Streetwise Professor

December 18, 2008

Boiling the Frog

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 7:54 pm

The Russian Central Bank is increasing the pace of its devaluation of the ruble:

The ruble fell to a record against the euro as Russia devalued the currency for a second time this week amid tumbling oil prices and shrinking reserves.

The ruble weakened to an all-time low of 40.1096 per euro, and was 0.8 percent lower as of 2:39 p.m. in Moscow. Bank Rossii allowed the ruble to decline as much as 1.4 percent against its target basket of dollars and euros, the eighth depreciation since Nov. 11, according to a bank official who declined to be identified. The currency fell 15 percent versus the dollar since August.

This slow motion devaluation is widely recognized to be a major policy error:

“It’s better that they do this quicker rather than slower because everything is looking particularly weak in Russia with the oil price where it is,” said Eugene Belin, head of fixed income, currencies and commodities in Moscow at Citigroup Inc. “The sooner they’re finished with this devaluation process the better for the economy.”

Maintaining the ruble at a level higher than justified by fundamentals bleeds reserves, and weakens the country’s ability to deal with macroeconomic and terms of trade shocks in the future.   Moreover, it damages Russian domestic manufacturing.   Russian industry faces competitiveness problems even absent an inflated currency–propping up the currency only exacerbates that problem. Note that Russia’s recovery from the 1998 disaster was greatly helped by the adjustment of the currency to reflect fundamentals.

So why is Russia boiling the frog by slowly turning up the temperature gradually, rather than allowing the currency float to a level that reflects the dismal fundamentals now facing the country?   The answer is almost certainly domestic politics.   Although several commentors have pooh-poohed my arguments that pronounced and protracted economic difficulties could spark domestic unrest, especially given the fundamentally dishonest way Putin and Medvedev are dealing with the situation, it seems that some people in Russia agree with me about the potential for civil disorder.   People like Putin, Medvedev, and the security forces:

In expectation of uprisingsThe powers have rethought reducing interior troops

Yesterday, the MVD [Ministry of Internal Affairs] decided not to reduce the interior troops (VV), called upon, in part, to disperse demonstrators. The command of the troops justifies this by «tasks that have been set », without specifying them. In the opinion of experts, the siloviki seriously fear unrest among the unemployed, automobilists, discharged military, those dissatisfied with the growth of housing-and-public-utilities tariffs and other victims of the crisis and of the decisions of government officials.

«Reduction of the internal troops of the MVD of Russia will be suspended », — reported, citing a decision of the leadership of the country, commander in chief of the VV general of the army Nikolai Rogozhkin. He in no way connects the decision to maintain the numbers of the VV with the financial crisis, citing the «necessity of fulfilling all tasks that have been set », but which ones specifically, Mr. Rogozhkin does not specify.

«Our troops are designated for the protection of state and industrial facilities, convoying of special cargoes, defense of service lines, suppressing internal unrests and resolving inter-nationality conflicts on the territory of the country, — clarified an RBK daily source in the VV. — Probably, the leadership of the country is assessing the domestic political situation as not very stable, which is why it rethought reducing us ».

The consequences of the crisis and unpopular decisions of the powers have already brought people out on the streets. In Vladivostok a march of protest of several thousand automobilists against the increase in customs duties for used foreign makes went outside the thematic bounds: people started talking about the costliness of fuel, food products and housing-and-public-utilities services, about unemployment, the crisis and property stratification. A protest rally against the growth of housing-and-public-utilities tariffs on 15 December took place in Izhevsk, while on 21 December in the Far east and in Khabarovsk Kray are expected new protests of automobilists. The slogans of the protestors have remained unnoticed by the central telechannels, but have attracted the attention of the siloviki: in the regions are being created anticrisis special groups of the MVD, the heads of the territorial administrations of the FSB are likewise expecting protest actions. MVD analysts are attributing to the risk group reduced military and rotation workers come back from Moscow. Also pouring oil on the fire are growing wage arrears. Thus, according to the data of Rosstat, overdue indebtedness on wages in November increased in Russia by 93% and comprised 7.765 bln rub.

«As much as I know, the power elites are seriously concerned by people’s unrest associated with the financial crisis, — clarified to RBK daily the political scientist Stanislav Belkovsky. — In the situation that has evolved the Kremlin has two ways out: pinpoint financial injections and cracking down on demonstrators with the help of internal troops ». In the opinion of Mr. Belkovsky, the peak of people’s dissatisfaction is going to come in the first quarter of the year 2009: «The ranks of the demonstrators will be augmented as well by people deprived of mortgaged apartments, because for this period is planned their mass repossession ».

The most recent–and most serious–protests occurred in Vladivostok in response to the government’s attempt to protect the imploding domestic car industry (misery loves company) by restricting imports of used cars.

As Russia has experienced numerous times in its history–think 1905, 1917, 1991–protests of this sort can snowball.   Protesters must overcome collective action problems, and isolated protests can be crushed.   When the level of discontent becomes sufficiently great, and a critical mass of protests occurs, it is easier for protestors to coalesce as the security forces become spread more thinly.

The car tariff decision reeks of desperation in the Kremlin–and the White House (on the Moskva).   An ad hoc response taken in haste to defuse one problem creates another.   Putin has few good options.   With the entire economy imploding, everybody is hurting, and moves to help one sector will only aggravate the suffering in others.   Such clumsy moves will quickly undermine the aura of competence surrounding Putin–an aura created by luck (skyrocketing prices for raw materials and a predictable recovery from an inherited economic disaster) rather than by any real economic policy acumen.   Once this aura disappears, the potential for protests and disenchantment grows.   He has only made the ultimate reckoning worse by his failure to level with the Russian people about the seriousness of the situation.   How will Putin likely respond?   I think we all know (and dread) the answer–the answer implicit in the strengthening of the MVD.

Russia’s ruble problem has been eased somewhat by the precipitous drop of the dollar against the Euro and the Yen.   The Fed’s dramatic easing is, in my view, highly unwise.   It appears to be doing little to spark the economy (high powered money is increasing, but velocity is decreasing, meaning that the injection of cash is largely being hoarded.)   Moreover, the huge dollar overhang that is building up will threaten a sharp increase in the price level when the banking crisis eases and financial institutions start lending, rather than holding, this cash hoard.   This will likely lead the Fed to dramatically reverse direction, raise interest rates sharply, and throttle any recovery in the crib.

The continuing fall in the price of oil–January NYMEX WTI closing at $36.25–is particularly remarkable in light of the substantial drop in the dollar in recent days.   Ordinarily, the sharp drop in the dollar would cause an increase in the price of oil.   Not this time.

Doubly remarkable, in fact, in light of OPEC’s record cut.   Or should I say, intended cut.   As I’ve said ad nauseum, these are pie crust promises (to quote Mary Poppins), easily made, easily broken.   The market’s sell-off in the aftermath of the OPEC meeting reflects (a) widespread skepticism about the willingness of OPEC members to adhere to the cuts, especially in the face of pressing budgetary needs and excess capacity, (b) continuing economic weakness and plummeting demand, as indicated by ballooning inventories, and (c) (drum roll please) Russia’s Lucy-and-the-football move of promising cooperation with OPEC, and even intimating joining the organization, and then refusing to cut output:

Russia is not in talks over joining OPEC and has not pledged any oil output cuts in its memo to the oil producers’ group this week, deputy energy minister Anatoliy Yanovsky said on Wednesday.

“There is no talk of Russia joining OPEC,” Yanovsky told reporters, adding that Russia has given a memorandum of cooperation to the Organization of the Petroleum Exporting Countries.

Asked if the document contained any output cut pledges on Russia’s part, he said: “Of course not.”

“Of course not.”   How sweet.   Especially mere days after this:

President Dmitry Medvedev said Russia may join the Organization of Petroleum Exporting Countries and reduce production to support the oil price.

“We have to defend ourselves,” Medvedev said in the Ural Mountains city of Kurgan today. “This is our revenue base, both from oil and from gas,” he said. “I believe that we mustn’t rule out any options.”

Defensive measures may include “cutting the volume of oil production and participating in existing organizations of suppliers, and in new organizations, if we can reach such an agreement,” Medvedev said in comments broadcast on state television.

So, the options are: (a) Medvedev was lying, and Russia had no intention of cooperating with OPEC let alone joining it, or (b) Medvedev gave his honest opinion, and was sandbagged by the real powers in Russia.   Regardless of the truth–and neither is especially flattering to Medvedev or the Russian government generally–there is no doubt that OPEC feels betrayed.   Not that I’m crying or anything, mind you.   As I’ve said before, there’s no honor among colluders.

Although some in the Russian government may feel that they’ve played OPEC like a fiddle, the fact of the matter is that Russia is in a world of hurt.   (Again, much company in this department, but Russia’s economic straits are more acute than Europe’s or the US’s.   Far more acute.)   With Urals blend well below $40/bbl again, domestic manufacturing cratering (with the slo-mo devaluation exacerbating the damage), and reserves ebbing, a hard but brittle political system faces an existential challenge.   The risks of a cataclysm increase by the day.   The probability is not yet 1, but it is rising.   And remember that these processes tend to be “jumpy” and exhibit positive feedback–meaning that once the dynamic of protest and repression begins, it often feeds on itself and spins out of control, and does so discontinuously and rapidly.

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  1. Putin is handling the ruble the way he handles every other problem he faces, because he only knows one way to deal with problems: Hide them. Sweep them under the carpet. If possible, kill them and bury them in the desert where nobody will find them.

    This is what Russia has for “leadership.” Neo-soviet behavior can only lead to a neo-Soviet disaster.

    Comment by La Russophobe — December 18, 2008 @ 8:49 pm

  2. This from

    При средней цене на нефть в ближайшие два года на уровне $30 России придётся снова занимать у международных финансовых организаций, прогнозирует Всемирный банк. Еще в 2004-м такая цена позволяла стране строить планы по удвоению ВВП и копить стабфонд. Россия стала слишком много тратить на силовиков и на инвестиционные программы, объясняют аналитики.

    The World Bank estimates that if oil were to drop to $30 a barrel and stay there, then Russia would have no choice but to seek financial help from international organizations. They note that the Russian government is spending at lot more on the siloviki and “investment” programs to not face major difficulties with oil at $30 a barrel. In 2004, the country was actually a lot better off and could build plans whereby the GDP would double and money could be set aside in a stabilization fund when oil was at the same price. Yeltsin, of course, would have dreamed of oil selling at $30 a barrel.


    Comment by Michel — December 19, 2008 @ 11:59 am

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