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The Russian economy will come roaring back
Howard Richman, 12/19/2014

Business Week published an assessment of where Russia has been and where it is going. Its analysis of the present was pretty good, but its pessimism about Russia's future was nonsense. Russia will probably come roaring back, as countries almost always do after a currency collapse.

The ruble started falling as a result of European and American sanctions and Russian counter-sanctions. These sanctions got the Russian currency falling in exchange rate. Here´s a first hand account from a commentary on the subject by Daniel Gurevich, one of my students, who was then living in Russia:

But as much as the food sanctions have hurt the West, Russian consumers are taking the brunt of the blow. Stores have not yet run out of some imported foods, but prices for these foods have shot up because of the very limited supply. For example, I have seen the price of my favorite cheese, Finnish dairy producer Valio´s Oltermanni, increase by about 50% in Moscow stores over the course of just a few months. So it is no surprise that many Russians are searching for substitutes. Demand is growing for Russian cheese and sausages, tomatoes and grapes from Uzbekistan, and other foods from Russia and its former republics, as are prices.

Sometimes there is no suitable substitute for imported food. Even then, consumers have found a way to satisfy their needs. Chefs in Moscow´s top restaurants whose recipes call for Italian Parmesan cheese now use "Belarusian" Parmesan. In fact, it is still the same cheese, imported from Italy to Belarus and then illegally re-exported to Russia with a "Made in Belarus" label slapped onto the original manufacturers´ packaging. In the process, the Belarusian cheese smugglers profit by raising the price of the Parmesan by about 20 percent.

The current crisis was precipitated by the falling price of oil. As a result of the falling price of Russian oil exports, there was less demand for rubles that could be used to buy oil. As a result of the falling demand for rubles, the price of the ruble went down in exchange rate, as shown in the graph below:

When the exchange rate of the ruble started falling rapidly, many people who had rubles, including Russians, tried to sell their rubles and buy dollars, euros, Swiss francs, or other currencies. This caused the ruble to fall even more rapidly. Meanwhile, the purchased currencies rose in exchange rate.

The Russian central bank tried to stop the falling exchange rate by buying rubles with its foreign currency reserves, but that was like trying to stop an avalanche with a snow shovel. They also tried to stop the decline by raising the short-term interest rate in Russia to attract foreign savings. But, again, that wasn´t enough. The ruble would have to fall further before the decline could be stopped.

Soon the ruble will stop falling. The Russian economy will experience inflation this year. The Russian consumer will find imported goods to be more expensive, and will feel poorer. 

What will happen next is that the Russian economy will turn around and Russia will start experiencing rapid economic growth as a result of its low labor costs compared to those in its trading partners (due to the fall in the ruble´s exchange rate), Russian manufacturers and mining companies will be able to make lots of money selling exports and competing with imports.

To make a long story short, Russia´s economy will come roaring back, just as other economies have after a currency collapse in exchange rate. The only exception to this rule are foolish countries, such as Argentina, which react to a currency collapse by adopting policies that prevent recovery -- such as price controls, export restrictions, or excessive money printing.