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28.01.2009

January 17, 20009 (the date of publication in Russian)

"WE ARE DRAWN INTO A MAELSTROM OF RECESSION". Part 2

Andrey Kobyakov's comments on the global economic crisis, and its implications for Russia

Part 1: http://www.rpmonitor.ru/en/en/detail.php?ID=12692

It is the full version of the interview with economist Andrey Kobyakov, director of the RPMonitor Analytical Online Journal and chair of the expert council of Russian Entrepreneur Foundation. The brief version of Andrey Kobyakov's talk with journalists Ilya Brazhnikov and Ilya Khaskevich was published in the December 2008 issue of Politichesky Zhurnal magazine, Moscow.

Q: Can we say that Russia is facing problems of its own that had been ripening during these years of excessive profit from oil exports? Why are Russian stocks collapsing faster than other corporate shares?

A.K: Russian stocks started to decline a year later than those of other countries. Western stocks have been crumbling since August 2007 when the mortgage crisis broke out in America. Since that time, the decline has only deepened. Last winter, Bear Stearnes went bust, and in autumn 2008, most dramatic bankruptcies followed. The fact that the US Treasury was forced to nationalize Fannie Mae and Freddie Mac, the two major mortgage institutions with aggregate liabilities of some $6 trillion, or that AIG, the world's largest insurance company, receives a $150 billion state loan but still fails to overcome its problems, you finally realize the scale of the crisis.

Thus, if we compare the scale of the disaster in the US and in our country, we have to admit that by today, they are not yet comparable. None of our major financial institutions has really burnt down.

The decline of stocks is another story. But I don't understand the excessive interest to the stock market in Russia. In the United States, 62% of the population is stockholders. For them, stock market game is an immediate issue of a household's survival. How many Russians are involved in stock trade? Not more than 1 per cent of adult population, I believe. Why are we so focused on that? The collapse of stocks is natural. When the whole world's stocks are falling, ours cannot grow. This is just impossible. These markets are associated by the same operators. In case a particular investment bank or fund is facing losses at one market, it starts compensating them by getting rid of certain positions at another market, especially in case of the so-called margin call, i.e. a force majeure return of debts.

By the way, that is one of the reasons for the current decline of gold prices. I think that this tendency is going to reverse. With oil, things are different. Consumption of fuel depends on economic activity. Under the conditions of economic depression, fuel prices tend to reduce. Meanwhile, gold is not only jewelry but a tool of investment.

The reasons for the collapse of Russian stocks are multiple. They were doomed to devaluate both due to the global stock market and to depreciation of all kinds of exported raw materials. In August, we also faced an additional political crisis, related to the events in South Ossetia. But that was a secondary phenomenon, though it contributed in the flight of hot money from our financial market.

However, the most important problem emerges from the wildly erroneous credit policy. None of Russia's banks would have got into trouble if they hadn't been forced to borrow mostly from outside. During recent years, it has been the global credit market that served as their major source of credit. While the Central Bank and the Ministry of Finance were sterilizing the allegedly excessive liquidity, salting it away in the Stabilization Fund, we were enjoying a boom of demand at the mortgage market, at the auto market, at the credit market of consumer goods. Where did Russian banks borrow?

They borrowed in the West against relatively low interest rates. However, the US mortgage crisis has triggered – and that should be foreseen Ц with a general crisis of inter-bank confidence. Even giants like Bank of America and Citigroup don't credit one another. Therefore, the interest rates and other conditions at the inter-bank market, and our banks cannot get new loans. And today, the state has to rescue them.

Why did our government experts fail to foresee this situation? I foresaw this problem more than a year ago. Speaking at Maxim Shevchenko's talk-show "Judge yourself" in spring on Russian TV Channel 1, I warned about it. My opponents were ridiculing me. They believed that nothing dangerous was happening, though by that time, already "only" $400 billion were written off in US banking system. By today, already more than $2 trillion are burnt down.

Q: Who were your opponents?

A.K. Why, those were such respectable persons as Gareghin Tosunyan, head of the Association of Russian Banks, and one of the deputy chairmen of the Russia's Central Bank. Both were telling me not to "sell fears". Most of the TV audience Ц 55 to 45 per cent Ц believed to them, as common people always vote for optimism. But my task was to warn the professionals.

During the break, I continued my talk with Tosunyan, trying to explain that the banks that borrowed for a year or two in international credit markets will have no liquidity to return the debts. What if the global situation does not improve in half a year? "We have large currency reserves and Stabilization Fund", he replied. And today, most of the currency reserves are likely to be spent for returning the debts they have created. Why couldn't this money work instead in Russia as a source of credit?

Q: How do you explain this logic today?

A.K: Insanity.

Q: You mean that the financial policy of Alexey Kudrin [Finance Minister] and Herman Gref [former Minister of Economy] is insane?

A.K: Kudrin's viewpoint that this money (liquidity) was redundant and provoked inflation is utterly stupid.

Q: Stupidity or treason?

A.K: I've been wondering over this question for several years. I'm not personally acquainted with Kudrin. Those who know him urge not to overestimate his intellectual capabilities. But whom does he consult with? The treason may be happening at a different level. Sometimes it seems that he regularly addressed IMF headquarters for advice and directly implements its recipe. In summer 2007, addressing the Universal Russian National Sobor (Assembly), I entitled my report "Paradoxes of economic policy, and the strategy of development".

They say they are trying to prevent inflation. On the one hand, they clamp the monetary mass, believing to be constraining monetary inflation, but at the same time, the Government approves the rate of increase of tariffs of natural monopolies for four years in advance. In a matter of 3-4 years, electric energy prices at the domestic market were supposed to triple, and gas prices to quadruple. Tell me how it is possible to combat inflation with one hand and to unleash inflation with the other! This planned increase of energy prices exceeded the official level of inflation 2.5-3 times. Did that just mean that the official inflation figures were understated?

But in case the real inflation comprised not 10-12% but 25%, the 7% growth of economy would be impossible: the economy would be just stalled, or declined. In any case, for what reason was the government going to unleash inflation, regarding the dependence of the whole real economy from the prices for fuel and energy which were going to increase transportation costs, and provoke a hike of all consumer prices? For what reason was Russia deprived from its natural advantage?

In case we consider an increase of all the consumer prices, we immediately lose all the advantages in the competition with other nations. What for are we going to sacrifice our natural advantage of excessive sources of energy?

There is no explanation for this insane policy except corrupt interests. The monopolies have a possibility to use inflation as an instrument of redistribution of national income in their favor. Inflation is thus a mere mechanism of redistribution. That means that certain lobbyist groups are using inflation for the purpose of distribution of wealth. They are better prepared and protected for this policy than other economic groups that will have to survive on a scarce ration.

Q: President Dmitry Medvedev expressed indignation with the fact that the sum of 1trln rubles, conveyed to our banks for increasing liquidity, was actually spent for buying back our own bonds for a half of their price. That means that the money, instead of supplying the domestic inter-bank market, was actually siphoned outside. Is that stupidity or treason? Was the government naive enough to believe that the supposedly patriotic bankers would spend money for the sake of the fatherland? Were the officials unaware that the first thing the bankers were going to do was to "invest" money in their own debts?

A.K: But that was not their money. The bankers were just going to earn a bit, and even in case the state would demand that they return a part of the money, they would still be on velvet. Take another example, the proposal of Vice Premier Igor Shuvalov Ц the very person that had been tasked to regulate the financial market, and to drag it out of the quagmire of crisis Ц to pour 500bln rubles into the stockmarket to keep it afloat. How should we interpret the logic of his behavior, at the moment when all the global stocks are collapsing? Isn't it clear that this sum would be sufficient for a couple of days, before the market collapses again? What does that actually mean? That means to throw out the money into this barathrum with a crowd of speculators who had failed to sell their packages in time, to enable them to do this and thus boost the price for some time. Okay, they will gladly use this occasion to sell the packages and put the money into their pockets. In this way, the taxpayers' money would be just donated to a bunch of speculators.

Is that stupidity or worse? Luckily, this deal failed, as the money was frozen, but this option was discussed quite seriously. Who is running the economy, after all? Outstanding fools, or outstanding cynics that believe that all this can work scot-free?

Q: A corrupted establishment usually behaves in this way at the brink of a crash, being concerned only of its own enrichment.

A.K: I am afraid that this people had been behaving in the same way during the whole 18-year period of Russian reforms. Only a few of them were concerned of long-term consequences, while the majority was focused only on immediate interests. That is why, on a certain stage, they did not pay taxes and exported all of their profits, in fact investing $1trln in the global economy. None of them invested at home. Even when you talk with the best of those people, they would boast that they had just sold their business in the West, "on the very peak, so luckily". What for had these persons establish a bank? Was that done only in order to resell it to "strategic investors" in a couple of years? Do we have strategic investors in our own? Do we establish banks just in order to resell them, and not in order to make them work?

Take the example of the Russian Development Bank. At a business forum in Nizhny Novgorod, I heard a report presented by the lady who was the deputy head of board. Surprisingly, she boasted that the bank was issuing loans for an interest that exceeds the market figures, and that these loans are snatched up like patty cakes. What was this bank once founded for? As far as I remember, that was a special bank supposed to identify the priority spheres of state investments. Instead, it became one more bank that uses the tense situation with crediting for extracting profit. Meanwhile, the priority spheres that never had access to substantial loans are not going to gain a privileged rate. Why on earth this dolly-shop is called Development Bank?

Q: Does the Stabilization Fund still exist?

A.K: The Government swore that these papers are not going to be sold. That is why the US dollar is gaining weight against the ruble. In case Russia or China started to sell US securities, the US currency would collapse.

Q: But the portion of the Stabilization Fund invested in US securities is shrinking because of the crisis. This portion was estimated in $250 billion. Aren't we going to lose part of this money if we try to sell it?

A.K: If we don't sell this portion, it will completely evaporate anyway. I don't understand why the Government takes an obligation of not selling them.

Q: Does that mean that the super-incomes from oil trade are wasted for a song? Does that mean that we are going to lose even the Investment Fund that was regarded as the Government's highest achievement?

A.K: The idea of the Stabilization Fund was doubtful from the very beginning. Firstly, we invest in an instrument that is supposed to bring profit. What profit are we going to gain if the Stabilization Fund is an article of budget expenses, nominate therefore in rubles. If the ruble inflation reaches, officially, 12% per year, what does the 5% dollar return mean? It means that only by this difference, the amount of money is devaluated by 7% per year, and if inflation is calculated correctly, this would make 25-26% per year.

Furthermore, while the ruble was on the rise and these securities were nominated in US dollars, they were devaluating in rubles. Furthermore, when the Fund's capitals were transferred to Western banks, part of the contract was paid to brokers. How much will they earn when the money will be returned? Besides, according to the habit of good economists, we have to calculate also the so called unrealized benefits. This money could have worked in Russia!

Q: What was necessary to undertake first of all?

A.K: In the conditions of a crisis of such a scale, state economic policy becomes crucial. On the ascending curve of development, the intervention of the state can be useful or useless, but it is not crucial, as particular errors can be recuperated by the general positive trend. In the situation of crisis, the state's intervention is inevitable. At the same time, the outcome depends of the choice of measures chosen by the state.

In case you don't intervene at all, the spiral of recession will unfold to a great extent, and the ensuing decline will be very deep. The state has to create an intercepting surface for this spiral, to guarantee additional demand by concentrating budget expenses in particular spheres, as it was done in the times of Roosevelt: public works, including construction of roads and power plants; a system of federal state contracts, etc. All this is described in textbooks and memoirs.

But unfortunately, the Russian Government's policy remains situational but not strategic; reactive but not preventive. Take the example with the devaluation of the ruble. I would understand the idea if I were explained the goal-setting. What for are we going to devaluate the national currency? In case our objective is to replace imported goods by boosting competitiveness of Russian producers Ц as it was done by Primakov's government in 1998, with a result of a 17% growth in real economy and compensation of all the earlier losses Ц the purpose is clear. However, the present proposal of devaluation is restricted to improvement of the balance of payments.

Does any Government body calculate the balance of advantages and losses we face in implementation of a particular scenario? Such a body does not exist, as it is still considered that scenarios can be borrowed from monetarist textbooks that allegedly contain any answers to economic problems. In fact, the Government is ready to function as just an element of a computer program. And what is the program is faulty, or inapplicable to the current extraordinary situation? It seems that the state just does not want to be a state.

In fact, the current crisis requires an urgent and complete change of the economic policy approach. This is well understood in the United States but not in Russia, despite its far deeper and far more tragic historical experience. I fear that in a couple of years, the United States will find a new figure of Roosevelt, while Russia will continue playing the same helpless liberal games.

Q: How will this "new Roosevelt" deal with an economic situation that is far direr than the Great Depression?

A.K: In the nearest period, Washington is likely to freeze all of its global obligations. The world will be supposed to humbly share the American hardships. Lyndon LaRouche believes that the US President will provide guarantees for nations who will commit themselves to assist America in its disaster. However, I doubt that the new Democratic administration will initiate this discussion. It is more probable that Washington will continue just to print money, in accordance with the old formula, addressed to the rest of the world: "The dollar is our currency and your problem".

Q: Do you expect that some countries will have to agree to that proposal of "exchange of hardships for guarantees" because of dependence on the US market? Will China agree for such a deal?

A.K: For a while, that is possible. However, we should not overestimate China's dependence on outside markets. If we judge upon Chinese economy by the exchange rate of the US dollar against the undervalued yuan, it will seem very dependent on export-oriented sectors. However, if we consider the yuan's real purchasing power, this dependence will look not very significant.

China always thinks a lot before making a decisive move. Right now, Beijing just does not intend to overtake global economic leadership. The Chinese will probably agree to support the US economy today, but this tactics does not contradict to the strategic commitment of becoming the world's leading power in a matter of five-seven years. Not today: for this purpose, they need to build the whole new financial infrastructure. They are unlikely to make victorious declarations in advance. But when they softly admit, "We are ready", it will be late to react.

Q: May China take part in the division of the Russian territory in case Russia disintegrates in the process of the crisis?

A.K: Theoretically, China may decide at some moment that its economy vitally needs the territories of Russia's Far East. This option is more likely in case the Russian Far East's economy goes out of function due to the demographic crisis. According to the recently published report of UN Population Fund, Russia's population is expected to shrink by 38 million by 2050 Ц certainly, in case the current domestic policy tendencies are not reversed. The crisis is likely to exacerbate not only separatist sentiments but also the demographic crisis. Some liberal authors may hope that Russia will be merged into a successful economy of a unified Europe. However, in case Europe's economy is really going to soar, Russia, in its shape of today, may be integrated into the EU only on the rights of a peripheral territory. In terms of prospects of survival, Russia's cooperation with China makes more sense.

China at least requires Russian scientific and technological intellect, not just primitive labor force. Therefore, the former Big Brother may acquire a possibility, according to Sinologist Andrey Devyatov, to exist in the form of the "Elder Sister", whom the powerful Younger Brother may agree to maintain under certain conditions. This doesn't sound optimistic but I can't give you a better forecast by now.


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