The Struggle to Save the Soviet Economy, part 8

Double digit inflation always implies that something is getting out of control

In any country, the control of the money supply reveals something about who is really in charge, or whether anyone is in control.

If inflation is so slow it becomes deflation, you can assume that the banks, and other financial powers, are in control, protecting their fixed-interest-rate assets from inflation.

Banks make estimates of future inflation. They build this into their interest rates. If the leadership of a bank believes that inflation will average 2% over the next several years, and they are also hoping for 3% real profits, then they will charge 5% interest. If inflation remains at 2%, then they make a nice profit. If inflation were to suddenly spike to 6%, then the bank takes a loss, once they adjust for inflation. In that sense, sudden, unexpected increases in inflation tend to (accidentally?) shift wealth from creditors to debtors. Lending institutions end up worse off, but those who had to repay the debt often find it easier to do so. If someone borrows money to buy a house, and if their salary at least keeps up with inflation, then a sudden spike in inflation makes it easier for the to repay the loan on the house.

A moderate increase in inflation might happen if progressives gain power and want to reduce the burden of debt that much of public is facing. If a young couple buys a house for $300,000, and is carrying a 30 year mortgage, they might feel money is tight if they only make $80,000 a year. But if a wave of inflation, over a few years, raises overall costs, and also their wages, by 25%, then in some sense they have not benefited, as costs went up just as fast as their wages, but in another sense, they are better off in relation to their debts, as they now make $100,000 but their house debt is still just $300,000.

Spikes in inflation are associated with eras of lower inequality.

If there is hyper-inflation, causing painful disruptions in everyone's life, and ruining the ability of people to have any kind of savings plan, because the value of any savings is undermined so quickly, then clearly there must be some kind of political crisis happening, often because multiple factions are fighting each other to the point that those supposedly in charge lack any real power.

Double digit inflation always implies that something is getting out of control, that the government is failing, often because it is so crippled by the in-fighting of various factions.

The Struggle to Save the Soviet Economy:

Mikhail Gorvachev and the Collapse of the USSR

By Chris Miller

©2016

Page 156

The effects of inflation were not only economic. Just as inflation was caused by political gridlock - a disagreement about who should bear the costs of budgetary adjustment - it also had serious political consequences. Though Gorbachev was beginning to move the Soviet Union toward a market-based system, the country’s economy was still largely based on command methods. Commands from the top were followed because failure to do so resulted in punishment. Inflation changed this calculus because it laid bare the political chaos at the center of the Soviet state. It sent a message to mid-level Soviet officials that rules no longer mattered. Carefully controlled prices previously had been a central tool of the Communist Party’s authority over society and economy; changes in relative prices were how the state mediated between different interest groups and redistributed resources. But where prices previously represented the state’s power, by 1988 they provided further proof of an increasingly desperate struggle between Gorbachev and his opponents in Moscow. No one was in charge.

For those who had long chafed under Moscow’s direct control, the political conflict about economic policy provided an opening for them to bolster their own independence. This led to a process that one political scientist has likened to a “bank run,” as local officials sought to seize control of factories and resources before someone else did. Soon there were few resources left. Regional governments, especially those in ethnic minority regions, used their new autonomy to remit fewer taxes to the central government. Enterprise managers, meanwhile, took advantage of feuds among the political elite to seize control of their firms, often subverting Gorbachev’s enterprise reforms in the process. Both of these tendencies further reduced the resources available to the central government, exacerbating the budget crisis and causing inflation to continue to spiral upward.

As the budget deficit eroded the government’s ability to enforce its writ, tax revenues began to fall sharply. At the beginning of perestroika, the Soviet government had several main revenue streams. One was a turnover tax, which functioned roughly like a tax on consumption. The tax only applied to purchases made in the official economy, which proved problematic during the late 1980s as shortages multiplied and consumers turned toward black markets. Revenue was reduced as turnover tax collection declined. By the end of perestroika, turnover tax revenue as a share of GDP had fallen by 20 percent.