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.

Heading for double-digit US inflation

I have spend a lot of my time since 2008 arguing that US monetary policy was much less expansionary than most people thought and has been arguing for a more aggressive response from the Federal Reserve to combat deflationary pressures.

Furthermore, I have last year welcomed the Fed’s policy respond to the lockdown crisis – see for example here – as I feared a repeat of the deflationary shock of 2008-9.

Furthermore, even though I have been somewhat worried about the sharp pick up in US broad money supply growth I for while was of the view that breakeven inflation rates were quite low and as a consequence we should not worry too much about inflation.

However, over the last couple of months I have become more and more convinced that particularly elevated stock prices, property prices and commodity prices reflected sharply increased inflation pressures.

I have therefore, gradually changed my view on inflation and am now quite convinced that inflation will pick up very strongly in the US. In fact, I now seriously fear that we are heading for double-digit inflation in the US before the end of this year.

I has taken me a lot of time to spell out this view publicly because I full well-know that this certainly is not the consensus view and it is certainly not (fully) priced – at least not by fixed income markets. As somebody who tend to believe markets are close to efficient I don’t lightly second-guess the markets, but I have also convinced myself that this ‘mis-pricing’ in particularly in the fixed income markets at least to some degree reflects a massive liquidity effect that ‘overshadows’ rising inflation expectations.

But today I call it – the US is heading for double-digit inflation in 2021 and it will happen very fast. What I expect is not necessarily permanently higher inflation, but rather a sharp one-off jump in the US price level.

What happens after this starts to unfollowed I believe is a lot harder to forecast and it will strongly dependent on the Fed’s response to this jump in the price level. One possibility is that we will see a serious erosion of Fed’s credibility and longer-term inflation expectations will jump. Alternatively the Fed moves aggressively to curb rising inflationary pressures and is able to convince the markets that this is indeed a post-pandemic one-off jump in the price level, but not permanently higher inflation.

No matter what this is likely to be THE main topic for global financial markets in 2021 and I have a hard time seeing this playing out without causing some volatility in global financial markets.

I am very hesitant even calling this a “forecast” for US inflation. Rather it is a simulation of what we should expect to happen to the US price level if Fed allows the ‘liquidity overhang’ to feed fully through to prices. I doubt that will happen but on the other hand the Fed seems to be ‘deliberately’ behind the curve so at least for the next 3-5 month we are likely to see a very sharp increase in the price level.

Below is my ‘simulation’ for US inflation.

This simulation is based on the so-called P-star model.

In a Twitter thread earlier today I discussed the model and the implications for US inflation and partly the implications for asset prices.

See the discussion below.

Again, I don’t make this forecast lightly. There is a lot of things that can change to change the outcome, but again and again over the last couple of months I have postpone making this forecast because I know it is a rather wild prediction, but I can no longer find excuses not to make this forecast because I fundamentally believe the analysis is correct and I have to follow the logic of the analysis and the numbers and the only conclusion I can reach is that we are in for a very sharp increase in US inflation – very soon.

I am as always happy to discuss the my analysis with clients and potential clients. Contact:

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