The ruble has appreciated exactly BECAUSE the sanctions are working

The question I have been asked most over the last week is why the Russian ruble is been appreciating despite the fact Russia has been hit by extensive economic sanctions.

I must honestly admit that since the sanctions were introduced I have not spent much time following the development of the ruble – or rather the ruble exchange rate on our screens does not really tell us much as the ruble today cannot really be said to be a convertible currency in the traditional sense.

If, for example. showed up at an European bank with rubles and wanted to exchange them for euros then in practice you would hardly be able to do so.

This is because the Russian central bank (CBR) has been sanctioned and what happens in practice is that if you have to exchange rubles for euros the money is basically deposited in the Russian central bank, which then gives back euros – directly from the Russian foreign exchange reserve.

This can now not be done as the CBR simply does not have access to trade in e.g. euros or dollars. The foreign currency remains in the foreign exchange reserve, but the CBR just cannot use it. This is equivalent to having money in your bank account, but the online banking and credit cards do not work.

At the same time, Russia is largely shut out of the so-called SWIFT system used to conduct international currency transactions. This means e.g. that in practice you cannot transfer money between e.g. Denmark and Russia. So if e.g. If a Danish company sells a product to Russia, it will now in practice not be able to receive payment for the product.

On the contrary, Russia’s oil and gas exports, which are basically the only thing that Russia exports, are not covered by the sanctions, and Russia can continue to receive payment for e.g. gas exports to EU countries.

Slightly simplified, Russia can now not import very much, but the country can continue to export. In other words Russia’s imports have collapsed while exports are less severely affected by sanctions.

Consequently, Russia’s trade balance surplus has increased sharply in the past month.

And that is basically the reason why the ruble has appreciated in recent weeks.

Does that mean that the sanctions do not work?

If you have a mercantilist view of the world – that is if you think that it is always good to export and that imports are bad then the sanctions are great for Russia.

This view, however, corresponds to saying that it is good to work and bad to consume, but there is basically only one reason to work – namely to consume. We do not work for fun – we work to be able to consume – whether it is food or luxury goods.

Right now, Russia is now basically forced to “work”, that is, to sell oil and gas, but at the same time Russia cannot use the revenue.

At the same time, it is part of the stpry that the Russian government has severely restricted the right and opportunity of Russian citizens and businesses to own foreign currency, and citizens and businesses are forced to convert the bulk of their foreign exchange earnings into rubles. This may also to some extent also have supported the value of the ruble.

In addition, it should be noted that Russian interest rates have skyrocketed and that is basically the market compensation for the fact that the ruble has lost value – and is expected to lose additional value in the future.

Finally, the Russian foreign exchange reserve has fallen quite sharply in the past month. Thus, the weekly foreign exchange reserve data from the Russian central bank show that the foreign exchange reserve on February 25 amounted to USD 629.4 billion. By March 25, that number had dropped to USD 604.4 billion.

This is remarkable given that we know that the trade surplus has risen sharply and that Russia cannot trade Western currencies.

Do the sanctions work?

If one is to judge whether the sanctions “work” then one must relate that to what the purpose of the sanctions is.

The purpose of sanctions is not just to “punish” Russia and revenge is certainly not the main purpose. The main purpose must be to sharply reduce Putin’s ability to continue waging war.

Russia needs imports when it comes to waging war. For example Russia must use technology in military production or tires for military vehicles etc. All indications are that these imports have now been severely hampered.

At the same time Putin is dependent on economic growth both to finance the war itself (and possible future “adventures”) and to bribe those he need to support him both in the wider Russian population and among oligarchs, and more importantly in defence and the security apparatus (the so-called Silovik).

Hence, the sanctions hit the Russian economy and Putin regime very hard, but as Russian oil and gas exports are not covered by sanctions the West will be affected to a much lesser extent.

If on the other hand the EU and the West in general closed off imports of Russian oil and gas it would send oil and gas prices skyrocketing and the European economy would be hit quite hard and the European economy would most certainly end up in recession.  

A recession that could potentially threaten popular support for the hard line against Putin and which could create divisions among the EU countries.

On the contrary, Russia is already in a situation where oil and gas revenues, which are typically in euros or dollars, are not worth much, as Russia basically do not have access to spend euros and dollars.

The only thing these foreign exchange earnings today can be used for is basically to service the Russian debt in these foreign currencies. Again, it is primarily the Western investors who own the Russian government bonds that are benefiting rather than the Russian government.

So yes the ruble has appreciated in recent week, but it actually reflects that the sanctions against Russia are quite well calibrated – it maximizes the negative effects on Putin’s ability to wage war and at the same time it minimizes the negative effects on the global economy.

The “black market value” of the ruble has fallen sharply

Finally, it must be said that the ruble exchange rate that we can observe on various financial news sites is not necessarily the actual exchange rate.

In Soviet times, there was an official ruble exchange rate, but it did not have much to do with the real exchange rate. The actual exchange rate was the one you could read if you asked the black market currency traders on the streets of Moscow when exchanging physical dollars for rubles or the other way around.

In currency terms, we are now to a large extent back to the Soviet era, but today we have an easier way of observing the “black market rate” of the ruble. Hence, you can still trade bitcoin and other cryptocurrencies in Russia.

If I want my money out of Russia, then I can exchange my rubles in Russia for bitcoin, and then fly to for example Turkey and get my bitcoin paid out for dollars or Turkish lira on a Turkish crypto exchange.

Thus, by using the “local” Russian bitcoin price, we can calculate what the real value of the ruble is if one were to exchange it for dollars on the “street” in Moscow.

This “premium” which you have to pay for for example Bitcoin in Russia relative to Bitcoin elsewhere has fluctuated between 10-30 percent over the past month. It is smaller now than in the days immediately after the war started, but it is still significant.

Finally, Russian exporters of goods must also accept a discount when they export. Thus, the price of oil from Russia today is about 30 percent lower than what oil otherwise costs on the world market.

We can thus conclude that, paradoxically, it is the sanctions – because it works – that help keep the ruble exchange rate up, but the goods that Russia exports are sold at a significant discount, and at the same time the “street price” of the ruble is significantly below the “official “Exchange rate.

There is therefore no reason to be blinded by the development of the ruble exchange rate, which we can observe on various finance sites, as it does not really say much about the financial flows in and out and Russia and the state of the Russian economy.

Ukrainian default risk drops BELOW Russian default risk

This is a bit of a humiliation of Putin – the so-called Credit Default Swap (CDS) for Ukraine is now LOWER than Russia’s CDS.

A CDS is the price to insure against losing money on a government bond in the event of a government default.

In other words, investors now see it as MORE likely that Russia will default on its sovereign debt than Ukraine will.

Below, the white line is Ukraine’s CDS, while the orange line is the Russian CDS. The green graph at the bottom shows the difference between the two.

It’s a lot of buts and ifs, but it’s probably a pretty good indication of the situation for the two countries.

On the one hand, Russia can look forward to tough economic sanctions from the West for many years to come – unless there is “regime change” in Russia.

On the other hand, Ukraine can probably very much look forward to help from the West when peace comes at some point.

Russia: From crony capitalism to planned economy in three weeks

For more than travel 20 years I have worked professionally and travelled extensively in Central and Eastern Europe – including in Russia and Ukraine.

My Polish and Lithuanian friends again and again over the years have warned me about what have now happened and I must admit that while I 15 years ago was sceptical about this take on Putin I have come to share the view of my Polish and Lithuanian friends and particularly since 2014 I have feared what Putin would do next.

So unfortunately I am not totally surprised by Putin’s invasion of Ukraine.

But this blog post is not about my feeling about the invasion – I am horrified and angry – but rather an attempt of sharing my view on where the Russian economy is going from here.

I a lot of course dependent on what happens on the battlefield in Ukraine and whether or not Putin stays in power and on that I can’t make an informed guess so my assumption here is that we effectively have entered a ‘New Cold War’ and the sanctions implemented against Russia will remain in place for some time to come.

A massive trade and liquidity shock

It is obvious to everybody that the sanctions and the global private sector reaction to Putin’s invasion of Ukraine is a massive direct shock to the Russian economy that completely have paralyzed the Russian financial system and the economy in general and cut the value of the Russian ruble in more than half.

The easiest way to understand that shock is essentially to think of it as a major liquidity shock what hit global economy in 2008. This one is just many times bigger. The implications for the Russian economy is obvious and that shock on its own should be expected to cause a drop in the Russian real GDP of at least 8-10 percent.

However, what I want to discuss in this post is not this from an economic theoretical perspective rather ‘normal’ shock. The purpose of this post is rather to discuss the possible transformation of the Russian economic political system that we likely will see in near future.

From crony capitalism to planned economy

Prior to the collapse of the Soviet Union in 1991 the Russian economy was a communist planned economy with little private ownership of business and essentially no use of the market mechanism.

Over the past three decade the Russian economy has gone through an enormous transformation from the planned economy to what we could call a commodity based crony capitalist economy.

Economic reforms in Russia has been rather imperfect, there is massive corruption and private property is certainly not automatically guaranteed. Furthermore, major business interests – popularly known as Oligarchs – are in bed with the ruling class and government.

Theft rather than trade has been a dominant factor of the Russian economy for decades – or rather centuries.

However, there is – or rather has been – a widespread use of the market mechanism and productive resources are to a large extent allocated based on market principles and therefore Russia can be described as a capitalist economy – but a rather imperfect one or what has come to be known has a crony capitalist economy. In that sense Russia, however, is not much different from many other Emerging Market economies.

Things are, however now set to change dramatically to the worse and while the Russian economy likely will remain a ‘crony economy’ it will likely be without the ‘capitalist’ part in the future.

The sanctions against Russia mean that Russia is now actually totally dependent on barter in foreign trade – oil and gas for cars, spare parts, medicine, technology, etc.

That combined with a ruble that has collapsed means that we may soon be heading towards 75-100% inflation in Russia.

That would be politically unacceptable for the Putin regime. Consequently, we will soon see the introduction of widespread price controls in Russia, where prices are frozen below the market price.

The result of price controls is always the same – soon you will see empty shelves in the supermarket. The regime will blame the sanctions and that will be partly true, but price controls will have an even more devastating effect. This is the kind of thing we have seen in Venezuela for more than a decade.

The political answer will most certainly be rationing.

And since the financial sector has essentially collapsed in Russia all allocation of credits will be state controlled and as companies will not be able to make any money with prices far below the market price, they will soon become completely dependent on government subsidies to survive. Nationalisations follow as a natural economic-political consequence.

In fact the Russian government has already announced that it does not rule out the nationalisation of foreign companies in Russia, and it has already dictated that companies in Russia must convert at least 80% of the companies reserve in foreign currency into rubles.

It is therefore to be expected that in the coming months we will see a wave of de facto nationalisations in Russia.

As foreign exchange reserves are now very limited and all imports essentially will be barter based and Russia will have to pay a price way above global market prices we should expect that all foreign trade soon will be strictly regulated. “Unnecessary” imports will be banned.

It is already happening. Yesterday, Russian Prime Minister Mishustin announced that all exports of sugar will now be banned as Russia is facing a “sugar shortage”.

Military needs will dictate the composition of Russian imports – and therefore also what may be exported.

Young men are also a production resource – a productive resource that is used to wage war, but Russia’s youth have had it with Putin’s regime and the collapse of the economy and the prospect for going to war and dying in Ukraine is causing young Russian to flee the country. It is said that more than 25,000 Russians have already left for Georgia since Putin’s invasion of Ukraine.

The exodus of young Russian in fact started more than a decade ago, but this process is now accelerating dramatically. Polls done even before the war on Ukraine have again and again shown that more than half of the Russian population would like to emigrate. That number is now skyrocketing – particularly among the young.

The Putin’s regime can hardly accept that much longer – and therefore it is only a matter of time before a “Russian wall” is erected – and in the same way as with the Berlin Wall, it is not about keeping enemies out, but about keeping the population confined.

Twitter users have in recent days shared films of Russians fighting over sugar in supermarkets and a lots of empty shelves. There is nothing to celebrate about this, but this is likely to be the reality that Russian will now be facing.


I personally have no joy in seeing regular and innocent Russians suffer because of the crime of Putin. I have travelled – primarily professionally – in Central and Eastern Europe for over 20 years, and know Russians, Poles, Lithuanians, Ukrainians, etc. and over the years they have shared stories with me about the horrors of living in communist dictatorial planned economies. I never met anybody longing for a return to a planned economy.

The free market economy and democracy have lifted millions of people out of poverty in Central and Eastern Europe over the past three decade. Now Putin has beaten 140 million Russians 30 years back economically and politically.

Putin wanted the borders of 1991 back, but he got the economy of 1991 instead. The question remains whether he will survive that.


New Paper: Digital cash, the conduct of monetary policy and the monetary transmission mechanism

I have a new paper out at Center for Corporate Governance at Copenhagen Business School.

Here is the abstract:

More and more central banks around the world are seriously considering introducing so-called Central Bank Digital Currencies (CBDC).

In this paper we discuss the implications of introducing digit cash for the conduct of monetary policy and the monetary transmission mechanism.

It is concluded that the introduction of digital cash will not necessitate a fundamental change in monetary policy operations, but it might nonetheless open the door for policy innovations.

The introduction of digital cash will, however, impact – potentially significantly – the size of the money multiplier and might increase the effective lower bound on interest rates.

Both factors will cause an initial tightening of monetary conditions. However, such tightening can and should be offset by a strict commitment to monetary policy rules and through measures to ease legal requirements for liquidity, capital and reserves.

Read the paper here.

New paper: The financial sector, welfare gains and regulaton – A Danish Perspective

I have a new paper out at Center for Corporate Governance at Copenhagen Business School.

Here is the abstract:

Throughout their lives, all citizens come into contact with the financial sector – whether through
children’s savings accounts, home loans or pension saving – and it is impossible to imagine a wellfunctioning market economy without one.

The financial sector plays a core role as a provider of financial intermediation and payment services, generating liquidity, and in assessing, pricing and allocating financial risk. One often overlooked role of the financial sector is its importance for wealth creation and economic growth.

Very extensive research in the field shows a close correlation between the size of a country’s financial sector and its economic prosperity. One way the financial sector contributes to wealth creation is through the provision of payment services.

Calculations in this paper indicate that Danes on average have an annual welfare gain alone improved payment services of least DKK 8-10,000 per Dane. Another significant channel for wealth creation is the financial sector’s abilityto generate liquidity and capital for entrepreneurs, which crucially depends on well-established and defined property rights.

A good legislative framework is essential for a well-functioning financial sector. The reverse applies as well. Failed regulation can not only lead to excessive risk-taking, but it may also inhibit economic growth by limiting opportunities for financial companies to fulfil their beneficial roles in financial intermediation, payment services and liquidity creation.

Read the paper here.

Paper: Financial regulation, demand for ‘safe assets’, and monetary conditions

I have a new paper out at Center for Corporate Governance at Copenhagen Business School.

Here is the abstract:

In the aftermath of the economic and financial shock of 2008-10, the wider policy debate has often turned on why inflation has remained very subdued and interest rates and bond yields historically low despite a marked drop in interest rates and a significant increase in the money base in the US and the euro zone.

In this paper, we try to explain these developments with a simple model which highlights the importance of growing demand for ‘safe assets’ (government bonds). By its effect on the demand for money, this shift is inherently deflationary. Expansion of the money base is a natural and necessary consequence of inflation-targeting central banks ‘doing their job’.

The model framework can also be applied to the Covid-19 shock of 2020-21 and it is shown that in the absence of growing demand of safe assets (and an increase in the supply of government bonds due to fiscal easing), a sharp increase in the money supply will be inflationary.

Read the paper here.

10 years of Market Monetarist thinking

On this day ten years ago I published a Working Paper on Marcus Nunes’ blog “The Faint of Heart” with the title “Market Monetarism – The Second Monetarist Counter-revolution”.

This is the Working Paper in which I coined the term “Market Monetarism”. Little did I know that over the following decade monetary scholars as well as central bankers would refer to market monetarism as a school of thought and little did I know that market monetarism would have such an impact on monetary policy discussions globally as it indeed has had.

I strongly believe that market monetarist thinking had a strong and positive influence on the conduct on monetary policy in particularly the US and the world is a better place for that reason.

I coined the the name of the school and I think I played a important role through my blog in developing the ideas of market monetarism, but others did a lot more – economists such as Scott Sumner, David Beckworth, Nick Rowe and Marcus Nunes.

This is the abstract of the paper I wrote 10 years ago:

Market Monetarism is the first economic school to be born out of the blogosphere. Market Monetarism shares many of the views of traditional monetarism but unlike traditional monetarism Market Monetarism is sceptical about the usefulness of monetary aggregates as policy instruments and as an indicator for the monetary policy stance. Instead, Market Monetarists recommend using market pricing to evaluate the stance of monetary policy and as a policy instrument.

Contrary to traditional monetarists  who recommend a rule for money supply growth Market Monetarists recommend targeting the Nominal GDP (NGDP)level. The view of the leading Market Monetarists is that the Great Recession was not caused by a banking crisis but rather by excessively tight monetary policy. This is the so-called Monetary Disorder view of the Great Recession.

Read (or re-read) the paper here.

The Fed’s Average Inflation Target (AIT) will soon tell the Fed to aim for DEFLATION

Back in April I warned that given the massive expansion of the US broad money supply we could very well be heading from double-digit inflation in the US later in 2021 or 2022.

At that time inflation was at 1.6% (March). Today we got inflation for June – and now inflation is at 5.4% and core inflation is at the highest level in 30 years.

So far my inflation simulation seems to be pretty much on track.

But that is not the topic for this blog post – at least not the main topic. Rather I want to discuss what the latest inflation numbers imply for Fed policy going forward.

Back In August 2020 at the online Jackson Hole conference Fed chairman Jerome Powell announced a revision to the Fed’s long-run monetary policy framework by re-framing this goal as an average inflation target (AIT) of 2% over the long-run.

This means that the Fed will tolerate inflation running above (below) 2% for a period if it in periods years has undershot (overshot) it’s target.

This was by many – including myself – interpreted as the Fed for some time could tolerant inflation above 2% as inflation since the outbreak of the Great Recession in 2008-9 far mostly have been below 2%.

The Fed, however, was not very clearly in telling us anything about the the timeframe – is it an average over 2 years, 5 years or even 10 years? We simply don’t know even though it by some Fed officials have been hinted that it probably was 4-5 years.

Where are we now?

The timeframe of course is relevant if we want to judge whether the Fed should ease or tighten monetary conditions going forward.

But lets say we want to give the Fed a lot of room to ease monetary policy and allow inflation to overshoot on the upside.

We can do that by saying that we will take the entire period after 2008 where inflation has been below a 2% trend path.

If we look at the US price level measured by CPI less food and energy then we can compare the actual development in the price level with a 2% trend path.

The starting point is the time, which gives the Fed the most room to overshoot inflation going forward. We get that by starting the 2% “target” path in the Autumn of 2010.

The graph below shows that.

We see that for a long time – particularly from 2013 to 2019 the Fed was undershooting the 2% inflation target. However, just before the Covid-19 pandemic (and the lockdowns!) hit in 2020 the price level was actually back at the 2% target path.

But when the shock hit in 2020 we saw the price level drop below the 2% path, which obviously justified monetary easing.

HOWEVER, we now see that the price level is well-ABOVE the 2% target path.

Consequently, if the Fed is serious about the AIT then US consumer prices should be growing SLOWER than 2% annualized until the price level (CPI core) gets back to the 2% target path.

Presently (June) the US prices level (CPI core) is around 1.5% above the target path and if the trend in inflation over the past year continues in the coming three months then the price level will be 2% above the target level in the Autumn. If my simulation (from) April continue to be correct then it will be an even larger ‘gap’.

This effectively means that in a few month the AIT will actually imply that the Fed should target DEFLATION going forward.

I very much doubt that the Fed will do that and therefore within a few months the Fed will have to revise it’s AIT framework.

One can only wonder what effect that will have on the Fed’s overall credibility.

Steve Horwitz, Mensch, economist and classical liberal scholar. A last farewell.

One of my great intellectual heroes is no more. Economist and classical liberal scholar Steve Horwitz has died.

Steve lost the fight to cancer. Far too young.

Steve and I was in contact over the years and he was always an extremely kind person and even when we disagreed (which wasn’t often) he always remained a gentleman scholar. A real Mensch.

Steve Horwitz was a great economist and particularly is writing on monetary disequilibrium inspired me a great deal. He was an Austrian and I am a monetarist, but we very much agreed on how to see monetary matters – both of us were inspired by the great economist Leland Yeager.

In recent years I have kept in contact with Steve though social media and again and again I have found myself in agree with Steve’s take on current affairs – both when he has been speaking out populism on the right and the left and in favour of a classical liberal world order.

To me Steve represented the best in classical liberal thinking – freedom, openness, tolerance, peace and optimism.

We have lost Steve far too early but his great scholarly work is still with us and I encourage everybody to read Steve’s books and articles.

My sympathies are with Steve’s wife Sarah and his children.

Rest in Peace Steve. You will be dearly missed.

Webinar: Too much money chasing too few goods

My former colleagues at Danske Bank has asked me to explain why I believe that the US might be heading for double-digit inflation in 2021-22.

Watch the webinar here.

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