Russia - A study in financial collapse

Russian financial crisis
From Wikipedia, the free encyclopedia


Inkombank was one of the most high-profile casualties of the events of August 1998. Once one of Russia's largest banks, whose billboards proudly announced its motto "We are for real, we are here to stay", it closed its doors almost overnight. Their Nizhny Novgorod building, which was one of the city's symbols of the new Russian capitalism, looks rather shabby in the above picture, taken 2006. But above the name of its current owner, one can still see a not-quite-erased Inkombank logo.The Russian financial crisis (also called "Ruble crisis") hit Russia on 17 August 1998. It was exacerbated by the Asian financial crisis, which started in July 1997. Given the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials, such as oil, were among those most severely hit. (Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue.<1>) The sharp decline in the price of oil had severe consequences for Russia. However, the primary cause of the Russian Financial Crisis was not the fall of oil prices directly, but the result of non-payment of taxes by the energy and manufacturing industries.

Course of events
Prior to the culmination of the economic crisis, the GKO bonds issuance policy was described as similar to a pyramid scheme or Ponzi scheme (Hyman Minsky 1992), with the interest on matured obligations being paid off using the proceeds of newly issued obligations. Note however this scheme is used in the issuance of currency through a Central bank but is limited by Fractional-reserve banking practices.

Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the background to the meltdown. The economic cost of the first war in Chechnya that is estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy) was also a cause of the crisis. In the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify. Two external shocks, the Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, also impacted Russian foreign exchange reserves. A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on March 23. <2> Yeltsin named Energy Minister Sergei Kiriyenko, aged 35, as acting prime minister (see also: Sergei Kiriyenko's Cabinet). On May 29, Yeltsin appointed Boris Fyodorov Head of the State Tax Service. The growth of internal loans could only be provided at the expense of the inflow of foreign speculative capital, which was attracted by very high interest rates: In an effort to prop up the currency and stem the flight of capital, in June Kiriyenko hiked GKO interest rates to 150%. The situation was worsened by irregular internal debt payments. Despite government efforts, the debts on wages continued to grow, especially in the remote regions. By the end of 1997, the situation with the tax receipts was very tense, and it had a negative effect on the financing of the major budget items (pensions, communal utilities, transportation etc).

A $22.6 billion International Monetary Fund and World Bank financial package was approved on July 13 to support reforms and stabilize the Russian market by swapping out an enormous volume of the quickly maturing GKO short-term bills into long-term Eurobonds. This had started to be implemented with some success by July 24, yet the Russian government decided to keep the exchange rate of the ruble within a narrow band, although many economists, including Andrei Illarionov and George Soros, urged the government to abandon its support of the ruble. On May 12, 1998 Coal miners went on strike over unpaid wages, blocking the Trans-Siberian Railway. By August 1, 1998 there were approximately $12.5 billion in unpaid wages owed to Russian workers. On August 14 the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, July monthly interest payments on Russia’s debt rose to a figure 40 percent greater than its monthly tax collections. Additionally, on July 15 the State Duma dominated by left-wing parties refused to adopt most of government anti-crisis plan so that the government was forced to rely on presidential decrees. On July 29 Yeltsin interrupted his vacation in Valdai Lake region and flew to Moscow, prompting fears of a Cabinet reshuffle, but he only replaced Federal Security Service Chief Nikolai Kovalyov with Vladimir Putin.

At the time, Russia employed a "floating peg" policy toward the ruble, meaning that the Central Bank at any given time committed that the ruble-to-dollar (or RUR/USD) exchange rate would stay within a particular range. If the ruble threatened to devalue outside of that range (or "band"), the Central Bank would intervene by spending foreign reserves to buy rubles. For instance, during approximately the one year prior to the Crisis, the Central Bank committed to maintain a band of 5.3 to 7.1 RUR/USD meaning that it would buy rubles if the market exchange rate threatened to exceed 7.1 rubles per dollar...cont'd

http://en.wikipedia.org/wiki/Russian_financial_crisis


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Capitalist Collapse
How can Russia Recover?
by David M. Kotz
Dollars and Sense magazine, November/December 1998


Russian scientists were once famous for launching the world's first space satellite. Their counterparts today survive by growing vegetables in their small yards. These are not retirees enjoying some well-deserved leisure time gardening, but prime age workers-miners and teachers as well as scientists-trying to meet basic needs in the face of economic collapse. People go to work every day and do whatever their employer asks, yet weeks and months pass without a single paycheck. They stay on the job because at least it provides some fringe benefits, and no alternative paying job exists.

This has been the meaning of Western-inspired "reform" to a majority of public and private sector workers in Russia. But the media began calling it a crisis only in August of this year, when Russia stopped making timely payments to Western bankers and other investors who had taken a chance on Russian bonds.

After imposing years of suffering on ordinary Russians, Russia's Western-inspired 'neoliberal" program for rapidly building capitalism appears to have finally collapsed under its own weight. This program was devised seven years ago by top economic advisors to Russian President Boris Yeltsin's government, working closely with specialists from the International Monetary Fund (IMF).
Any visitor to Russia can see the effects of the IMF program. The nation's economic output has fallen by half and its investment by three-fourths since 1991, with no recovery in sight. Money is so scarce that half of economic transactions are conducted through barter. A small group of influential insiders has been handed ownership of the former Soviet Union's most valuable properties, while the majority has been plunged into poverty and hopelessness. The economic and social collapse has caused more than two million premature deaths since 1991, due to sharp increases in alcoholism, murder and suicide, infectious diseases, and stress-related ailments.
Despite the unprecedented economic depression, until recently Russian bankers kept getting richer and the stock market soared, buoyed by the lucrative trade in Russia's valuable oil, gas, and metals. Western banks helped to finance the speculative binge that drove up Russian stock prices, making it one of the world's best-performing stock markets in 1997. Then in the late spring of this year, Russia's stock market began to fall and investors started to pull their money out of the country...cont'd

http://www.thirdworldtraveler.com/Economics/CapitalistCollapse_Russia.html

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Lessons Learned From The Russian Meltdown:

http://books.google.com/books?id=k9G86K3isJwC&dq=russia+financial+collapse&pg=PP1&ots=ihH24KU1jK&source=citation&sig=hbsfmYH4YTAQytHqu3VDxaOVR8A&hl=en&sa=X&oi=book_result&resnum=12&ct=result#PPA12,M1

http://www.highbeam.com/doc/1G1-55891274.html

"These are not retirees enjoying some well-deserved leisure time gardening, but prime age workers-miners and teachers as well as scientists-trying to meet basic needs in the face of economic collapse. People go to work every day and do whatever their employer asks, yet weeks and months pass without a single paycheck. They stay on the job because at least it provides some fringe benefits, and no alternative paying job exists."

This is what the recipients of "tax cuts", the top 1% have in mind for the rest of the masses. As long as they live in their gated communities, the teachers, nurses, police, garbage collectors, shopkeepers, etc., the rest can go to work every day and go home every night to see what they can pull out of their garden to cook up for dinner. And if the crops fail for lack of diesel fuel (as in North Korea) well, everybody can just make do.

From that same article:

The financial sector cannot prosper indefinitely while production of real goods and services is collapsing.

..snip..

When the financial crisis struck Russia, the IMF actually insisted that the solution was more of the same-more cuts in government spending, higher taxes, and tighter credit. For a country suffering from a 50% decline in production, this is absurd advice. Any economics textbook notes that such measures, by further reducing the demand for goods and services, will only make an already severe recession worse-as President Herbert Hoover proved during 1929-32.