Streetwise Professor

November 19, 2008

Agency Costs, Transactions Costs, and the Wisdom of an International Superregulator

Filed under: Derivatives,Economics,Politics — The Professor @ 8:32 pm

In yesterday’s FT Carmen Reinhart and Kenneth Rogoff argue for the creation of an international financial regulator.   Their analysis essentially internationalizes the argument in favor of creating a super-regulator in the US.   Unfortunately,   I think that this conventional diagnosis and prescription is completely misguided.   An understanding of the transactions costs of regulation and politics implies that this solution will make things worse, rather than better, because it aggravates the underlying factors that caused the regulatory failure in the first place.   I know many people want to improve financial market regulation in the worst way–and this would be it.

Reinhart and Rogoff argue that an International Super-regulator (sorry, but that reminds me of the title of Green Day’s greatest hits CD, International Superhits) would be beter able to overcome the influences of domestic financial services interests than national regulators:

Finding ways to insulate financial regulation from political meddling is critical to creating a more robust global financial system in the future.

Indeed, the need for greater regulatory independence is a compelling reason for establishing an international financial regulator, another topic the G20 conspicuously avoided. We recognise that international financial institutions are far from perfect. Nevertheless, a well-endowed, professionally staffed international financial regulator – operating without layers of political hacks – would offer a badly needed counterweight to the powerful domestic financial service sector lobbies. The independence argument is in addition to the well-recognised need for better mechanisms for co-ordinating regulation to reduce regulatory arbitrage in a world of global capital markets.

. . . .

Important regulatory appointments are, of course, largely political, and governments determine the extent and power of the regulatory agencies. During the boom, many regulators throughout much of the world were put under pressure by leading politicians to lighten up. The lack of transparency, which the G20 leaders complain of so vehemently, also served as a convenient shield to keep politicians’ interference out of public view.

With asset prices soaring and rating agencies giving their usual overly optimistic boom-time assessments, regulators had few available weapons. This was no accident. Look at the list of leading contributors to the presidential and congressional candidates in the US election (including the primaries). Financial companies dominate. Thus it is no surprise that, during the boom, all the supposed market watchdogs were neutered. This is an international problem, not just a US one.

I have no doubt that interest group influence can neuter regulators.   I am just far from convinced that creating an international regulator will solve the problem of “neutered” regulators.   Indeed, there is some economic theory that predicts the exact opposite.

Specifically, in his “The Making of Economic Policy: A Transaction-Cost Politics Perspective,” Avinash Dixit draws on agency theory to show that the more diverse a regulator’s constituency and the broader its responsibilties, (a) the weaker its incentives will be, and (b) the less discretionary authority it will possess.

Agency theory shows that in the presence of measurement costs it is usually optimal to provide multi-task agents with weaker incentives and less discretion than single task agents in order to mitigate moral hazard problems.   This, by itself, implies that regulatory agencies (note the word “agency”–they are agents of the legislative principal) with broad and diverse responsibilities will typically face weaker incentives and have less discretionary power; it is in the interest of the principal–the legislature–to structure the agency in that way.

Dixit extends the analysis based on an observation by James Q. Wilson that regulatory agencies usually have multiple principals.   For instance, a regulatory agency deals with the executive, the legislature, and disparate interest groups.   Dixit shows that the greater the number of principals-constituencies, the weaker should be the incentives and the more circumscribed the discretion that the agency faces.

Applying that to the idea of an international financial regulator suggests that is a very bad idea indeed.   An international super-regulator as envisioned by Reinhart and Rogoff and others (e.g., Sarkozy) would have numerous responsibilities, over banking, equity markets, derivatives markets, in multiple countries.   Thus, an international regulator would be more of a multi-tasker than traditional national regulatory agencies with authority over a single slice of the market in a single country.   Moreover, it would have more principals than any national regulator.   Creation of a super-regulator would not make domestic financial services interests go away; it would just give them an interest in influencing a new regulator.   Moreover, whereas a regulator such as the SEC might have a single national legislature and a single national executive as principals, a super-regulator would have myriad national legislatures and myriad national executives as principals.

Thus, a super-regulator–either within a country, but especially an international one–has many tasks and many principals.   The Dixit analysis implies that rather than being an aggressive regulator that would overcome petty national interests, a super-regulator would in fact be extremely weak.   To make a play on one of Reinhart-Rogoff’s words criticizing incumbent national regulators, the super-regulator would be super-neutered.   Put differently, expanding the scope of the regulator both in terms of its responsibilities and the nations which it would regulate would actually result in weaker regulatory oversight.

Indeed, Reinhart-Rogoff mention an example that illustrates my point: “The Basel agreements on bank regulation have succeeded to some extent in achieving this, but they take too long to negotiate. The Basel II agreement is already dead on arrival.”   I would also argue that the European response to the crisis, notably the halting response of the European Central Bank, also should sound a note of caution to those who believe that a super-regulator with authority over institutions in multiple states would actually be more aggressive than a narrower regulator in an individual country.

Of course, issues of coordination must be considered as well, and perhaps a single regulator could more effectively coordinate a response than multiple, autonomous   ones.   But in my view, the “agency” problems would overwhelm any benefits from improved coordination.   Reinhart-Rogoff and many others bewail the inability of national regulators with multiple regulatory responsibilities answering to multiple constituencies to address the financial crisis in an aggressive way.   The Dixit argument implies that this is an inevitable feature that is purposely baked into the design of these agencies–to address agency problems their designers provide weak incentives and limit discretion. This is not a mistake–it’s supposed to be that way!   That’s exactly what Congress and national parliaments designed them to act.

These agency problems arise from multi-tasking and mutiple principals.   From this perspective, adding tasks and adding principals will make things worse rather than better.

Overall, the Dixit book (which I highly recommend–it’s a quick and pleasant read packed with insights) should make anyone highly doubtful about the prospects of regulation to fix serious problems like the financial crisis, or to prevent them from recurring in the future.   Dixit makes a persuasive case that agency problems and transactions costs inherently limit the capability of political and regulatory institutions.   Political, incentive, and information constraints sharply circumscribe what regulators can do–and what they should be allowed to do.

And the most persuasive part of the book is that which uses standard economic tools to demonstrate that the usual prescription for regulatory failure–make the regulators bigger with more responsibilities–is exactly the wrong thing to do.   It aggravates, rather than ameliorates, the sources of regulatory failure.   It is, in short, the political equivalent of bleeding to cure anemia.

November 18, 2008

Like Minds

Filed under: Energy,Politics,Russia — The Professor @ 8:05 pm

A couple of blogs have posts that make points familiar to SWP readers.   One is at Cicero’s Songs.   He also argues that the economic crisis raises the specter of internecine warfare and civil unrest in Russia. (Since Cicero describes himself as “an economic liberal”–as am I, in the British/European, rather than American sense of the word–this confluence of opinions on Russia probably reflects a similarity in worldviews.   A worldview that differs notably from DR, for instance–hence our almost perfectly negatively correlated opinions on virtually every issue;-)   Except for ethanol, perhaps.)

Although I agree with Cicero’s bigger points, I have a few quibbles.   Putin didn’t consciously elect for Russia to suffer the resource curse–it was endowed with it.   That said, Putin et al have done everything to exacerbate, and nothing to palliate, all of the pernicious effects of this curse.   They revel in it.     Also, the “85% of GDP relies on the extraction of raw materials” figure is clearly wrong.   I think Cicero means that 85 percent of export earnings are derived from natural resources.

Another SWP-approved post is this one from Political Betting.   Author Balakirev argues that economic reality is slowly dawning on the folks in power.   That is likely, although there are still behaviors that suggest that denial has not been banished altogether.   Now the question (implicit in the previous post) is: when will everybody else in Russia figure this out?

Apropos the Ongoing Debate

Filed under: Economics,Energy,Politics,Russia — The Professor @ 7:50 pm

A very nice and spirited interchange going on in the comments.     This article in the Telegraph speaks to many of the issues under discussion.

Regarding the apparent nonchalance of the Russian populace to the ongoing crisis, the Telegraphs says:

Subjected to more than a century of propaganda masquerading as news, Russians often seem to live in a different reality from the rest of us.

And sure enough, at a time when their country is locked in its worst financial crisis in a decade, they are more optimistic about the economy than they have ever been. According to opinion polls, 57 per cent reckon it is flourishing, up from 53 per cent in July.

The survey’s findings are a triumph for the state, proving that the Kremlin has not lost its touch when it comes to manipulating fact. Obeying orders from the top, Russian television has banned the use of words such as “crisis”, “decline” and “devaluation”. Coverage of the mayhem in the country’s stock market, where shares have fallen by 75 per cent since August, is scant.

Instead, just as in Soviet times, Russians are told how bad everything is in the West. The US, Russians are told, is in irreversible decline, while desperate Britons are throwing themselves into the Thames. The Queen, facing imminent penury, has been forced to pawn her diamonds and, according to one tabloid front page, we can no longer afford to bury our dead.

It has fallen to Russia, one television commentator gravely intoned, to come to the rescue of Europe. Russia, another newspaper declared, was set to become the continent’s lender of last resort.

Objectively, there is no possible basis for increased economic optimism, either here in the US, or in Europe, or in Russia.   One may not think that things (and the future) are as bad as I or others have postulated, but it is utterly delusional to think that the Russian economy is doing better now than in July.   Utterly.     As the article says (echoing things I’ve written before–eliciting Timothy’s dissent), this is a testament to the government’s information/propaganda strategy.   It also says something about Russians.   But it is consistent with Timothy’s assertion that most Russians are blithely unconcerned with the financial situation.

That’s where we part company.   I can believe that lulled by a steady drumbeat of nationalist crowing and economic propaganda, they are unconcerned now, but this is not sustainable indefinitely, as propaganda can hide economic reality for only so long.   If things do not improve, or especially if they worsen, (the most likely outcomes in the coming months), the government’s “who you gonna believe, Vlad or your lyin’ eyes?” strategy will fail.   Cognitive dissonance can only be pushed so far.     That’s why (contra Timothy) I consider this to be a very high risk strategy.   If it doesn’t work, the backlash will be intense.

Russians have often been described as possessing two natures–usually inert and passive and supportive of authority, but capable of wild, violent, and anarchic outbursts when disillusioned with that authority.   They are in the inert/passive/supportive phase now.   But will they stay there when the realization dawns that however battered the US is, Russia has suffered far more damage?   I doubt it.

The article also discusses the machinations over the Constitution and the presidency.   In WWMD (“What Would   Machiavelli Do”) (hundreds of posts ago!   whoda thunk?)   I postulated that Putin would find some way to hang onto the formal powers of the presidency.   I was wrong–then.   My post-mortem was that Putin figured that he could maintain sufficient control from the White House that he did not need to take the draconian step of changing the Constitution.   This would have, among other things, cost Putin and Russia diplomatically.

But that decision was made when things were breaking Putin’s–and Russia’s–way.   Commodity prices were high and going higher.   The government was swimming in money, and the perceived leverage derived from its energy resources at a time when the world was panicking about energy supplies.     Those conditions reduced the strains on the country’s political equilibrium.   There were a lot of rents to distribute to keep everybody happy.   This reduced the necessity of taking the potentially controversial step of modifying the supposedly sacrosanct Constitution.

The worm, as they say, has turned.   The energy rents are a thing of the past–and only a hope for the future.   As the article notes (echoing SWP):

The Kremlin has always been heavily factionalised, with rival groups competing for control of Russia’s lucrative energy and metals companies. As Russia’s economy boomed after 1999, Mr Putin was able to maintain a veneer of unity between these factions, many of which acquired their fortunes during the carve-up of state assets in the 1990s, and protected them ruthlessly. But with oil and commodity prices plunging, there are no longer enough spoils to go round.

Russia’s biggest businessmen owe Western banks more than $500 billion, borrowed using stock as collateral. The fall in share prices has triggered a wave of margin calls, prompting many banks to call in their loans. The state has promised $50 billion to rescue the oligarchs as part of a $200 billion bail-out – but not all will be saved.

For Mr Putin, the crisis provides plenty of opportunities that he could take advantage of. Assets that were privatised in the 1990s will again come under the control of the Kremlin and can be palmed out to his closest allies. The oligarchs who are allowed to survive will be bound to him even more closely.

At the same time, the risk of internecine warfare among these powerful individuals is high and could destabilise Russia. There was a whiff of the potential danger last year, when contract killings rose dramatically amid uncertainty over Mr Putin’s future.

Dmitry Oreshkin makes similar points in Monday’s Moscow Times.

Under these circumstances, the diumvirate is a far chancier proposition than it was before.   What’s more, Putin and Mededev pretty much shot their international   image and cred with their excellent Georgian/Ossetian adventure, and Western governments are distracted by other issues, so the diplomatic cost of Constitutional legendermain that magically returns Putin to the presidency is far lower than it would have been in late-2007 or early-2008.

Of course, maybe I’m wrong, and this isn’t a maneuver to return Putin to the presidency sooner rather than later.   If I am, I will have a good deal of company–as virtually nobody other than Kremlin puppets believes otherwise.     At the very least, it is giving Putin an option.   If things continue to go pear shaped, he can swoop in and “save the country.”   If problems ease–well, Medvedev can keep the chair warm for a little while longer.

One thing in the article that caught my eye, and which I found not completely credible, is this:

There is compelling evidence that the crisis has started affecting ordinary people. The middle class has shrunk from 25 per cent of the population to 18 per cent in the past few months alone.

This is a dramatic figure (a greater than 25 percent decline in the “middle class”).   So dramatic that I take it with a grain of salt.   It would be interesting to know the basis for this figure.

In sum, I agree with this article’s assessment (and Oreshkin’s and others’) that there is a substantial risk (not a certainty) of serious political and civil turmoil in Russia as the full effects of the financial crisis set in.   Political machinations and propaganda can buy time, but they can’t change economic realities.   The higher the expectations–and the polling evidence from the article suggests that the expectations have actually become rosier–the greater the disillusionment and anger that will result when those expectations and hopes are dashed.   The delicate political balance in the country, and the prominence of those comfortable with the use of violence, and expert in its use make it vulnerable to large shocks.   And the ongoing world financial crisis, and its dire implications for the prices of natural resources and the economic health of a country acutely dependent on such resources is a very large shock indeed.

For these reasons, the poll evidence cited in the article actually leads me to increase my estimate of the probability of a political crisis and civil unrest.

November 16, 2008

That Was Fast

Filed under: Economics,Energy,Politics,Russia — The Professor @ 10:47 am

I went to the World Bank website to see if their November report on the Russian economy was up.   It wasn’t, so I took another look at the report issued in June.   It looks prescient in some ways, although I doubt that the WB folks thought that this danger would be realized so soon:

Issue 1: Oil revenues, booming today, could become a drag on economic

The strong recovery of oil prices since 2000 increased Russia’s dependence on oil and gas revenue, making it more vulnerable to price declines.

The share of oil revenue in total fiscal revenue increased substantially—from 10 percent of GDP to about 30 percent. Instead of diversifying, Russia has specialized in oil, which now accounts for about 60 percent of exports (figures 2.1 and 2.2). Higher oil revenues create more room for spending, but they also complicate macroeconomic management and foster dependence on a volatile, uncertain source of income. This has not been a problem in the face of high oil prices, but it could become a major vulnerability if oil prices begin a rapid descent.

The report also notes:

External debt stock and external vulnerability remain within a comfortable range, but Russia’s private corporate and banking debt is growing fast (figure 1.13). A rapid buildup of corporate and banking debt partly financed the massive consumption and investment spree of recent years. With general government external debt modest and declining, this banking and corporate debt—public and private—explains almost all the buildup of external debt (figure 1.13, left panel). External private debt almost tripled, from $106 billion at the end of 2005 to $275 billion at the end of 2007. External public debt, which includes the general government and public financial and nonfinancial organizations, has also grown thanks to borrowing in large state companies—but not nearly as fast as private sector debt. Although overall debt appears low compared with the economy’s size and its massive international reserves, it has become a concern at the central bank. That exuberant private borrowing, if continuing at the same pace during a prolonged global credit crunch, could undermine corporate liquidity and repayments, spilling over into the banking system, which faces its own risks.

The report mentions the real estate financing issue too:

Russian banking has weathered global financial turbulence, but credit, liquidity,
and market risks require monitoring.

The credit portfolio may face strains from the rapid credit expansion over the last decade, the entry of new and inexperienced borrowers, and banks’ uncertain ability to manage the risks. The brisk growth in mortgage lending could become a concern. Mortgage loans increased fivefold during 2000-06 and by at least 70 percent in 2007, though the consumer segment remains small (13 percent). The following issues are worth noting.

  • The retail deposit base is concentrated in Sberbank, forcing large and medium-size banks to rely more on international funding.
  • Household deposits represent 30 percent of bank liabilities on average, but they are concentrated in the state-owned banks, which hold more than 40 percent of bank assets (Sberbank, VTB, Gazprombank, Bank of Moscow, and the Russian AgriculturalBank).
  • The concentration of corporate deposits • remains a concern for smaller banks. Withdrawals by a few large customers could reduceliquidity. For some smaller banks, the 20 largest depositors account for more than half of customer funding.
  • Banks relying on external funding risk a   contraction in global credit. Benefiting from abundant global liquidity, banks operating in Russia have borrowed significantly from abroad over the last few years. This may pose refinancing risks for some banks.
  • Banks’ exposure to market risk has grown with deeper capital markets and banks’ greater sophistication. Securities portfolios, about 20 percent of assets at the end of 2007, are dominated by corporate bonds, though equity holdings are also significant for some banks. These securities expose banks to potential equity or bond prices.losses from adverse movements in equity or bond prices. sustained strong earnings, but profits are coming under pressure.

The continuing global credit crunch is straining banks’ funding model. If the global credit crunch is prolonged, the system could face funding problems. With Russia’s thin domestic capital markets and its retail deposits concentrated in the largest state banks, some banks must depend on foreign funding. Sustained, restricted access to foreign borrowing could increase funding costs, slow credit growth, reduce profitability and capital, and expose banks to refinancing difficulties. Rapid credit growth has so far sustained strong earnings, but profits are coming under pressure.

In sum, most of the major vulnerabilities that the World Bank identified are being tested, and far sooner and far more severely than pretty much anybody had anticipated at the time the report was written.

The report also details Russia’s investment-led growth, and notes that this investment was heavily-oriented to the resource extraction sector, and largely ignored manufacturing.   These investments are not looking to good now, with resource prices down hard across the board.   The report further notes that although Russia’s investment rate (investment/GDP) has ticked up in recent years, it is still far below (barely half) the rate in other rapid growth emerging economies (21 percent vs. 38-42 percent.)     The report’s data shows that growth has been heavily driven by non-tradeables, notably construction.   So much for that.

In other words, the WB painted a picture of a nation with its private economy and government finances highly dependent on natural resource prices, largely funded by hot money, and dependent on a fragile banking system.   Oil prices (and the prices of other natural resources) are the lynchpins of such an economic system.   It is pretty clear what the implications of a collapse in these prices are.   And we are seeing them unfold before our very eyes.

The WB mentions the outstanding institutional issues facing the country, but doesn’t place tremendous emphasis on them.   The problem is that the very institutional weakenesses that the Bank acknowledges will exacerbate these problems, and make it very difficult for Russia to surmount them.


Filed under: Military,Politics,Russia — The Professor @ 10:02 am

Belarussian president and Cold War leftover Alexander Lukashenko is allegedly in negotiations with Moscow to base Iskander missiles (a short range, non-nuclear ballistic missile) in his country.   This is based on Lukashenko’s representation.   He goes on to say that Russia approached him about the basing possibility.

One potential problem.   There aren’t enough missiles to go around.   According to StrategyPage:

For the second time this month, Russia has changed its policy regarding its new SS-26 (9M723K1, or “Iskander”) ballistic missiles. First it said it was sending some to  Kaliningrad, as a way to threaten the new NATO anti-missile system being built in Poland (to protect Europe from Iranian missiles). Now Russia says it will halt any exports of the Iskander missile until it has produced the hundred or so it plans to send to Kaliningrad. Syria, Kuwait, South Korea, India, Malaysia, Singapore and the United Arab Emirates were all interested in Iskander. The export version, Iskander-E, would have a shorter range (280 kilometers) and fewer countermeasures for the warhead.

Russia now plans to send five brigades of Iskander (60 launchers, each with one missile, plus reloads, which could amount to over a hundred missiles) to Kaliningrad. Iskander is just entering production, and it would take several years, at least, to produce that many. Actually, it might take five or more years to produce enough missiles for five brigades, because Russian missile production capabilities have sharply deteriorated since the end of the Cold War in 1991. This is one reason why the current Russian government is making so much noise about this imaginary NATO plot to surround and subdue Russia. Losing the Cold War did not go down well in Russia. Rather than forget and move on, many Russians prefer to remember, and use the imagined evil intentions of their Cold War foes to explain away defects in the Russian character.

[Bonus jab at the end. Austin Bay/Jim Dunnigan/SWP must drink the same water;-) ].

So, if SP is to be believed (and it is a pretty reliable source, certainly more informed and informative about military matters than any mainstream publication), the Lukashenko statement is just gas.   So why make it?

For one thing, Lukashenko is something of a publicity hound, and with all the attention to Iskanders in Kalliningrad, this is an opportunity for him to get some attention.

For another, Lukashenko is busy, very busy, playing both sides against the middle.   Due to energy and other things, the Russians have him by the, well, you know, and so he has been trying to clean up his act (or at least his image) in the West in an attempt to get some leverage to use against the Russians.   At the same time, given his delicate position, he needs to give the Russians something.   Especially since he has pretty much stonewalled them on supporting their actions in Georgia/South Ossetia/Abkhazia.   A very public air kiss on something like the Iskanders is just the ticket.   It plays into the very public Russian campaign against missile defenses in Central Europe.

Lukashenko’s assertion that the Russians approached him with the idea is also consistent with the notion that he is being a willing participant in a broader Kremlin anti-anti-missile-missile campaign, a campaign that has ratcheted up several notches with Medvedev’s greeting card to Obama.   Of course, Lukashenko probably expects some love in return.

But, if StrategyPage is right, this is all PRBS, and should be treated accordingly.

Finally, one other SP note.   It has a predictions market.   The newest prediction on which you can bet:

As a result of the financial crisis, Russia loses it internally, and descends into civil disorder.

Sounds made to order for SWP readers!   I know how Timothy, DR, Penny, and LR are gonna vote;-)

As for me, it depends on the price.   I’d be a buyer at any price under, say, thirty percent.   Maybe even a little richer than that.

One question about the prediction/bet though–how does one define “civil disorder”? 1917 redux?   A repeat of 1991?   What about 1993?   How many heads does OMON have to bust to qualify?

The interesting thing to me is that the possibility is even being mooted.

November 13, 2008


Filed under: Economics,Energy,Politics,Russia — The Professor @ 9:39 pm

That’s the price of Urals Med (per the online WSJ).   Interestingly, the basis between Urals and Brent widened dramatically today.   It was about $.70 yesterday, and earlier in the week.   Today it blew out to $2.60 (i.e., Urals was quoted for $2.60 less than Brent.)   I don’t know why the basis moved so strongly today, but it is another ill omen.

Life on a Volcano

Filed under: Economics,Politics,Russia — The Professor @ 9:23 pm

From Vedomosti (via JRL):

Federal TV networks, the prime media agency in Russia, make a point to ignore the crisis. There is no saying how advantageous this policy will turn out to be. Only one thing is clear. Should discrepancies between what the people see outdoors and what TV networks tell them become profound and impossible to ignore, the population will stop trusting TV networks and start regarding the current exchange course as the only trustworthy source of information.

This mum’s-the-word policy will become pointless then because trust in the source of information will be lost.

. . . .

Unfortunately, there are essentially no institutions in the country the population trusts enough to let them discuss the problem and suggest a solution to it. With the kind of Duma we have in Russia, expecting it to come up with anything worthwhile is pointless. As matters stand, anti-crisis measures are mostly decided on within small groups of decision-makers. Their traditional disinclination to discuss it with anyone else ups the risk of mistakes.

It is necessary to remedy this situation and therefore to alter information policy.

Continuation of TV networks’ current policy may eventually undermine trust in the principal line of communications between society and the powers-that-be. The latter will then have to pretend that the crisis has taken them by surprise. Also importantly, this whole situation serves as a reminder to all of us that it is wrong to have TV as the only channel connecting the population and the authorities.

There must be other channels as well – independent parliament where all civil forces and represented, non-governmental organizations with experts of their own, independent media… No better cure for distrust and panic has ever been invented.

Russians are living on a volcano. All may have looked placid mere months ago, but there were tremendous forces hidden from sight capable of exploding at a moment’s notice. The risk of an explosion is increasing dramatically , but as the Vedomosti article notes, and as I have argued on SWP, the government’s attempt to control the information flow is an extremely dangerous policy that could make the effects of the explosion far worse.

Failure to deal with the situation in a forthright way dramatically heightens the risk of massive disenchantment and a fatal loss of trust if–as is highly likely–the evidence at the exchange kiosk or the workplace or the bank gives the lie to the official line that all is well. Unrest of some sort–say, coal strikes or other industrial actions, as occurred in 1998–may well result. What then? The government will be forced to choose between capitulation and crackdown. If it chooses the latter, things will spiral further downward economically–but I have little doubt that is the choice that the Putin government would choose.

The exchange rate is doubtless a more reliable source of news than the TV news. Prices aggregate vast amounts of information . The problem is that getting information from a market price runs the risk of creating information cascades. A group of people panic and frantically sell rubles. This drives down the ruble, instilling fear in those who use the exchange rate as their gauge of the health of the economy. They sell rubles . . . and on and on.

This can happen even in circumstances when people have access to other sources of information, but it is most likely to occur when most everybody is using the same single source of information, and that source of information responds to the behavior of the people watching it. Then self-fulfilling, positive feedback, information cascades are relatively easy to start and very hard to stop. This is a danger of depriving people of multiple sources of information and news.

So, the government’s “information” strategy is extremely dangerous on at least two grounds: (a) it threatens to undermine the trust in the government, thereby increasing the risk of widespread civil unrest, and (b) it raises the likelihood of an information cascade that could precipitate a 1998-style ruble collapse. (This last is also another reason why trying to manage a “soft landing” of the ruble is probably a bad idea. People will be on the lookout for a faster than anticipated decline, and if they see it, will try to get ahead of the run on the currency–creating a self-fulfilling prophecy. If it is going to fall, it is better to let it fall quickly and decisively.)

There is a difference between Russia and a volcano. Volcano eruptions are exogenous–people can’t do anything to affect their likelihood or their severity. Economic collapses can be endogenous, or made more severe by the endogenous responses to exogenous shocks. Virtually the entire Russian policy response to the crisis seems designed to make the explosion catastrophic if it in fact comes.

If you believe that . . .

Filed under: Economics,Politics,Russia — The Professor @ 8:42 pm

The disjunction between the first two stories in today’s Johnson’s Russia List could not be more striking:

November 12, 2008
Russia Has Bright Future in Poll

The majority of its citizens (82%) expect Russia to join the ranks of the world’s ten leading countries in the next 15-20 years, according to a new poll by the All-Russia Center for the Study of Public Opinion. Thirty-seven percent of respondents say Russia should “regain the superpower status the USSR had,” compared to 34 percent in 2003. “Lagging behind the advanced countries in economic development” is seen by 44 percent of respondents as the main obstacle to that Russia’s progress in the world.

Confidence is mounting. In 2003, 35 percent of respondents thought Russia would become one of the most “economically developed and politically influential” of the world’s countries. Now 45 percent say so, although that figure was 2 percent greater at the end of last year. General director of the All-Russia Center for the Study of Public Opinion Valery Fedorov attributed the slight reversal of opinion to the complex economic this year.

And now, for something completely different:

Russia population to decrease by 34 mln by 2050- UN forecast

UNITED NATIONS, November 13 (Itar-Tass) – Russia’s population by 2050 will decrease by 34 million, according to a forecast made by representatives of the United Nations Population Fund (UNFPA) who on Wednesday presented here a regular report State of World Population 2008.

At present 141.8 million people live in Russia and by 2050 this figure will be 107.8 million people, according to the UNFPA report.

There are both objective and subjective issues here. First, how is it objectively possible for a country with a rapidly shrinking population to assume world leadership, and to become one of the world’s most “economically developed and politically influential” countries? Second, subjectively, how can large numbers of people believe that a dying country can achieve such status?

The answer to the first question is pretty obvious: there’s no way. The answer to the second is by no means obvious. It suggests a disconnect from reality, whether driven by fantasy or denial or something else I know not. Or maybe it reflects genius, as it is sometimes said that the sign of true genius is the ability to hold simultaneously two mutually contradictory thoughts in mind.

The Third Rome

Filed under: Politics,Russia — The Professor @ 3:35 pm

Russia as the successor to Byzantium is an enduring motif in Russian thought.   Given the bizarre machinations and maneuvers going on in Moscow I am tempted to say that Russia has indeed inherited the Byzantine legacy.   It is passing strange to see so much time and effort devoted to unnecessary constitutional “reforms” in the midst of an existential economic crisis.

I don’t practice Kremlinology (not being practiced in occult arts),   but the fact that it is needed speaks volumes about post-Soviet Russia.

As Conjectured Here

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:17 pm

Putin has threated to halt construction of Nord Stream unless the Europeans pony up more Euros:

Putin said ”we cannot do it alone, and we won’t,” the ITAR-Tass news agency reported.

In other words, more chutzpah.   “Pay for the gun we will hold to your head.”

This also has obvious implications for South Stream.   If there’s no money for Nord Stream, where is the money for its southern twin?

Oh, and by the way: Where is the gas that is supposed to fill Nord Stream (and South Stream, for that matter) going to come from?

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