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Why the Ruble Is Gaining and Why That's a Good Thing

  • Russia's central bank is pursuing far sounder policies than its American counterpart
  • The widely held belief that a weak ruble is good for Russian industries is mistaken
  • The present oil price rally is more dollar weakness rather than oil strength
MORE: Business

In 2014 when Russia was hit by the oil price bust, western financial sanctions and some loss of trade with the west and Ukraine ruble naturally begun a dramatic decline against the US dollar. 

However, as soon as the decline commenced a slew of commentary actually welcomed it, proclaiming it would be a great thing for Russia's manufacturers, particularly exporters.

In reality the idea that a weak currency is a good thing is an extremely dubious proposition. All that a weakening ruble means is that the purchasing power of ruble earners on the international market is declining.

If ruble weakens against the dollar all this means is that Americans now have a stronger claim to goods and services in Russia and Russians have a weaker claim to goods and services in the US. How is that a good thing for anyone in Russia?

The claim is that it at least benefits Russia's "exporters" -- manufacturers who earn (strengthening) dollars but tally their expenses in (weakening) rubles. However, this is rather dubious firstly because there are very few pure exporters. There are very few enterprises that don't need anything from abroad and fewer still which only service foreign markets.

By and large Russia's exporters also make sales on the ruble-denominated market. Ruble weakness does nothing for them except create an impetus to orient more of their production for export -- however, if they are successful at that the real loser is the Russian buyer (whether another enterprise or the final consumer) that sees goods that would compete for his rubles instead flow elsewhere to compete for stronger dollars.

The Russian buyer is also hurt in another way. Many Russian-made goods he normally buys involve inputs denominated in other currencies. This may be the cost of foreign-made components or materials, or else of foreign-built machines used in the production process. 

Thus a Russian airline may discover those sleek Sukhoi Superjets it was going to purchase are actually a fair bit more expensive now that its numerous foreign-made components cost twice as much as before and instead opt to rely on its ageing, and spare-parts-hungry, fleet of Boeings a bit longer. (And with fewer buyers in Russia to lead the way, who knows, perhaps also fewer foreign buyers opt for a manufacturer they do not yet know despite the lower, part ruble-based price.)

Even in the case of pure exporters advantages are a lot more qualified and conditional than one may think. The standard argument is that a weak domestic currency means a lower production costs calculated in the foreign currency so that the manufacturer-exporter may now lower his selling price and capture more of the market. 

However, there is no guarantee that is going to work -- there may not be much additional market to capture even at a lower price, and who knows, what if expanding production to actually capture the market really first entails foreign currency expenses such as German or Japanese-built machine tools?

In of itself a weak currency is a very mixed and uncertain blessing at best. In fact a depreciating currency is normally associated with a weak economy, not a strong one. It conjures up the image of Italy, Yugoslavia and Zimbabwe rather than of Germany, Netherlands and Japan.

Assuming currency isn't declining due to money creation at home the only thing a currency that is falling on the foreign exchange means is that domestic thirst for foreign goods is growing faster than foreign thirst for one's domestic goods. Usually that occurs when a country is falling behind economically and has increasingly relatively less to offer to the outside than it can be offered by the outside.

In Russia's case the decline is largely because its key export (oil) is a lot less lucrative than just two years ago. Foreigners can now get what they want from Russia (oil) for far fewer dollars than they could before, but Russians would ideally still import from foreigners as much as before. As a consequence there are fewer dollars chasing an undiminished number of rubles meaning dollar becomes more, and ruble less, expensive. 

Fortunately this doesn't have to be a permanent condition. For over two months now the ruble has been gaining steadily against the dollar (admittedly from record lows). The oil price rally which is the cause of the move is confusing at least one financial commentator. The well-informed Kenneth Rapoza over at Forbes is befuddled that the oil price is currently going up despite the failure of Doha conference to cap oil production, decreasing demand in China and growing supply by Russia, Saudi Arabia and Iran.

The oil rally then isn't a sign of oil strength but instead of dollar weakness. The US Federal Reserve begun scaling down its "QE3" money-printing operation in February 2014 and ended it in October 2014. Henceforth it signaled it would instead significantly raise interest rates which would put a further brake on dollar creation. Oil price begun its dramatic decline in mid-2014 and its hit record lows in early 2016 -- just after the Fed delivered the long-anticipated interest rate hike at the end of 2015.

The oil price declined due to an end of super-inflationary policies of the US central bank and in anticipation of hard money policies that were being promised at the time. However, the Fed has been dragging its feet on actually delivering. It has only raised the rate once so far and by a miniscule 0.25%. It then promised four more rate hikes in 2016 but it's now the month of May and nothing has happened yet. By and large financial operators still believe the rate increases are coming, albeit at a later date than previously believed.

This faith is slowly being shaken, however, and is bound to crumble completely eventually because significant USD rate hikes are in fact not coming. The Fed can not turn off the easy credit without plunging what it pretends is a healthy economy but is actually an inflated Frankenstein hooked to artificial stimulus into a corrective recession -- which is the last thing it wants in an election year.

This doesn't solve the problem of oil oversupply but it will ease the pressure on the oil that comes due to anticipation of a hard dollar. This will allow currencies of oil exporters to recover, but only if they don't follow the US into the folly of inflation.

Fortunately Putin has recently said he doesn't believe money printing can do anything for Russia's economy and the Central Bank rejected reports it is interested in a weak ruble.

Hopefully that is true. A depreciating currency is a very dubious advantage at best, but inflationary policies are unequivocally bad and represent nothing more than a transfer of purchasing power from the poor to the politically connected (but that's a lesson for another time). But by sticking to its guns and continuing the relatively sound laissez-faire and hard money policies Russia stands to profit from the coming dollar weakness (whether it comes on the heels of easy money or a corrective recession).

The main problem of Russian industries are not ruble-denominate labor costs. Russian workers always earned far less than workers in more successful industrial economies. The problem of its industries is that they're relatively outdated.

And it so happens that the biggest obstacle to modernizing any industry is that this requires an enormous amount of expensive new or re-tooled capital goods. A weak ruble hampers their accumulation because it means Russians have to painstakingly labor to build more of these (and to learn how to build them) on their own, instead of being able to simply lay claim on more of the capital goods that already exists abroad and simply transfer them to Russia.

Whatever Russia wants to build -- products that can compete on the foreign markets, or products to displace foreign-made goods on the Russian markets -- a solid purchasing power on the international market that allows it to quickly import a great deal of the machinery and expertise needed is an immense and invaluable boon.

Russia can eventually modernize its industry on its own, with a weak ruble. But it can do so much quicker if the oil price and ruble's purchasing power pick up again.

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