On the 24th of February 2022, Russian president Vladimir Putin announced that the Russian military was to conduct a ‘special military operation’ in the Donbass region in Ukraine, bordering Russia. Effectively, war had been declared on Ukraine, following decades of regional tension between the two nations, and broader geopolitical factors that rose tensions even further. Being the first conflict fought between two European nations since the Second World War, Russia’s decision to invade its neighbour was unprecedented, and incurred widespread condemnation from the international community.[i]
Foremost in the West’s response, were increasingly severe economic sanctions, such as freezing the assets of Russian oligarchs and businessmen abroad, cutting Russia off SWIFT payments so that payments to Russian banks are impeded, and suspending Russian-produced oil (which is why fuel prices have been so expensive lately!).
These sanctions are designed to strain the Russian economy, and therefore put political pressure on the government from the business community and Russian citizens, in hopes of compelling Russia to withdraw its military.[ii]
Unsurprisingly, this is not the first time Russia had faced such sanctions or unwillingness to trade in recent memory. Russia has historically been at odds with the West for centuries now, particularly during the rise of the Soviet Union and the Cold War, where geopolitical tension, as well as efforts to implement communism through a centrally planned economy, led to the Soviet ruble having zero value as an international currency — leading to Pepsi becoming the sixth largest military in the world.
But that will be covered in part two of this series. For now, we first need an overview of how the Soviet economy worked, and how the ruble was worthless for international exchange.
Centrally planned economy
In 1917, Russia had undergone two revolutions: The first one deposing the Tsar and the system of monarchy that had ruled Russia for centuries, and the second being a coup staged by the Bolshevik faction of communists, in what came to be known as the October Revolution.
By this point, Russia could be considered a semi-feudal society. It had an agrarian economy, with around half of its GDP consisting of agriculture, and it severely lagged behind Europe in industrial development.[iii]
After the Bolsheviks seized power, the Soviet Union (USSR) eventually formed in 1922, emerging from the brutal Russian Civil War. Vladimir Lenin, leader of the Bolsheviks, advocated for Russia to bypass the development of industrial capitalism, and forcefully transition from an agrarian society to socialism.[iv] This included forced collectivisation of grain (i.e., taking extra grain that farmers produced and redistributing it), liquidating the kulak (rich and land-owning) peasant class through sanctions and repression, and nationalising most of the USSR’s industries, outlawing private ownership of capital.[v] The government took near total control of the economy and was the sole agent determining what goods needed to be produced, how much, and at what price.
This led to resounding market failure; With mass starvation throughout the Russian Civil War, families in urban areas moved to the countryside in order to grow their own food, as supply chains were mismanaged and incapable of supplying food to the cities. This migration led to a shortage of factory workers, in turn lowering overall production and resulting in the closure of numerous factories. With the economy entering near free fall, Lenin was forced to implement the New Economic Policy. This allowed some private enterprise and slightly freed up trade in an effort to stabilise the economy. [vi]
Economic theory can explain why such a market failure occurred. The quantity produced, and the price of a product are determined by the forces of supply and demand. If people want something, and firms are willing to produce it, then both actors will trade according to their own needs and self-interests. This will lead to an efficient outcome because people are free to choose their demand for a product, and firms can decide at what level to produce at. Thus, an equilibrium is formed, and the market is cleared.
Intuitively, it is near impossible for someone to evaluate exactly what another person’s level of demand is for various goods and be able to accurately match that demand with supply. On a broader macro level, one may roughly gauge which region needs which resources according to demographic variables. However, one simply cannot account for the infinite complexities and demands of both consumers and suppliers, no matter how sophisticated a country’s central planning agency may be. This is what led to supply chains failing, as cities and provinces in Russia were not getting the adequate supply of goods provisioned by the government.
Exchange rates
In addition to the supply and price of goods and services, the value of the ruble was also centrally planned, domestically and internationally.[vii]
As Joseph Stalin rose to the Soviet leadership, his signature five-year plans and doctrine of ‘socialism in one country’ further intensified the government control over the economy and isolated the USSR from the world.[viii] This made international trade with the Soviet ruble unattractive for foreign countries. As evidenced by the market failure discussed above, the value of the ruble could incorrectly state the actual value of particular goods and services. The arbitrarily determined value by the government, not only in terms of exchange rates but as a representation of the USSR’s own economic value, made the ruble unreliable as an economic metric. Furthermore, with the Cold War developing between the USSR and the United States, there was even further disincentive for the West to use Soviet currency or engage with the USSR.[ix]
Hence, despite becoming a superpower in the twentieth century, the USSR had to trade through barter, as opposed to currency. And nothing illustrates this better than on the fateful day at the World Fair in 1959, when President of PepsiCo Donald Kimball offered General Secretary Nikita Khrushchev a cup of Pepsi…
To be continued in part two.
[i] Andrew Osborn and Polina Nikolskaya (2022), Russia’s Putin Authorises ‘special military operation’ Against Ukraine’, accessed 4 May 2022, https://www.reuters.com/world/europe/russias-putin-authorises-military-operations-donbass-domestic-media-2022-02-24/.
[ii] BBC News (2022), What Sanctions are Being Imposed on Russia over Ukraine Invasion?, accessed 4 May 2022, https://www.bbc.com/news/world-europe-60125659.
[iii] M. E. Falkus (1968), ‘Russia’s National Income, 1913: A Revaluation’, Economica, 35(137):52-73, https://www.jstor.org/stable/2552161.
[iv] Oxford Reference (2022), Marxism-Leninism, accessed 6 May 2022, https://www.oxfordreference.com/view/10.1093/oi/authority.20110803100137769
[v] Mark Harrison and Andrei Markevich (2012), Russia’s National Income in War and Revolution, 1913 to 1928, accessed 4 May 2022, https://voxeu.org/article/russia-s-national-income-war-and-revolution-1913-1928.
[vi] The History Learning Site (2015), ‘War Communism’, accessed 13 June 2022, https://www.historylearningsite.co.uk/modern-world-history-1918-to-1980/russia-1900-to-1939/war-communism/#:~:text=War%20Communism%20was%20the%20name,emergency%20measures%20and%20socialist%20dogma.
[vii] Christina Majaski (2020) Fixed Exchange Rate, Investopedia, accessed 4 May 2022, https://www.investopedia.com/terms/f/fixedexchangerate.asp.
[viii] Encyclopaedia Britannica (2022), Five Year Plans, accessed May 6 2022, https://www.britannica.com/topic/Five-Year-Plans; Seventeen Moments in Soviet History (2022), Socialism in One Country Versus Permanent Revolution, accessed 7 June 2022, https://soviethistory.msu.edu/1924-2/industrialization-debate/industrialization-debate-texts/socialism-in-one-country-versus-permanent-revolution/.
[ix] Willis C. Armstrong (1948), ‘The Soviet Approach to International Trade’, Political Science Quarterly, 63(3):368-382, https://www.jstor.org/stable/2144779.
