Russia's Problems Are Everyone's Problems
"Cyprus with nukes." That's how someone, maybe me, referred to Russia in an IM conversation this morning. It's not really a fair comparison; Russia is a vast country loaded with natural resources, not a tiny island banking haven. But it does express a very real fear: that the world is about to experience a major financial crisis in a country that seems to deal with its internal troubles by slicing off bits of neighboring countries.
The ruble is plunging, for reasons that have roots in the falling price of oil. Yet the trouble now runs deeper than that, so the ruble's problems will continue even when the price of oil recovers a bit. As our own Leonid Bershidsky explains, markets are no longer just worried about oil prices, but also about the Russian Central Bank's apparent decision to bail out a suffering oil company by printing money:
Central Bank technocrats have been worried that the government would force them to print rubles for the direct funding of industries, primarily the military industrial complex and the state companies run by Putin friends. The Central Bank's obvious complicity in the Rosneft deal means the pressure is on, and the Central Bank is caving. It cannot prevent the funds loaned to corporations in special deals such as Rosneft's from destabilizing the currency and fueling market panic. Besides, the Rosneft deal sends a clear signal to market players that some of them are more equal than the others. That is a sure way to foster distrust and send the ruble into a speculative tailspin regardless of what happens to the oil price.
The central bank tried to make up for this action by ratcheting interest rates up to 17 percent. It hasn't worked; the ruble continued its plunge this morning. This tells us many things, all bad: that the central bank is not strong enough to resist President Vladimir Putin; that Putin is desperate enough to print money to cover Rosneft's problems; that capital controls may well be in the offing (so oligarchs and traders are eager to get their money out of the country); that Russia's financial situation is spinning out of control.
If that's not terrifying enough, consider that Russia is not the only country headed for problems. The Middle East is full of countries that need a high oil price to protect their economies. Take Iraq. Three years ago, I wrote:
But at least the oil is still flowing, and high prices help the government make up for shortcomings elsewhere. According to Frank Gunter, the economy needs to create about 250,000 net new jobs every year in order to absorb the young people coming of age. “A good year,” he says, “is a year when oil prices are high, which allows the government to create those 250,000 jobs.” And a bad year? That was 2006, when maintenance and capital investment were slashed. “You had Iraqi ministry employees going to work and sitting in the dark because there was no money for lightbulbs … but no one was fired, and no pensions were cut.”
Half of the labor force works for the national government, either directly or indirectly, and another 20 percent or so is unemployed. “Iraqis believe that the only real job is a government job,” Gunter says. It “pays more, has benefits, you can’t be fired, and the work intensity is lower than in the private sector.” Gunter estimates that if the price of oil falls below $40 a barrel, the government is in serious trouble: below that price, it will not have enough revenue to pay salaries and pensions, even if no services are provided at all.
Oil prices were hovering around $110 a barrel back then. Now they're at $55. And as a bond trader noted to me this morning, "Oil is lower, market concludes demand must be weak. Commodities guys look at equities ... and see weakness, bid oil lower. Equity guys see oil is lower ... hmm. Must be weak demand. Wash rinse repeat."
"If this rate of sell-off is sustained," said trader continued wryly, "oil will be free by mid-January."
Outside the Middle East, Venezuela is already well into a long economic crisis. The Hugo Chavez regime diverted investment funds from the state-owned oil company into social spending, which caused production to decline. That was a workable trade-off when prices were rising, but now that they're falling fast, so is Venezuela's economy, along with political stability.
Last week, I noted that this meant the risk of serious geopolitical repercussions. (The last time oil prices experienced this kind of run-up and decline, the Soviet Union fell.) In the modern global economy, it also means the risk of financial crisis, as problems in Russia and other oil-rich nations reverberate outward through our tightly interlaced networks of finance and trade. China is already fragile, the euro zone is struggling to hold everything together, and while U.S. growth finally seems to be back on track, we will not be immune if the rest of the world is reeling.
Bershidsky suggests that capital controls may well be next for Russia, though the central bank governor denies that they are being considered. Whatever Russia does next, we'd better hope it works. Because if not, the rest of us may be using our newly cheaper gasoline to fuel up for a very bumpy ride.
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