*****

Yeah right!

I don’t drink anybody else’s KoolAid. I prefer to imbibe my own:) At the same time, I hope that those who read what I write do so with their critical faculties fully activated. Montaigne said something to the effect that everything I write is by the way of discourse, and nothing in the way of advice. I would not be so hardy to speak if I ought to be believed. I have my opinions, try to bolster them with facts and logic, but it’s up to the readers to make up their own minds.

Re LR, apropos my earlier comment in reply to “David,” his/her/its real identity is a matter of indifference to me. I prefer to focus on facts and analysis, and to the extent that you can demonstrate that LR is wrong on either score, more power to you. Likewise, to the extent that LR scores a few hits, power to him/her/it. That’s all that matters. “True identity” is a distraction at best, but more likely an irrelevance. But it’s your bidness as to how you spend your time and efforts.

Anyway, Prof. Pirrong, Kim Zigfeld regularly draws vast conspiracies connecting the Kremlin with all manner of blogs, individuals, and websites in the U.S., in true John Birch Society fashion, even though many of these entities are up front about who supports them (while nobody knows who the heck pays La Russophobe to keep the lights on in NYC). Charles Johnson, of Little Green Footballs notoriety, also did the same thing, and in the process has alienated practically everyone who contributed to his website when it was just an anti-jihad forum (Robert Spencer, Gates of Vienna, et al) by connecting them to allegedly fascist anti-Islamic immigration parties in Europe.

Kim Zigfeld also brags about having received 600,000 visits to her site since it started three years ago. I know for a fact tje joke/image site English Russia gets about that many hits in a month, or more, and other Russia blogs also get more. Kim pretends that the number of linkages to her blog somehow proves anything about how many people actually read it. But obviously Kim feels the need to demonstrate her traffic to whoever is paying for the site, and disavows fundraising because he/she is using copyrighted articles and doesn’t want to be sued for infringement (which she ought to be).

Kim also employs a whole host of sock puppets who apparently enjoy no existence outside of the La Russophobe website, such as “David Essel”, “Jeremy Putney”, “Leonard Daulton” et al, and denounces individuals for contributing to “Kremlin shills” like Russia Profile, while using content from RP contributors like Prof. Ethan Berger of Georgetown. But at least Prof. Berger, unlike yourself, has some sense of shame about having his content posted by Kim Zigfeld and has quietly stopped contributing to “her” site. Oh, and did I mention that Kim has the chutzpah to declare that if individuals educational credentials in Russia cannot be obtained via an English language Google search then they must be fake, and people who do not have Google or Wikipedia pages are “losers” (I guess that would include the aforementioned Putney and Essel!).

Anyway, since Kim Zigfeld’s statements can’t even survive a one minute reading, the basic purpose of the site remains to Google bomb certain individuals. That’s why I created La Russophobe Exposed to fight back. However, once “La Russophobe” and “Kim Zigfeld” return my rebuttals in Google searches, these smear tactics will fail, just like Scheunemann and his crowd failed to elect their easily manipulated Russophobic puppet McCain. Whether Z. Bzerzinski will be able to similarly manipulate Obama remains to be seen. My guess is Obama is enough of a pragmatist to quietly drop the missile defense system in Poland in return for the Russians withdrawing the Iskander missiles from Kaliningrad. That seems to be the endgame that Medvedev is playing for. And whether or not some of those 2 million $200 contributions came via online credit cards funnelling money out of Russian, Arab, and Venezuelan bank accounts remains to be seen.

“DR–I extend an invitation to put your money where your mouth is–sell protection on Korea, buy it on the UK. ” – SWP

No thanks. I know very little about finance. That’s why I’m asking these question.

“I haven’t looked in detail, but I imagine that virtually all UK government debt is denominated in sterling, so it can always print pounds to cover its obligations. Korean banks and corporations have large dollar denominated debts, and its households are heavily leveraged.” – SWP

Why can some countries denominate their debts in their own currencies, while the peripheral countries have to borrow in dollars?

Is there a site which lists a breakdown of national debts and what they’re denominated in?

More seriously, reserves are not immaterial, but they are not a sufficient condition to explain sovereign credit/default risk. Indeed, they point to an important issue–the currency in which a country has borrowed. I haven’t looked in detail, but I imagine that virtually all UK government debt is denominated in sterling, so it can always print pounds to cover its obligations. Korean banks and corporations have large dollar denominated debts, and its households are heavily leveraged. Korea just extended $100 billion in guarantees of the foreign currency borrowings of its banks, essentially converting private foreign currency denominated debt into government FX denominated obligations. These debts have become even more onerous due to the decline in the Won (30 percent at one point.) In present circumstances (and analogous to the argument I made re Russia some weeks ago) a country can run through $250 billion extremely quickly.

And the trade deficit/surplus issue could actually be working against Korea. With export earnings almost certain to decline due to a worldwide recession, the main prop of the Korean economy will be weakened. This will put a crimp in earnings of foreign currency (making it harder to service the foreign currency denominated debt), weaken the Won (which has already occurred), and reduce personal income (creating problems due to the substantial leveraging of Korean consumers noted above.) Reductions in personal income and business profits from exports will reduce tax revenues, putting a strain on Korea’s ability to service its debts, and likely causing public indebtedness to rise.

Korea’s political system is also more brittle than Britain’s, and large corporations and financial institutions in Korea are often successful at obtaining government support when they are in trouble. This means that the FX reserves are at the beck and call of Korean business and banks. (This is similar to the issue I’ve been raising re Russia, including in this post.)

So, I wouldn’t be so hasty as to conclude that Korea is the QED on the proof that sovereign CDS markets are irrationally priced.

One other issue. Yield spreads do not just price the likelihood of default, and recovery rates. They also reflect the pricing of systematic risk, and differences in systematic risk across (in this instance) countries. Default probabilities and recovery rates affect cash flows. CDS yields reflect cash flows AND the rate at which cash flows are discounted. Discount rates should vary depending on systematic risk, and cash flows that exhibit a higher correlation with overall wealth/consumption movements should be discounted more heavily (leading to higher yield spreads.) So, two countries with identical default probabilities and recovery rates could be priced differently, depending on how those defaults are correlated with overall world economic activity.

Korea’s export dependent economy implies that its economic fortunes are particularly closely tied to the state of the world economy. The world economy does badly, and Korea is especially hard hit. This contributes to very high systematic risk, higher discounting, higher yield spreads.

Put another way, it’s not just the probability of default that matters, it’s when that default occurs. A Korean default is most likely to happen when the world economy is in the dumper–which is just when a unit of consumption is particularly valuable. Cash flows on securities that are most likely to default when economic conditions are especially bad are discounted most heavily because they pay cash flows reliably in good times but are more likely not to pay in bad times when such cash flows are particularly valuable. That is, they are sunshine friends, paying when you don’t need it as much, and not paying when you do.

Now of course most debt instruments are more likely to default when worldwide economic conditions are bad (which is why all defaultable spreads tend to widen during weak economic times), but the relevant issue in evaluating relative spread movements is the relative sensitivity of default to economic conditions. Export driven economies like Korea’s are highly sensitive to world economic conditions, and hence their spreads are most sensitive to weakening world economic circumstances.

This could be a serious issue with Russia too. The dependence of its economy on oil, the price of which is highly sensitive to world economic conditions, injects serious systematic risk into Russian debt. There are several channels, including the fact that weakening oil prices puts pressure on the Ruble, making it a lot more costly for Russian firms to service their dollar denominated debts. (Depreciation relative to the Euro has been much more modest as you’ve noted.) Moreover, cash flows of Russian borrowers are lower when oil prices are lower, making it more difficult for them to service their debts. Russian government revenues fall too.

Historically, oil prices tended to move in the opposite direction of world stock prices. This was because supply shocks were the dominant source of oil price movements, and adverse supply shocks raised oil prices and dampened economic activity, leading to a negative correlation. Thus, oil historically had negative systematic risk; it did well when economies were doing badly, making it a valuable hedge against bad economic news.

Things are different now. At present, the main factor driving oil prices is expectations regarding economic growth worldwide, and growth realizations. You tell me what world stock indices did today, and I’ll tell you what oil did–they move the same way, and oil is shackled to the major indices. This means that oil now has a very high systematic risk loading, and that anything that has cash flows that are oil price sensitive (i.e., almost anything related to the Russian economy) and those cash flows will be discounted extremely heavily.

This is one reason why it is quite sensible that movements in Russian stock prices have been so much more exaggerated than those in the US and Europe. It also contributes to the very high yields on Russian debt (not just CDS spreads on Russian sovereign debt, but on private debts e.g., Gazprom.)

So, Russia faces a perfect storm, largely reflecting its acute dependence on oil prices. This dependence has two extremely deleterious effects. One is the systematic risk considerations I’ve discussed in this comment. The other is the corrosive effect of natural resource rent dependence on political institutions, which is the gravamen of the political risk analysis in the main post.

За неделю по 24 октября резервы Центробанка уменьшились на $31 млрд до $484,7 млрд. За четыре недели они упали на $78,1 млрд.

Так быстро резервы не таяли никогда. Скорость превзошла ожидания экономистов. Накануне бывший первый зампред ЦБ Сергей Алексашенко в своем блоге предположил, что за счет падения курса евро к доллару резервы ЦБ усохнут на $13-15 млрд, а на валютные интервенции ЦБ потратил $7-9 млрд (всего — $20-24 млрд).

Of the remaining monies, half or so has already been committed according to Vedomosti, leaving $250 billion in the reserve funds:

Но долго тратить деньги на поддержку рубля теми же темпами ЦБ не сможет, ведь примерно половиной резервов он уже не распоряжается. Порядка $180 млрд — средства Минфина (фонды резервный и благосостояния, по курсу на 1 октября), еще $50 млрд обещаны Внешэкономбанку (ВЭБ) на рефинансирование внешних займов, а $8-10 млрд — на поддержку банков, перечисляет Алексашенко. Остается около $250 млрд.

According to one leading banker, spending the reserves at such a rate is “irrational”:

Тратить резервы такими темпами на поддержку рубля нерационально, полагает председатель совета директоров МДМ-банка Олег Вьюгин, ранее — первый зампред ЦБ.

Next week, Russia will be spending another $10 billion to help the first of the Russian corporations refinance their debts:

“Ð’ следующие недели резервы будут уменьшаться еще и за счет перечисления денег ВЭБу, полагает экономист «Траста» Евгений Надоршин. Ð’ среду председатель ВЭБа Владимир Дмитриев объявил о выделении первых кредитов ($10 млрд) российским компаниям на рефинансирование внешних займов. Наблюдательный совет ВЭБа решил выдать кредиты 27 октября и на прошлой неделе эти деньги из ЦБ еще не поступали, говорит источник, близкий к ВЭБу. Представитель ВЭБа от комментариев отказался.”

At this rate, there won’t be much left in the reserves. I do have one question for the Streetwise Professor: how much of the reserves do you think is tied up in investments that cannot be recovered or cannot be cashed in the near future? I.e. money tied up in Lehman Brothers and other such ventures. Simply put, how much of the money in the Russian reserves is on the books, but can’t be spent because of the financial crisis in the United States or Europe?

http://www.vedomosti.ru/newspaper/article.shtml?2008/10/31/166938