choice to intervene. How can one understand that the rouble was overvalued? Inflation.

You see inflation is a reflection of the value of the currency, its price if you will. If a currency is overvalued then national prices will rise until the currency has been devalued to its ‘correct’ price. The same effect occurs in the exchange rate, another reflect of the currency’s ‘price’.

Thus we can understand that, unless the decline continues for an extended period, that there is no problem here. If the ‘correct or market sustainable price has been reached then inflation will start to fall as well.

Of course a declining ruble has advantages, for example, Russia imports fewer consumer goods from the rest of the world than most other advanced economies, that’s because Russia has a very robust (believe it or not) manufacturing base and can substitute many manufactures with local goods, but that base suffers from low productivity per dollar of inputs.

As the dollar becomes relatively more expensive then the relative productivity per dollar of input goes up and local manufacturers move into profit at the same ruble prices, thus they become more competitive than potential imports from other countries such as China. This seems to be quite noticeable in the manufacture of clothing.

Also, the relative profit per unit of energy exported increases because the hydrocarbons in the ground cost very little to extract per unit, on a marginal cost basis, but their price in roubles is actually going up meaning more profit for the country. Also, because Russian energy is relatively cheap anyway, they mop up extra sales in comparison to more expensive producers. Oddly enough, this benefit applies even is, as is suspected, the US and Saudis are conspiring to push the cost of oil down.

Access to credit has been pointed out as an issue affecting Russia, but not so much, in truth. You see Russia runs a balanced account in respect of its budget and has a huge amount of reserves of currencies of all reserve denominations plus a LOT of rubles stashed away. If necessary, and this has already been made clear, Russia will lend to Russian capital investment projects.

Most countries could not do this but Russia can and will even make a profit from it because they can almost certainly obtain a better rate of return from such investment than they could from investing in the global markets with their current almost invisible rates of return.

Lastly, for this post at least, the issue of ‘capital flight’ this is something of an invention of western media and their handlers. It is normal for money to leave a country and to be replaced by other money. However what has been happening is that all forms of money leaving Russia, for whatever reason, have been allocated, incorrectly by western ‘analysts’ to the heading ‘capital flight’.

So, all money leaving the country for foreign investment, all purchases of currency by Russian tourists, all banking transactions between Russian banks and their foreign branches, all purchases have been lumped into the heading. In truth in the current account the only money that should be labelled as ‘capital flight’ comes under a heading of ‘errors and omissions’ or similar and is a pretty small amount.

The reality is that import substitution of foodstuffs as a result of sanctions against the west will have had a one off hit on inflation but those prices will tend to fall anyway. Most of the effects upon Russia of sanctions upon them are, as the Russians have said, in fact, a stimulus to the economy.

There is now a move toward sustainable autarky in some areas of the economy and given Russians unusual degree of vertical integration from energy and raw materials up to value added consumer goods there’s no worry that they can not attain over a short time productivity increases independent of the dollar valuation of the rouble that become globally competitive manufacturers.

If the US was faced with a similar set of issues to Russia could they react with equanimity? Not a chance, the manufacturing base does not exist, the vertical integration does not exist, the financial structure does not exist and the will of the people, almost certainly, does not exist.

That’s probably why it is easy for foreign (western) commentators to come up with these stories, because they might actually believe them due to their own cultural bias – they know the US (and EU) could not withstand what is going on in Russia and so they assume that Russia can not either.

Europe needs gas and oil. America needs neither from Russia. Europe will soon notice that America’s sanctions affect Europe more than America. Finland, Hungary, Czech and a few other places are already eschewing sanctions. Close neighbours don’t want to piss off the bear because Uncle Sam won’t send them gas.

Putin isn’t dumb. This will level out soon enough. And if he starts to play hardball, watch American big business that wants a bit of 140m consumers pressure the US government to shut up. Finland is already begging the EU for money, Polish farmers are watching piles of apples rot and Warsaw isn’t paying their bills.

One cold winter with reduced Russian gas will soon make Europe wonder who its friends are.

Putin only has to wait. Europe will eschew America and come to him. Rightly so. America has no business meddling in Europe.

Thousands died needlessly in Ukraine because of American meddling. Same as in Iraq/Syria now and any other place far from America where America is the common denominator. People are slowly waking up to the worlds most prolific terrorist state.

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