Putin’s Economic Waterloo

Streetwise Professor dispels the nonsense that Russia’s “stabilization fund” can protect it from economic apocalypse:

I have often written that Russia is a natural state, a cartel of violence specialists that is held together by economic rents, primarily generated by natural resources. As I have noted, such states/cartels are fragile, and subject to collapse. Collapse occurs when (a) the rents dissipate, or (b) the time horizons of the colluding parties shorten. Natural states look strong pendant les bon temps roulez, but have a tendency to implode once the music stops.

The crash–crashes plural, actually–of the Russian stock market, the gridlock in the money/banking markets, and the decline in oil prices, are dissipating rents, and arguably convincing the various clans that the game will soon be up. Moreover, the financial crisis has weakened some players (Deripaska is a well-publicized example), which could tempt others to exploit this weakness and grab what they have left. This could induce a breakdown in the uneasy peace between competing factions of violence specialists.

What is occurring now is just the sort of crisis that threatens the natural state with collapse. The facade of order and control can quickly dissolve into chaos and conflict. Like glass, natural states are strong but brittle, and shatter when the stress becomes too acute.

It has been reported that numerous big state firms–most notably, Gazprom and Rosneft–are importuning the state for financial support. It is well known that these two firms are at the centers of two contending clans. They will be competing to get at the same money. Both are tightly connected to heavyweights in the Russian government and security services (to the extent there is a difference between the two.) A battle between the two would shake Russia to its foundations. If each–or either–senses that its future is in question, tacit cooperation is no longer an optimal strategy, and out will come the knives.

Everyone’s attention is turning to the stability fund. In virtually all of the commentary written since the beginning of the meltdown in August, the phrase “the $570 billion dollar stability fund” has been repeated like a mantra, an incantation that will ward off a return to 1998. As commentor Michel points out, however, the government has already committed a substantial fraction of this sum in various market and bank support schemes, none of which have stemmed the bleeding. Hence, the line of mendicants begging for a piece of the fund is getting longer, and more insistent. Kudrin, who has played Horatius at the Gate defending the fund against those who desire to divert it to their purposes, is under pressure. You think it was a coincidence that Storchak was just indicted? I don’t. Moreover, those now pleading for the money–Gazprom, Rosneft, the three amigos from BP-TNK–are really heavy hitters. I doubt that Kudrin, or Medvedev, or even Putin, can resist their pressures.

The market apparently has its doubts too. Credit default swaps (EEEEEEEK! CDSs! Run for the hills!) on Russian government debt rose 52 basis points to 352 bp, as compared to 36 bp in May ‘07. If the stability fund makes Russia immune from default, why the bulge in CDS prices? (Part of that is due to an increase in the market price of risk in these unsettled times, but certainly part reflects a perceived increase in the probability and severity of a default.)

I think Michel has put his finger on the matter. He conjectures that “[m]any have been lusting after those billions for years, and the crisis was the perfect cover to launder piles of money from the reserves to the offshore accounts of friends of the regime.” That makes perfect sense, and today’s Moscow Times provides evidence for it: “Four major energy companies have asked the government to lend state money on market terms to help refinance foreign debt and buy new assets abroad as they become cheaper, a top oil executive said on Tuesday.” Cheaper. Riiigghht. That’s the ticket. No, I think the key word in the sentence is “abroad.” Like Michel, I read this to mean: “Give us money in the stability fund so that we can take it out of the country while the taking is good.”

In brief, although the existence of the fund makes survival of the current system in Russia more likely than it would be in its absence, it is not a talisman. If the crisis–in the US, in Europe, and in Russia too–shows anything, it shows that $570 billion can evaporate in a trice. That is especially true in a country like Russia, where the formal institutional safeguards are so weak. In a highly personalized natural state, rife with corruption, where the state is essentially the cash cow for aggressive and amoral individuals who are comfortable with the use of violence, when the deluge begins, no property is safe. So, to those who repeat “the $570 billion dollar stabilization fund” to lull themselves to sleep, I say–there are monsters under the bed. And it is at times like these that they come out and play.

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