Global crisis: Its origin and implications for Russia’s macroeconomic and social stability

229

ISSN 1075-7007, Studies on Russian Economic Development, 2009, Vol. 20, No. 3, pp. 229–242. © Pleiades Publishing, Ltd., 2009.Original Russian Text © V.S. Panfilov, 2009.

With tightening global and Russian financial mar-kets and collapsing commodity prices we need to givemeaning to developments bearing on economic dynam-ics worldwide, the place of the world financial systemin the reproduction process, and the need for extraordi-nary government intervention. The questions as to theorigin of the crisis, its depth, and duration cannot beanswered without analyzing the foundations andbehavior of the global socioeconomic system.

The disturbances that occurred in the financial fieldand are already extending to the real sector and thelabor market have properties essentially inherent tomodern national and universal money. To be moreexact, these properties are inherent to an economywhose functioning depends on money. It provides thegroundwork for the operation of the banking and finan-cial system and access to external finances for corpora-tions and individuals. The realization of this capabilitygave rise to the industrial, agrarian, and later on, scien-tific and technological revolution, leading to tremen-dous growth of production forces. At this stage ofdevelopment, sci-tech innovation is being financed—for the first time in human history—more by privatesector than by public sector.

The extended facility potential is in direct relation-ship to the development of financial technologies andinstitutions. The most important financial technologiesinclude the issue of bank money, bank loans to nonfi-nancial sector, interbank loans, deposit multiplication,financial leverage, swaps, repos, options, futures, for-wards, securitization, structured financial products likeCDO,

CMO, or CBO,

and default swaps. Modernfinancial technologies make it possible to split overallrisk of investment into an object into credit, interest,currency, and market risks and to transfer them toanother financial intermediary. The emergence of insti-tutions that allowed financial technologies to be used inthe functioning of the nonfinancial sector is an integralelement of the global and national socioeconomic sys-tems. Financial institutions grew as both new financialinstitutions were establishment or existing institutions

were drastically restructured. For example, recentdecades saw the appearance or spread of major institu-tions such as forex, futures exchanges for staples (oil,metals, grain, etc.), and stock indices, pension funds,unit funds, money market funds, hedge funds, manage-ment companies, and rating agencies. The functions ofbanks, insurance companies, and stock and commodityexchanges underwent considerable change too. Latelybanks tended to change from lending institutions intointermediaries between borrowers and financial mar-kets. Payment and settlement systems have moved fromreal money payment to electronic payment.

Consequently, the real sector and household couldrely on the financial system to manage and augment itsmaterial resources, which would have been unavailableto it in the first place and could not be created in the sec-ond. The multiplier, which shows a theoretically possi-ble increase of the money base (central money), is ageneralized characteristic of the potential strength of afinancial system. In practice, this increase is realizedthrough banks’ credit expansion, which depends less onreserve requirements or central bank rates than ondemand (effective and excess) for credit. Effectivedemand refers to the kind of demand that has adequatesupply, while banks and their creditors maintain andmultiply their money capital. Excess demand, by con-trast, does not generate corresponding supply, andbanks and their creditors lose money. Socioeconomicdevelopment is effective when the benefits from theaccommodation of effective credits are greater than theloss from the accommodation of excess (bad) credits.

The actual value of the multiplier, besides theabove-mentioned one, depends on the prevalence offinancial technologies and the credibility of the finan-cial system. Compare the United States and Russiafrom this perspective (Fig. 1).

A monetary unit put into circulation by the FRS inthe United States generates three times more monetaryassets and debts than one issued by the Russian CB, andwith respect to M3, which is greater than M2 by theamount of long-term deposits, money market and short-

ECONOMIC POLICY

Global Crisis: Its Origin and Implications for Russia’s Macroeconomic and Social Stability

V. S. Panfilov

Abstract

– The author explains his view of the origin of the global economic crisis as the consequence of thedepletion of growth financing resources. Its scale, depth, and duration are estimated. The influence of the globalcrisis on Russia’s macroeconomic situation and stabilization measures of financial and economic policy are dis-cussed.

DOI:

10.1134/S1075700709030010

230

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Times

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199

6

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. 200

8

Period

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0Ja

n. 1

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Fig. 1.

Money base multipliers: (-

�

-) by M2; (-

�

-) by M3; (-

�

-) Russia by M2

Times

Jan.

199

6

Sept

. 200

8

Period

Jan.

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7

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454035302520151050

Fig. 2.

Cash base multipliers: (-

�

-) USA by M2; (-

�

-) Russia by M2

term buy-back commitment transaction funds (the FRSdiscontinued the official estimation of the aggregate in2006), over four times more. A banking system credi-bility gap persists, too. In Russia, the proportion of cashin the monetary stock, which diminished to 26.8% from42% in December 1998, stays 2.5 times higher than inthe Unites States (10.2% at the beginning of 2008).This said, an estimated 50% of all dollar bills are out-side the United States. However, even leaving out thelatter, a monetary unit issued into circulation andremaining inside the US system generated about40 units of assets and in Russia, only about 10 (Fig. 2).

With respect to the current stage of financial crisis,it is important to note

the limited scope of direct action

by monetary authorities, including Russian ones, onbanking system saturation with liquidity, capital, andlong-term government credits.

If monetary authoritiesresort to the doubling of the liquidity

(monetary base)

of the US banking system, to $1900 billion (recentdevelopments show that this path was selected), and thelevel of credibility and development of financial tech-nologies in the United States lowers to the present Rus-sian one, then

the monetary stock will not increase butdecrease

. The monetary stock (M2) will diminish by some30% (with cash increasing by $635 bln) to $1385 bln andbanks will lose 40% of their resource base, or about$4000 bln. This illustrative estimate characterizes

theincipient phenomenon of monetary stock contraction

inthe context of general (from New Zealand to the UnitedStates) active government efforts to pump liquidity intotheir economies. Market agents, on their part, shed riskyassets in a big way and reduced their bankrolling of bothfinancial and real sectors, preferring to invest in US instru-ments. For the first time in history, the yield on US 10-yearand 30-year instruments decreased below 3% (Fig. 3).


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GLOBAL CRISIS: ITS ORIGIN AND IMPLICATIONS FOR RUSSIA’S MACROECONOMIC 231

If a similar estimation is made for Russia, based onthe 2002 level of credibility and financial technologies,then in order to maintain the nominal resource base ofcommercial banks, Russian monetary authorities mustissue nearly 5 trillion rubles, or nearly double theamount of central money. Accordingly, the main chal-lenge in rising from crisis is

to seek and discover chan-nels and objects for efficient investment

. The availabil-ity of fields for economically sound application of cap-ital – which assumes proper payback and liquidity—can alone ensure the effectiveness of government injec-tions into the banking sector. While payback can beachieved through the implementation of suitable busi-ness plans, the liquidity of investment cannot beachieved unless up-to-date financial technologies andliquid financial markets are used. Only market profes-sionals can apply financial technologies and supportliquidity; without them, we cannot weather the crisis,still less return to dynamic growth. Any hope of aninterest rate reduction by money authorities and subor-dinary credits leading to the restoration of economicgrowth has no solid ground. Indeed, even if someonereceives an interest-free loan for a long period, invest-ing this money into potentially defaulting assets ordepreciating assets is one way of going bankrupt.

The loan granting process is both a great growthopportunity and a big threat to socioeconomic stability.The financial system’s inability to refinance debts andto create effective extra demand leads to crises on dif-ferent scales. Local crises arise because the presumedquality of considerable amounts of

ex ante loans differsfrom that of ex post ones. The effect of local crises uponthe world economy depends on the scale of the afflictednational economy and foreign investors’ involvementin the country’s financial system. Global crises can begenerated either by developed economies lacking ade-quate effective demand—which in the final count is

caused by the wearing off of engineering and organiza-tional innovations’ effect upon productivity and output-capital ratio raising and material and energy intensityreduction—or the economic system’s inability tofinance it. The deepest crises arise when there is bothlack of investment objects, which shape effectivedemand, and the economic system is losing its ability toeffectively reallocate existing financial resources.

Glo-bal crises act as economic growth financing crises

,which affect the bases of the global financial system asa whole as well as those of national ones.

The current crisis has both local and global features.The former are associated with the world’s greatesteconomy, the US economy, and the mortgage lendingproblems that hit the entire financial system of theUnited States. The latter stem from the fact that in thelast decade

the global reproduction process was deter-mined by the American consumer’s demand

(about 30%direct count and 50% with due consideration for theexporting country’s internal utilization of added exportrevenues owing to the US rising balance of trade andpayments deficit). The balance of payments deficit,which peaked at $753.3 bln in 2006, was, on the onehand,

financed by the American consumers, whose debtto the financial sector grew, and the debt itself wasfinanced by foreign investors who bought up differentAmerican financial assets

, including sub-prime securi-tized mortgage loans, which feature lower borrowerrequirements compared with ones refinanced by federalmortgage agencies. For developing countries, particu-larly those employing rigorous exchange regulation,export revenues were bought from exporters withoutfail. As a result, central banks in developing countriesaccumulated their currency reserves. Chinese, Indian,and other workers in developing countries, who madeexport products, received their pay, peasants in thesecountries could sell their farm produce, and the Ameri-

Period

1615141312

1011

98

67

5432

Jan.

2, 1

962

Jan.

2, 1

965

Jan.

2, 1

968

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Jan.

2, 1

998

Jan.

2, 2

001

Jan.

2, 2

004

Jan.

2, 2

007

Fig. 3.

Yield on 10-year US debt instruments ( ) and on 30-year debt instruments ( )

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can consumer bought durables, apparel, etc. However,this apparently idyllic process began to be destroyed byincreasingly complex currency issues.

From the mid-summer of 2001 up until August2008, the US dollar, the world reserve currency, gotprogressively weaker relative to major currencies: by25% to the ruble, 88% to the euro, 42% to the pound,

and 16% to the yen (Fig. 4). The weakening of the dol-lar was the consequence of both double deficit (the USbalance of payments and federal budget) and the risinginterest rate difference (Fig. 5).

The dollar downing led to a sharp rise in monetaryand financial funds’ demand for exchange goods as

Period

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Fig. 4.

Exchange rate dynamics of the dollar, euro, and yen (100 yens): euro/dol.; dol./yen

Period

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Fig. 5.

Interbank market rates in dollars and euros: LIBOR ($, 1 week); LIBOR (EU, 1 week); CBR rate(rubles); margin (euro-dol.) (right-hand scale)


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financial assets, which, in turn, accelerated the growthtrend in the prices of oil, metals, etc. (Fig. 6).

As a result, the departure of the exchange rate fromthe euro-dollar PPP ratio reached an unprecedentedlevel (table).

The world exchange market’s tentative trend move-ment in favor of the US dollar and the policies of lead-ing central banks aiming at the successive lowering ofbase interest rates, as well as price reduction at interna-tional commodity markets, normalized to a degree theexchange rate fundamentals: purchasing power parity,balance of payments surplus, inflation rate, and growthoutlook. However, this normalization was unprecedent-edly rapid, causing additional problems of bank bal-ances connected with exchange rate revaluation.Besides, fears that large-scale FRS issue and growingUS federal budget deficit could spur inflationary devel-opments led to the exceeding volatility of exchangerates.

Crisis as external shock for Russia’s socioeco-nomic development

. The behavior of Russia’s keysocioeconomic indices for some time past—until theactive action phase of financial crisis—gave evidence

of the onset of post-crisis growth, which was character-ized both by market makers’ attempts at acceleratedeconomic growth and by the government’s declaredgrowth stimulation program. It was clear that the GDPgrowth rate increased, the rate of growth of the manu-facturing industry doubled, leading to two-digit indica-tors, and there were indications of an investment boom.On the other hand, this acceleration was associated withlarge-scale flow of foreign capital ($80 bln in 2007), anabrupt rise in import growth rates (from about 20% in2006 to 40% and more in 2007). According to calcula-tions, accumulated resources and balance of paymentsand budget surpluses even under favorable commoditymarket environment worldwide are bound to run out atthis reproduction mode after less than three years.Accordingly, central questions of a short-term forecast(and also a short-term forecast under rapidly develop-ing criris) are stated as follows:

Can the Russian econ-omy sustain rapid growth under changed conditions?To what extent and in what way need we use our accu-mulated reserves? What needs to be done in order thatthe Russian economy not only generate adequateamounts of raw material exports but also successfully

Period

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31,

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Fig. 6.

Commodity Channel Index (CCI) (1967 = 100)

Ratio of purchasing power parity and exchange rate

Country 1996 1999 2002 2005 2008 (July) 2008 (October)

Eurozone (Germany) 1.34 1.04 0.90 1.11 1.39 1.12

Japan 100 1.52 1.42 1.15 1.18 1.20 1.34

Russia 0.43 0.22 0.30 0.45 0.57 0.50

Britain 1.00 1.05 0.01 1.18 1.28 1.04

USA 1 1 1 1 1 1

China 0.42 0.44 0.44

Korea 0.77 0.75 0.47

Brazil 0.58 0.60 0.43

India 0.30 0.34 0.39

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compete at the domestic market by supplying goodswith high processing value?

From the monetary (i.e. exchange) policy angle, themost important task is to determine the national cur-rency rate mechanism and the manner in which rublerate will influence macroeconomic balances.

The past currency and financial policy, whichencouraged the building of considerable gold and for-eign currency reserves as well as state reserves in theshape of a reserve fund and a future generations fund,simultaneously led to very dangerous imbalances. ByAugust 2008, the government and private debt came upto $500 bln (with the private debt exceeding $450 bln),some 40% of commercial banks’ assets were formed byforeign liabilities and foreign currency deposits (pre-dominantly in US dollars), which given the rapid dollargrowth in August—September led to exchange ratelosses –26% of bank capital, or some $46 bln, by ourestimate. So outrageously great Russia’s dependenceon world raw material prices came to be that if theprices of Russian exports were reduced to the level ofthe third quarter of 2007 and the rate of growth of itsimports was kept, it would lead to a current accountdeficit of $17 bln as early as the fourth quarter of 2008.Obviously, this scale of foreign exchange deficit at themarket will impel exports to refrain from selling foreigncurrency receipts; banks, to wind up their foreignexchange positions opened in rubles; and households, todrastically change the currency structure of their savings;recently, foreign currency in hand was diminishing at therate of $10 bln a year. Add to this nearly $49 bln in fourthquarter payments by Russian companies to externalcreditors, which for all practical purposes could not berefinanced on foreign market, and the total foreign cur-

rency deficit in the fourth quarter will top an estimated$104 bln.

The currency surplus conditions, in which the mon-etary authorities were quite comfortable, reversed. As aresult, the exchange market conditions cardinallychanged, too. As already mentioned, foreign currencydeficit could be felt even in the fourth quarter of 2008.The year 2009 is predicted as a very strenuous: theretirement of foreign debt and interest will amount to atleast $121.1 bln, the balance of payments deficit undera “strong ruble” policy may top $100 bln year on year,and even if the price of Urals oil goes up to $60/bl, itwill not eliminate the deficit of the federal and mostregional budgets. A sharp slump in external demand,problems with government funding, and a nonoperatingbanking system may not only decrease, but also restrainthe rate of economic growth for a long time.

Amid the crisis, when a relatively low level of pricesfor staple exports will last in the medium term, it willbe urgently necessary to take steps toward import sub-stitution and alternative exports, which would help tosolve the problem of economic growth and foreigntrade balance. So far, however, there is hardly any signof such developments. What many perceive as a rela-tively low level of oil prices, $40–50/bl, looks retro-spectively, rather, as moderately high (Fig. 7).

As a matter of fact, under the circumstances,

deva-luation of the national currency is the only on-the-spotinstrument for maintaining economic stability

. Whatwe need is not something along the lines of the 1998exchange rate collapse, but a conscious, moderatedecrease by 30–35% to 42–46 rubles within the dualcurrency basket (according to the author’s estimatebased on place-to-place comparisons and calculated

July 2008 oil $144/bll.2009 forecast oil $45/bll.

Year

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Fig. 7.

Global GDP ( ), $bln (left-hand scale) and world oil market relative to global GDP (-

�

-) (right-hand scale)


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Bln rubles

Oil price, $/bll.

14000

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6000140 130 120 110 100 90 80 70 60 50 40 30 20

Fig. 8.

2009 federal budget revenues for three variants of the mineral extraction tax: exemption limit ( ) $9/

bll

.; ( ) $15/bll.;( ) $25/bll.; ( ) 2009 federal budget expenditures

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Jan.

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5000

Fig. 9.

Nikkei-225 index

import elasticity with respect to real ruble rate) and thechangeover to a real rate support policy. Otherwise wewill almost unavoidably—barring the unlikely speedyresolution of the global crisis—face the depletion ofcurrency reserves, the soliciting of credits from worldfinancial organizations, the collapse of the national cur-rency similar to the Argentine scenario at the beginningof this century, and the loss of the available potential fortransition to an innovation-driven development path.

The scale of dependence of federal budget on oilprices at a stable ruble rate (the 2009 average annualrate of 25 rubles per dollar) can be illustrated by a para-metric diagram (Fig. 8).

Devaluation is not the only or, in the final count, themain element of economic policy, but delaying the appli-cation of this measure may devaluate all the others.

The causes of the world crisis.

Let us come back toanswering questions as to what developments are tak-

ing place in the world economy and finances and why,what are the causes of the crisis, how long it will con-tinue, and what can be expected in the long run.

Indeed, rather unusual developments are takingplace in the world at large and at emerging markets inparticular. To begin with, all stock indices plummeted andthe wealth held by owners decreased in proportion. If welook at these developments from a historical point of view,technically they are nothing out of the ordinary. For exam-ple, the Japanese market, which “fell” in the late 1980s,has not yet achieved its precrisis state (Fig. 9).

The US stock market fell almost ninefold during theGreat Depression (1929–1933) (Fig. 10).

As regards major international stock indices, e.g.,Dow Jones and S&P, their values are currently atroughly the late 2003 level (Fig. 11).

The Russian stock market’s price indices also sug-gest its return to roughly 2004. While it is not any good

236


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it is apocalyptic, either. Sags of indices, though not uni-versal, did occur periodically in the 1990s. The Asiancrisis of 1997–1998 is just one example.

At present, as at that time, high volatility can befound not only on stock markets, but on money andexchange markets too. Shocks born in the financialsphere are transmitted to the real sector and the labormarket, i.e. the crisis is directly affecting not only well-to-do but also the average citizen in different parts ofthe world.

Let us consider the

currency sphere

. While in lateJuly 2008 the dollar-to-euro rate was nearly 1.60, itdropped to less than 1.26 by November 2008, that is, bymore than 20% within a short period. The yen showedeven more spectacular growth in relation to all curren-cies. At the same time, the Polish zloty and the South

Korean won, and lately the Ukrainian hryvna as well,fell by about half. It gives rise to suspicions as to banks’capacity to provide adequate service to customers. Peo-ple are starting to withdraw money from the bankingsystem, which is accompanied at best by its exchangefor a foreign currency. This is the next manifestation ofcrisis.

The rise of crisis occurred early in 2007 and itsactive manifestations on a global scale began in thesummer of 2007. These events were termed a “credibil-ity gap” at world markets; banks having some liquidityrefused to credit each other.

In order to explain the causes of this crisis we muststart from events farther back.

The last 25 years, particularly the last 8-9 years, sawthe proliferation of modern financial technologies, var-

Period

Oct

. 1, 1

928

0

Oct

. 1, 1

930

Oct

. 1, 1

932

Oct

. 1, 1

934

Oct

. 1, 1

938

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. 1, 1

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Oct

. 1, 1

942

Oct

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Oct

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Oct

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400

350

300

250

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Oct

. 1, 1

936

Fig. 10.

Dow fall and recovery

Period

Oct

. 1, 1

973

Oct

. 1, 1

976

Oct

. 1, 1

979

Oct

. 1, 1

982

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006

14000

12000

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8000

6000

4000

2000

0

Oct

. 1,2

000

Oct

. 1, 2

003

Fig. 11.

Three phases of dynamics of the Dow stock index (-----) (1973–2008) from the oil shock to the conclusion of financialmarket deregulation


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ious derivatives: futures, forwards, CDO, CDS,options, and so on. They enabled the financial system tocredit and generally finance economic growth veryquickly and flexibly. Before WWII, capital—whichwas scarce by present standards but readily available by19th century standards (the 19th century likewise dif-fered from the 18th century in this respect)—led to aprolonged period of unprecedented socioeconomicdevelopment and later on, to a crisis of overproductionand the Great Depression. After the war, the develop-ment of banking and financial structures and new waysof financing, led to new growth opportunities. However,by the mid-1970s, not only the Soviet administrativeplanning economy, but also the market economies ofdeveloped countries were afflicted by systemic crisis.

The capitalist market economy, unlike the adminis-trative planning economy, could overcome it largely byliberalizing the banking and financial system and devel-oping financial institutions and technologies. Thedevelopment of financial instruments such as financialleverage, swaps, repos, options, futures, forwards,securitization, structured financial products like CDO,CMO, CBO, and default swaps materially facilitatedthe processes of financing and crediting of both busi-ness and consumption. We illustrate it by the dynamicsof the Dow stock index. From the early 1970s to theearly 1980s, the US economy was in a state dubbed“stagflation.” The start of liberalization of financialmarkets during R. Reagan’s presidency (the singlingout in the banking system of investment banks not sub-ject to tight banking regulation, the appearance of WTIcrude oil futures trading, the easing of commercialbank regulation, the achievement by the FOREX mar-ket of the dominant position in determining exchangerates of currencies, etc.) led to an upward trend both ineconomic growth and in consumer activity. By the mid-1990s, however, this kind of growth had exhausted itspotential. The further liberalization of financial marketsgave a powerful impetus to the growth of the so-callednew economy as well as large-scale housing construc-tion; sub-prime loans played an important role in thefinancing of home building. At present, not only is thisresource being depleted but also the level of deregula-tion of the present-day American and worldwide finan-cial systems is under fire.

The financial system worldwide, the American onein the first place, met with the following problem. In theclassic bank—customer scheme the bank made a loanto the customer and the customer gradually returnedthat loan. In the modern world beginning with the1930s, such loans became increasingly common. How-ever, in the period from the mid-1960s to the mid-1980s, this kind of lending reached its high.

A new stage began when banks and other financialinstitutions, to finance their credits, turned to the secu-ritization of debt obligations. The mortgage loan is anexample; banks issued papers, which were secured, on

the one hand, by the flow of earnings from the borrowerand on the other, by a pledge of borrower property.

Further on, the development of derivatives led to thelarge-scale issue of various CDOs; papers began to beissued against mortgage-backed securities (MBSs),auto-backed securities (ABSs), credit cards, and others,whose sales financed new credits. Other papers beganto be issued against those papers, etc. As a rule, thelonger a credit, the higher was the interest rate. To illus-trate, the interest rate on a 25-year credit was about 9%in the United States. Ten-year securities were issuedagainst this credit. The interest on these papers wasapproximately 7%. On the one hand, the bank of issuereturned its money and on the other, it had some incomeas it gave these papers away at 7% interest, keeping 2%.

But in the purchase of securities, a bank was nolonger sure who was behind its borrower and could notbe certain that it could respond to a problem quicklyenough. A question arose: do borrowers meet their obli-gations? Though there was no convincing evidence thatthey did not, at that time, banks and other investorsthought they had better market the securities. A snow-balling sales flow sharply reduced their prices and thepapers themselves became nonmarketable. A funda-mental difference between the net value of a paper andits actual value comes down to the different costs ofborrowing depending on the life of a loan. For instance,if a loan is issued for 25 years, the borrower will returnsevery month 1/300 part of it. Accordingly, if the bankneeds money it can only sell this debt instrument towhoever will be content with having 1/300 part of itevery month. The purchase, in turn, will demand abonus for his renunciation of liquidity and the sellerwill agree to pay it. Thus, the difference between thecost of short and long money arises.

Under normal circumstances, change is smooth, andin imbalance situations, the price of deficit arises. Inthis context, the price of liquidity (cash) grows stronglyand rapidly while the cost of future revenues, on thecontrary, decreases.

At the onset of crisis some, then all, holders beganto sell above-mentioned CDOs and their price began tofall, first slowly and with time increasingly fast. A fallin securities’ prices means for financial entities adecrease in the value of their assets. If it bought a paperfor 100 units and its value halves, a bank even if it doesnot sell the paper, must reflect—immediately or after acertain time—a 50-unit loss in its balance. Faced witha loss, the bank must replenish its resources and its cap-ital because of the rules that dictate a certain ratiobetween a bank’s capital and its operations, betweenborrowed money and its available assets. The sale of thepaper turns the loss from a technical, bookkeeping oneinto an actual one, i.e. something that can be indemni-fied by the recovery of market prices.

Banks were trying to issue their own bonds toreplenish their resources and then, when these actionsbecame not quite possible, started to attract foreign

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capital. As for American banks, it was Asian and Arabcapital, which began to enter the largest banks. At thestage of aggravation of crisis, government in the per-sons of finance ministry and central banks took part inthe replenishment of the banks’ resource base.

Thus a situation developed, which remained unno-ticed by the authorities, the majority of business people,to say nothing of the population, which saw it as irrele-vant to Russia.

Here a small remark on recent events in Russia is in order. Mid-October 2008 saw speculative buy-up of foreign currency.Exchange offices bought foreign currency one ruble dearer and soldit two rubles dearer than stock exchanges. However, the readiness topay dearer was not supported by the supply of currency, which notonly failed to grow but in fact decreased. We note that the deliveryof currency to an exchange office is in itself a lengthy procedure.Even if a Russian bank has cash in an American or European bank,it must send it to an appropriate bank specializing in cash supply.This bank will draw the amount required, turn it over to the deliveryservice that will transport currency in cash to Russia, go throughcustoms clearance, and then deliver it to an exchange office, i.e. it isnot only a lengthy but also an operationally expensive procedure. Asa result, the ruble exchange rate changed not only because of a panicbut also because of the shortage. This example illustrates the tech-nical impossibility of using the currency reserves of the central bankfor prompt action upon the spot currency market.

Technical factors sometimes prove to be crucial in crisis devel-opment.

Technical default or failure to issue requested cash resources (inrubles or a foreign currency) in the context of alarmist sentiments isnot perceived as an exclusive problem of particular obligators andlenders. The problem is transferred to the whole economy, particu-larly the banking and financial system, leading to exponentialgrowth in drawing from bank accounts throughout the system, thedepletion of bank resources, the depreciation and decreased liquid-ity of securities, and in the final count to the paralysis of the repro-duction process financing system. Preventive measures to protectthe banking system in this situation, e.g., the establishment of insti-tutions to ensure deposits and provide government money-backguarantees are necessary but not sufficient. There must be in addi-tion a transparent money-back mechanism, which shows how soon,from what funds, and in what amount investments and deposits willbe returned. Depositors’ understanding of this mechanism makesthe whole system ineffective during large crises. In particular, the

question arises, in what way and at what time budgetary resourceswill be appropriated if the Deposit Insurance Agency’s ownresources will be shy of meeting all the demands for return ofdeposits. In the current conditions, when the receipt of pensions onpersonal accounts in Sberbank was delayed for five or six days, thereliability of the available technologies guaranteeing the fulfillmentof obligations raises serious doubts.

The slow brewing of processes inside the financialand banking system long remained unnoticed in West-ern countries, too. Then, the situation in real estatemortgage and housing became threatening, in the firstplace in the United States. Borrows had problemsrepaying their loans. Demand for construction compa-nies’ services dwindled: banks simply had no moneyand the market mechanism of borrowing for all practi-cal purposes ceased to function. However, constructioncompanies could not work without borrowing frombanks. As a result, new construction in the UnitedStates decreased almost fourfold (Fig. 12).

Simultaneously, US housing prices were stronglyaffected (Fig. 13).

Given that housing in the United States is the singlemost important wealth, possessed by the majority offamilies, it impacted other fields from industrial con-struction materials to auto loans and car making. Ifbanks are short of funds, they will grant fewer autoloans the demand for cars slumps. In October 2008,Nissan and other leading carmakers around the worldfaced 30–40% declines in auto sales in the UnitedStates, which was a colossal blow to the real sector faroutside the United States.

Speaking of global dynamics, most of the marketparticipants and politicians have come to realize thatthe likelihood of a worldwide recession is very high,indeed, and it may prove to be the most painful sinceWWII.

The impact of the world crisis on Russia

.

Theimpact is extremely adverse. Russia’s current economic

Period

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Start of new housing construction, thou units


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policy is not quite appropriate. While it secured highrates of growth, the source of this growth turned out tobe highly unstable. For example, the 8-percent growthpresupposed 40-percent rise in import. Thanks to a pos-itive trade and payments balance reserves were simul-taneously being formed. Foreign currency reserveswarranted what is now viewed as a hazardous currencypolicy of raising the real ruble rate. The raising of thereal ruble rate tended to greatly increase import vol-ume.

Since the time the ruble began to get stronger (innominal terms from nearly 32 rubles at the end of 2002to almost 23 rubles in the summer of 2008), the externalsituation has changed beyond recognition. A decline indemand worldwide and the perception that it will con-tinued for rather a long time began increasingly to influ-ence the consumption of raw materials in the world,which had an acute effect on their prices. It means thatnot only oil, but also Russian raw material exports as awhole suffered very much. With the diminution indemand the prices of silver, copper, and all primarygoods plummeted; even gold came under pressure,which could not but affect the value of Russian compa-nies. This in turn sharply reduces fiscal revenues suchas export duty, mineral extraction tax, income tax, etc.

Countrywide, the need is felt for financing the bal-ance of payments and federal budget deficit. Under nor-mal conditions, it is common practice that one can bor-row at the world market relatively inexpensive financialresources on the condition that the import thus financedwill be channeled into the development of productionrather than consumption. Actually, Russia had a rarechance, which was missed by the economic authorities:during the period of high oil prices, to diversify theeconomy in order to manufacture domestic goods,which would also be competitive with imports at exter-nal markets. But the existing currency policy impeded

these developments because the ruble was gettingstronger and its competitive power decreased.

Continuation of a strong ruble policy will lead tofurther depletion of the still available tremendousreserves. Hopes for a reversal of world commodity mar-kets are slim and any policies based on them are adven-turist.

Economic history identifies three kinds of crisispath: V-shaped, U-shaped, and L-shaped. The drop inproduction is nowhere near hitting bottom yet, and it isobvious that the decline in demand will continue longenough. The appreciation of primary commodities inthis context is only possible if demand plunges, thelikelihood of which is limited by the need of exportingcountries for foreign currency revenues. Furthermore,in the event of an abrupt cut in production high com-modity prices will aggravate the crisis and contribute totheir own fall in the medium turn.

I note that the authorities’ thoughtless persistence in economicpolicy often leads to deplorable results. For instance, at the peak ofthe Asian crisis (1997), when stock markets crashed and a large-scale (for that period) capital flight from Russia exerted pressure onthe ruble rate, the Russian monetary authorities, pursuing a “keepthe ruble” policy, announced new parameters of the exchange rateband to restrict “opportunities for speculators to line their pockets,”and should this prove insufficient, they promised to resort to exter-nal borrowing. It was a period of acute fiscal crisis, resources tofinance public expenditure were lacking, oil prices affected by theAsian crisis fell to very low values, and public finances increasinglydepended on the “state treasury bills pyramid.” But in reality theauthorities were opposing a process which was objective.

The government was gradually drawn into borrowing at higherand higher interest, more money was attracted to the market with aneye to high yield, which was withdrawn from the real sector. Shortlybefore a default, premier S. Kirienko converted most of the ruble-denominated papers into foreign currency, i.e. a ruble debt turnedinto a currency one, which ended in the August 1998 default.

Today, the authorities are asserting that no devaluation is goingto happen in the near future and insist that dollars and euros shouldnot be bought. In this connection, it will be remembered that ourpopulation has relevant experience: shortly before the August 1998meltdown, President B. Yeltsin, too, also stated that there would beno devaluation of the ruble.

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280260240220200180160140120

Fig. 13.

US housing prices

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The fact that the Russian government allotted to Vneshekonom-bank $50 bln for the refinancing of external debts of Russian com-panies indicates, on the one hand, a patently insufficient amount forthe purpose, and on the other, a moral problem caused by privatecompanies’ being credited with tax payers’ money. However,nobody ever made a calculation to show that these funds could andwould be returned. This gives rise to the problem: how is the gov-ernment going to account to the taxpayers if the credits are notrepaid.

If the authorities persist in maintaining the ruble rate, a verynegative situation may develop.

Fiscal policy could well absorb reduced domesticdemand, e.g., in construction (particularly housing), inorder to prevent the crisis in the construction field turn-ing into a catastrophe and to keep housing constructiongoing. The kind of housing construction needed mustallow, on the one hand, the population to buy suitablehomes at prices less exorbitant than in Moscow, andbuilders, to make profit. Available resources need to bechanneled not into the refinancing of Russia’s foreigndebt but into the stimulation of production.

As for debts, it should be remembered that, gener-ally speaking, the state alone has long money. A merefour months ago, liberal thinkers could never evendream that nationalization would occur in the veryheart of capitalism, the United States, where govern-ment is entering into banks’ capital. Why is it happen-ing? Because in the world financial system, includingthe United States and any national financial system, itis impossible to wait for 25 years before all the moneyis returned. Securities are nonmarketable not becausethey cannot be sold at all, but because banks cannot—or unwilling—to sell them at the price at which buyersare prepared to buy them. As a result, banks’ balances“do not tally,” the financial system stops working,demand, then production, plunges, and unemploymentstarts to grow.

How was the balance of capital operations in Russiaformed? The government accumulated reserves, getting3% on these assets abroad, while domestic companieswere financed by the world financial system using thesesame resources at 7–8% per annum. In other words, afinance facility was “at work,” whereby there was anegative yield of 4–5% per annum on Russia’s ownfunds in the shape of gold and foreign currencyreserves.

Of course, reserves must be created. But thereshould also be both opportunities and a mechanism toopen Russian businesses access to Russian resources.During a crisis, the government alone has long money.Private business under a crisis, i.e. when it is short ofmoney, issues securities, which can only be boughtunder the guarantee that the debts will be repaid ontime. But under a crisis, such guarantees are unlikely ifat all workable: within that time (10–20–30 years!?) acompany will either turn bankrupt or the assets will godown in value.

Crisis of the economic growth financing mecha-nism.

The situation worldwide is generally tense. Opin-ions vary as to how it will develop. As I see it, we are

witnessing a crisis of the mechanism of financing ofglobal economic development. This mechanismevolved over the last 25 years and the world economydepended on it to develop, in the last 20 years, at thehighest possible rate.

Due to the crisis, critical opinions about the global currency andfinancial system and especially the United States’ role becamewidespread. America is under fire for using its dollar to dominate inthe world economy and to get corresponding dividends and otherbenefits. But in the world economy there must always be the univer-sal money phenomenon, and the dollar currently acts as universalmoney. As for the benefits, as already mentioned, all effectivelyobtain benefits. Let us consider how the People’s Republic of Chinadeveloped. A Chinese company, for example, sold toys to the UnitedStates, and the United Stated bought nothing in China. An Americanbought a toy, paying a dollar. The dollar went to the Chinese com-pany’s account and was transferred to China. China’s Central Bankbought this dollar and the company got a yuan. The company spentthe yuan on Chinese workers’ wages. The Chinese workersincreased their income and consumption. A Chinese worker spenthis income on farm produce, thereby increasing a Chinese peasant’sincome.

Can it be said that the United States consumed more? Yes, butin a market environment it is only possible if all consumed more. Anextra dollar generated an extra yuan, extra consumption, and invest-ment not only in the United States but in the PRC as well.

There is, of course, also a contradiction because thedollar acts not only as universal money but also as anational currency. Now, both governments and someanalysts are concluding that the world financial systemmust change, and it must become multipolar. Neverthe-less, from a world policy angle, universal money, likenational money, must be common. If, for instance, inRussia, “Muscovia” will use its own rubles and “Sver-dlovia” its own, it will mean the death of the monetarysystem. The same is true of universal money.

When people start talking about regional currenciesas a substitute for the universal currency, the US dollar,they seem to forget the inherent function money, whichis to be a measure of value. This brings up the question:how will regions trade with each other in the circum-stances? For example, it has been suggested that Russiashould sell oil for rubles. Meanwhile oil is quoted indollars. Accordingly, Russia will not be able to trade forrubles, only for dollars, or it will be settlements in dol-lars at the ruble-to-dollar rate. Otherwise, an exchangewill have to be put into place at which the buyers of oilfor rubles will bear an additional exchange risk, fornobody knows how the ruble will change over the time.

First, it is essential that the ruble become a normalnational currency. Which was not the case all throughRussian history because there has not been a single yearto see inflation under 10%? The most important thing isthe ruble’s firmness and price stability.

If the objective is a regional currency, we mustmaintain a stable rate. In this sense the demand for thiscurrency may arise in the short run.

Here is one fact to illustrate that it is short-lived. In the periodwhen the ruble was getting stronger, Azerbaijani started openingruble accounts at home and keeping savings in rubles. Lately,exchange offices in Azerbaijan stopped changing rubles for Azer-baijani manats, etc. Artificially made things are transient. The rublemust get stronger from within and it must have backing, which is the


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economy. As we can see now, backing based on natural resources isunreliable. Quote the satirist Saltykov-Shchedrin: “Today, they willgive you fifty copecks for a ruble and soon they will start roughingyou up.” I explain that this was written during the Crimean War,when much paper money was put into circulation. At the same time,metal money was in use. And while legally the paper ruble and themetal one were the same ruble, in fact the paper ruble cost only halfthe silver one.

It was mentioned above that the current economiccrisis is a growth-financing crisis.

In the world economic system as it was in the lastfew decades, an enterprise could get funding from bankloans, market borrowing, bond issue, or secondaryequity issue.

For an economy to develop it needs both availablecapital and solvent demand. Periodically there occurbreakdowns both in capital application and in solventdemand. When it takes place on a mass basis, a crisisstarts. Sometimes, the resolution of a crisis is a verylengthy and agonizing process.

The Great Depression of 1929–1933 comes to mind here. Inpractice the restoration of the economy to the 1929 level was onlypossible because of the development of defense industries duringthe Second World War. And it was not until 1953 that the Dow Jonesindex exceeded the peak figure of 1929, that is to say, the bailoutprocedure turned out to be extremely painful. For instance theUnited States had to devalue the dollar relative to gold from $20.67to $35.8 per troy ounce and to switch to deficit financing of budget-ary expenses targeted at public works and welfare payments. Emer-gency acts to restore national industry and control farming werepassed, which required seemingly irrational measures such as thedestruction of more than 25% of crops and the slaughter and dis-posal of six million pigs in order to check the crisis drop in prices.These measures somewhat stabilized the situation but did not pro-mote growth.

The capitalist system’s fundamental contradictionsbetween labor and capital, the drive for efficiency andto sales growth intermittently curb socioeconomicdevelopment. A country will go on a growth path whenboth its financial system and financial instrumentsdevelop and allow financing both sci-tech progress andgrowing consumption. In recent years, high technolo-gies were created in the field of finances, too. Hightechnologies, on the one hand, offer great advantages,and on the other, bear some risks. For instance, atomicpower is, on the one, hand, a supreme technology, andon the other, the world knows of the Chernobyl tragedy.

Even before a fall in primary commodity prices,there were fears that currency speculators would buy uprubles wholesale with the purpose of appreciation ofthe ruble exchange rate. Something like this is takingplace with regard to China. But when the net flow ofcapital ran up to 80 bln in 2007, it turned out to be toolittle for any substantial appreciation because the posi-tive trade balance was even greater than this value.Imagine what if it were not $80 bln but $300 bln (whichis not a formidable challenge for speculators). Whatcould happen here? The ruble rate would have shot upand almost all production would have come to a stop

(because all foreign-made goods are two-three timescheaper). Only production that cannot be importedwould have lasted: repairs and to some extent construc-tion. Very soon, the system would have collapsed. True,it never happened. But the real strengthening did notallow Russian producers to become competitive; to sur-mount the crisis they must be given a chance!

Prospects and possible aftereffects. Objectively,Russia has what it takes to go through crisis in a digni-fied manner and possibly turn it to good account. Rus-sia still has broad scope for the spread of high technol-ogies both in the real and financial sectors, and there areno resource limitations. In practice, however, every-thing is strongly dependent on the kind of economicand monetary policy to be pursued in Russia and world-wide. The development of global processes such as iso-lationism, protectionism, and the introduction of vari-ous reserve and settlement currencies will considerablyaccelerate the downturn already evident the world over.It is still a long way to go before equilibrium sets in;thus far, the downturn has been spreading only in realproduction.

This recession can be characterized by the return ofcommercial banks and other private financial institu-tions to conservative policies and the abolition or severrestriction of the use of modern financial technologies.Before the passing of the 1999 Gramm-Leach-ÇlileyFinancial Services Modernization Act in the UnitedStates, there were significant restrictions on the use ofderivatives and the participation of commercial banksin open-market transactions, which prevented lendingpractices from transcending certain limits. As a result,household debts were closely linked to their currentincome; they were 59.7% of GDP in 1997 and by the endof 2007, after financial technologies had succeeded inloosening this link, they grew to 97% of GDP (Fig. 14).The overall household debt was $13.7 trillion, involvingmonthly payments of interest and loan, some $60 mln and$90 bln respectively.

If the return to the former system is accepted as atight macroeconomic constraint, its realization willtake more than five years at a rate of decline of (-0,6%)a month (the overall decline is 37%), which is fullycomparable to the Great Depression (industrial produc-tion decreased then by 46% in the United States, 41%in Germany, 32% in France, and 24% in Britain). Themeasures being taken, which are similar to the Depres-sion-era NIRA (National Industrial Recovery Act) andAAA (Agricultural Adjustment Act), naturally, are tem-pering the continuing contraction of the American, andconsequently, the world economy. The adoption of thePaulson plan and, possibly, the Obama plan may reducethe potential downturn in the United States to 25–26%of GDP. It would be natural to presume that the USGDP having achieved the level of (–2%) a quarter (inthe first and second quarters of 2008), under the actionof current measures may even grow somewhat, only tobe followed by a fall, unless the global growth financ-

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ing mechanism works at the former, precrisis level.Many analysts hope that this mechanism can be acti-vated with the help of inflationary measures, whichwould reduce the debt burden and revive demand. Wecan remark to it that inflationary measure can only beeffective in a cyclic downturn, including compensationof real income loss. But in the context of a mountingthreat of deflationary processes against the backgroundof stagnating nominal incomes, liquidity buildup canonly lead to short-term price hikes. In general, in ouropinion, the US and world economy is being trans-formed into a recessionary economy and the crisis form(path) will be L-shaped.

The Russian economy will be fully exposed to theexternal shock, which will be multidirectional. The firststems from a fall in the prices of Russia’s staple exports(oil, gas, metals, etc.), leading to a loss of income at therate of 12–18% of GDP. The second is due to the con-

traction of external demand, which has the effect ofreducing the quantum of Russian export by 3–4% ofGDP. The third stems from the virtual termination offinancing from the world financial system, leading to adecrease in final investment and consumer demand by3% and 1% of GDP respectively. Generally, losses mayamount to 19–26% of GDP, and their impact, unlike indeveloped economies, will be more in the nature ofshocks.

On the other hand, Russia currently has resourcescapable not only of mitigating external shocks but ofpreserving resources for further development. How-ever, this requires brilliant manipulation of theseresources as a component part of active socioeconomicpolicy. For the time being, it is clear that we are goingto see times of stress. And at times of stress, miscalcu-lations and blunders are impermissible.

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Fig. 14. US household debt relative to US GDP

Documents

Global crisis: Its origin and implications for Russia’s macroeconomic and social stability